Analysts Find Value in Long-Discarded Infrastructure Stocks

Most analysts recommend 'pure play' small-cap construction cos with less exposure to BOT assets

Infrastructure stocks, which have been one of the worst hit in the recent market fall, present a good opportunity for long-term investors accumulating them at current levels.
In 2011, many infrastructure stocks declined by 10-23% compared with the 7% fall in the benchmark share index, Sensex. High input cost, rising interest rates, policy delays, low order inflows and slow execution dented these shares over the last few quarters. However,the sector remains one of the key focus areas of Indian policy makers. In the Budget for fiscal year 2011-12, finance minister Pranab Mukherjee allocated over . 2,14,000 crore for the sector, up 23% from a year ago.
"Infra sector stocks have been pricing in the risks, creating more value for longterm investors and some are now going at less than one-time the book value and at single-digit forward PE ratios," said Devendra Neogi, founder and principal partner, Delta Global Partners.
Infrastructure companies saw an average revenue growth of 17% in Oct-Dec FY11, significantly lower than the guidance of 25-35% growth. Profit before tax (PBT) margins, on an average, declined by 140 basis points year on year. Analysts expect interest rates to harden by another 50-100 bps in the next 3-6 months, denting PBT margins further.
For investors in the sector, most analysts have recommended small-cap "pure play" construction companies with limited exposure to build-operate-transfer (BOT) assets. Moderate growth in revenue and order flows could provide significant upside to these companies at current valuations, analysts said. Also, over the last four financial years, smaller construction companies have posted better operating return ratios than their larger peers. "Debt levels for most construction players peaked in December 2010 due to rising working capital requirement and increasing equity contribution towards BOT assets," said Chhavi Agarwal, research analyst, Ambit Capital. Companies with lower debt and higher capital employed turnover will perform better than peers going forward, she said.
Analysts suggest investing in companies with low balance sheet leverage, low equity requirements for embedded assets, and sound business management. One such company is Consolidated Construction Consortium Limited (CCCL). Paltry order inflows, muted revenue growth (9%), working capital induced leverage and faltering PBT margins have led to the company's stock price declining by 41% over the past six months. Despite this, the shares are trading at 55% premium to peers and one reason is the lowest leverage of 0.6x against industry average of 1.3x and less equity requirements for asset developments, analysts said. Others like Sadbhav Engineering, Madhucon Projects, and KNR Constructions are well placed than their mid-sized peers. While Sadbhav and Madhucon are quasi-developers (captive projects feeding most construction business), CCCL and KNR are two of the few construction companies with low or manageable asset ambitions. All theses companies have underperformed the benchmark indices by 10-40% in the past year. According to Agarwal, KNR and CCCL have the lowest debt-equity ratio of 0.2x and 0.6x, respectively, in the industry and this gives both enough headroom to grow without having to raise external equity.

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