Viewers may like to see the May 2012 update of this report at LINK

• Date: March 15, 2012. Price: Rs 199, Mid Cap with a market cap of 6617 crores
• JainMatrix valuation for IRB is 271. It is available at 36% discount.
• Target: 352 by 03/13, and 432 by 03/14. Advice:  Buy now and systematically

IRB Infrastructure is a leading mid-sized roads & highway focused construction firm. It has a very good portfolio of legacy and current projects. Tight internal financial controls and a 5-year CAGR growth in Sales (58%), EBITDA (51%), Net Profit (76%) and EPS (69%) make this an attractive business to buy into. Poor market sentiment in 2011 drove the price down. The recovery has begun, but IRB is still available at attractive valuations. 

Subscribers exclusively received this report around 15 Mar ’12. 

IRB Infrastructure Developers – Description and Profile

• IRB is focused on the fast growing Indian road and highways sector. The revenues for FY11 were 2,502 crores, with PAT at 464 crores.
• Road projects by IRB involve first the Construction of Highways; then Operation and Maintenance (BOT) of this for a ‘concession’ period (of 15-30 years) while collecting toll, before handing it back to the government.
• The key business & income segments are Construction (69%)and BOT (31%). IRB has one of the largest BOT portfolios in the country, a total length of around 6,446 Lane-kms, with a market share of 11.1% on the Golden Quadrilateral. This portfolio includes remunerative projects like the Mumbai-Pune expressway, Surat-Dahisar, etc. As a result, IRB earns a high daily gross toll collection today, which is expected to double in 3 years.

• The Shareholding pattern depicted in Fig 1 shows Promoters hold a significant stake – a good sign
• In addition to Toll, the Construction part of the business may be paid in terms of milestones achieved in the project execution, so revenues tend to be lumpy. In fact newer projects involve upfront payment of premium to government, so revenues may start only once Toll collection starts, while all construction work may have to be internally funded.
• IRB has strong in-house integrated execution capabilities, which give it a better control on execution and project costs . Experienced personnel, expertise and high end equipment are the main resources of this firm.
• The force behind IRB is the CMD, Virendra Mhaiskar, an experienced construction engineer.

Strategies executed by IRB

• Competition is intense. To counter this, IRB is now bidding for larger ticket projects. With its excellent portfolio of BOT projects, this is a good strategy.
• A recent achievement was the Feb’12 financial closure of the 4,880 crore Ahmedabad-Vadodara road project. It is the first ever Ultra Mega project of NHAI on BOT basis & DBFOT pattern. The project involves 6-laning of a 2-lane highway, road length 196 km & construction cost of ~3,600 crores, with concession period of 25 years. IRB mobilized debt of Rs 3,300 crore, incl. Rs 1,100 crore of foreign currency borrowings, at a cost of 10.5%.
• Strong financial record and relationship with leading financial institutions – helps it get loans on tap. Also the firm is careful about the profitability/ IRR of projects it bids for. In 2010, it slowed down on bidding for new projects due to a higher interest rates in the economy.
• Structurally, IRB is a holding company, and each new project is floated as a separate company. There are about 20 subsidiaries. This structure gives IRB flexibility in financing and executing projects.
• IRB has diversified into related areas – Airport and Realty.
  • The Realty project is Real estate development alongside the Mumbai – Pune Expressway. Land acquisition of approximately 1200 acres has been completed for township development.
  • It will develop a Greenfield Airport in Sindhudurg District, Maharashtra, adjacent to Goa
• IRB prefers to own the road construction machinery and plants/ units required on projects.
• From a dominant Maharashtra operation, it has consciously gained a pan-India presence with recent wins in Karnataka, Gujarat and North India.

Industry Note:

• Out of the recently identified critical Infrastructure sectors of Power, Airport, Roads, Oil, Ports and Rail, the Roads sector has done the best in growth, new projects bid out and performance. Unlike in Telecom, Ports or Power, Governance scores high in Roads & Highways. Bidding out has happened in a transparent manner. Outperformance in project delivery is rewarded with better returns.
• Competitors of IRB include over 50 Listed firms. Plus there are diversifieds and unlisted firms. These includes Reliance Infra, Jaypee Infra, IL&FS Transp., GMR Infra, Lanco Infra, L&T, IVRCL, Ashoka Buildcon, etc. About 90 companies are pre-qualified for National Highways Authority of India projects.
• My quick estimate is that IRB has about 4-6% market share, by revenues. In terms of quality of projects and proven expertise, IRB definitely falls in the top 5.
• Earlier the Highway projects were awarded to the lowest bidder, and the Govt. would then pay the developers to make the projects viable. Today the new economics are that projects are awarded to the bidder that pays the highest premium. This is a result of high competition for bids and higher traffic volume projections on Highways. Govt. also is able to bid out more projects and earn revenues :-)
• There is a huge demand for Road construction. For Road projects built under National Highways Development Project (NHDP), the flagship road-building program of the Transport Ministry, the plan is for upgradation of about 50,000 km of roads, at a rate of 7,300 km of roads every year. Also the budget shortfalls in the government will not restrict this work, as bids are now generating a Premium for the government.

Stock valuation, performance and returns

• IRB had its IPO in early Jan 2008. The subscription was fair at 4.3 times. Pricing was at 185, the lower end of the range. Luckily the IPO was before Reliance Power, and listing was before the crash of ‘08.
• From its IPO price of 185, it fell in the 2008 crash to 65, later peaked in Aug 2010 at 312, and is now in the 190 range. See Fig 2. Thus IPO investors have seen barely 3-4% gains in 3 years.
• Dividend is 15%, gives a yield of only 0.76%, but a steady increase indicates good financial health.

Fig2 – IRB – Investment and Returns, , click on image to expand

• As compared to share price, Income, EBITDA and Net Profit show a wonderful growth path in Fig 3. Note that Q1 & Q4 of every year have higher numbers due to end of year and seasonal factors.
• For a 5-year period the growth figures are Sales (58%), EBITDA (51%), Net Profit (76%) CAGR. These are astonishing numbers, and we are seeing the rapid rise of a very competent Roads Mid Cap stock.

Fig3 – IRB – Quarterly Sales and Profits, , click on image to expand

• We can see from the Consolidated EPS and Cash Flow – Fig 4, there has been a rapid growth in Cash from Operating activities. Steady Cash flow is coming from several BOT stage projects.
• Consolidated EPS has risen by a super 69% CAGR through this period, though this is from a low base.

Fig 4 – IRB – EPS and Cash Flow, click on image to expand

• While the Cash Flow is good, in fact IRB is in a very cash intensive business. Net Debt has been rising at 33% CAGR since FY08 (Fig 5). Seen along with other business data presented above, this is safe and sustainable.
• Debt-Equity is 1.67, below the infra firm warning level of 2.0. Fall in DE in Mar08 was due to IPO funds usage.

Fig5 – IRB – Debt and DE ratios, click on image to expand

• Current Order Booked position at IRB is 9258 crores, which is about 3 years of business, at current runrates.
• An important ratio for IRB is the Orders Booked to Billings ratio (BTB). This has shown a falling trend, but even so is quite comfortable, see Fig 6. This trend is due to IRB strategy to look for profitable and stable new business from larger and more prestigious projects.
• Thus we can see that IRB has enjoyed good growth patterns, while at the same time has managed its finances well, particularly debt, so far.

Fig 6 – IRB – Booked to Billings Ratios, click on image to expand

• The Price and PE Chart of IRB, Fig 7, indicates that IPO of IRB in 2008 happened at aggressive valuations. However IRB has justified this over the last 5 years with excellent business performance.
• Today the PE of IRB is 13 times, below the industry average of 15.6. In fig 7 we can see that the average PE in the last 3 years has been 25. CMP is now at the lower end of the valuation range.

Fig 7 – IRB – Price and PE trend, click on image to expand

• The view of the EPS charts in Fig 8 shows that EPS grew very rapidly in 08-11 periods, then flattened in the high interest rate situation of 2011. The expectation is that the interest rate cycle has peaked today, and with fall in interest rates, the EPS will resume the upward march.
• The EPS of IRB is expected to stay in the Trend line range as per Fig 8.
• ROCE is 13.3% and RONW is 18.6%, these are good ratios.
• PEG is at 0.188 – indicates undervalued status

Fig 8 – IRB – Price and EPS trend

Peer benchmarking and Financial Estimates till FY14

In a Benchmarking exercise, find a comparison of infra firms is in Exhibit 9

The conclusion we come to is that on a combination of high growth, low valuations and good financial controls, IRB is a better all round player.

The financials and PE of IRB have been projected for the next 3 years. See Exhibit 10

Risks:

• Industry: Roads sector has done well and a lot of new entrants have driven up competition in the sector.
  • However, high competition has driven infra firms to bid aggressively. Many firms in this sector may have overstretched their balance sheets and may even default on payments/ need restructure debt.
  • This sector is dependant on the government for a lot of key inputs. Risks here include environmental clearance, handover of land by government for Road construction as well as roadside land for development (wherever applicable), procurement of land by government and political / R&R issues.
  • There may be resistance from Road users/ consumers to Toll charges.
•  Interest rates increases in the Indian economy are certainly impacting the balance Sheet of IRB
• IRB: The focus in IRB has shifted to execution quality. The firm needs to maintain its standards and quality of construction even with a 50% growth in project volumes. This requires astute project management, scaling up of operations and hiring and development of talent within the organization.
• IRB needs to develop a second rung of management and leadership to take it to the next level of growth. It seems now to be a one-man show of current CMD.
• One way for IRB to deal with the high debt situation is to monetize its toll road assets by a securitization process. I am not sure if this is permitted for a non-NBFC. However if permitted, the low risk future revenues of the Toll roads can be encashed today, which can reduce debts and improve finances.

Opinion, Outlook and Recommendation

• IRB has a great portfolio of Road projects. Its strategy of bidding for larger and more prestigious projects will succeed and sustain its leadership profile. The 3-year review of financials shows that the company is in good shape.
• In 2012, the sentiment has improved in the markets. IRB price too has gained, from a low of 121 on 3rd Jan’12 to current 199 levels (a 64% gain in 2 months). Past peak is 312 around Aug ’10.
• It is the nature of markets that sentiment makes share prices fall far below or appreciate far above the fundamental value. IRB is underpriced at these levels. In a falling interest rate scenario, IRB will continue to outperform as it lowers its cost of debt and delivers on projects.
• IRB is a Medium Risk, High Gain stock. At these levels and in this trajectory, it is a BUY.
  • Our valuation prices the share at 271. Thus today it is available at a 36% discount.
  • By Mar ’13, our projected price is 352, a 77% appreciation from CMP
  • By Mar ’14, the price projected is 432, a 117% appreciation from CMP

Disclosure: It is safe to assume that if the JainMatrix website recommends a stock, the researcher has already invested in it.

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