• Date 25th July 2017
• CMP: Rs 217
• Mid Cap with Rs 7,600 cr. Mkt Cap
• Industry – Infra/ Roads
• Advice: BUY

Summary

• Overview: IRB Infra is a top 5 roads & highway construction firm. It has a good portfolio of legacy and current projects, including Mumbai-Pune expressway and Ahmedabad – Vadodara highway. The 10 year growth in revenues, EBITDA and profits are 25.1%, 23.8% and 21.2% CAGR resp. With tight internal financial controls, this is a well-run business. They bid for larger BOT road projects and are able to execute successfully and within timelines.
• Why Buy Now: 1) With the IPO of the IRB InvIT, IRB’s debt to equity fell from 3:1 to 1.8:1. The firm will now move to a more profitable period. 2) The sector outlook is good with revival of many stuck road projects, good budget allocations and a fast moving ministry 3) Attractive valuations.
• Key risks are: 1) Political and legal risks of this sector. Criminal investigations pending against the top IRB executives 2) Periodic protests against toll collection on some roads.
• Advice: The valuations are attractive at a P/E ratio of 9.9. IRB is a Medium Risk, High Gain stock. BUY with a 2 year perspective.

Additional Notes

• A report on IRB was published for paying subscribers in Apr 2016.  We revisit the firm as it is once again attractive at these levels.
• SIGN UP for the investment service subscription to gain exclusive access to such high quality investment reports.
• We’ve been tracking this firm for 5 years, see our 2012 report – IRB Infra Developers – A Rising Road Star  

Here is a note on IRB Infrastructure Developers (IRB).

IRB Infrastructure Developers – Description and Profile

• IRB is a Mumbai based road construction firm which does EPC and BOT projects.
• FY17 revenues were Rs 5,846 crores & PAT 715 cr. The Revenues, EBITDA and Profits grew by 25.1%, 23.8% and 21.2% CAGR over 10 years.
• IRB constructs Highways. The revenue segments are EPC (60%) and BOT (40%). It developed India’s first BOT project (Thane Bhiwandi Bypass) and operates Mumbai – Pune expressway. It has one of the largest BOT portfolios as it has constructed 11,828 km. of road so far. It has a 20% share in the golden quadrilateral (highways between 4 metros).
• IRB has 6,000 employees. The order book stands at Rs. 9,959 cr. (FY17).
• IRB operates in 2 models, BOT and EPC. The govt. in FY16 launched the hybrid annuity model, however IRB intends to focus on BOT toll road projects.
• IRB launched India’s first Infrastructure Investment Trust (InvIT) in May 2017 which had an IPO. Through the trust, IRB (Sponsor) is holding 6 operational NHAI toll road assets with 3,645 lane km of highways across 5 states in west and south India. These assets are operational and generate income through inflation-linked tariff hikes. InvIT Investors are expected to be offered returns in the form of dividend, interest and buyback for holding units in the InvIT. The IRB InvIT CMP is Rs 97.5.
• Leadership is V Mhaiskar (CMD), Ajay Deshmukh (CEO), and Anil Yadav (CFO)
• Shareholding pattern % is: Promoters 57.4%, DII 7.4; QFIs 27.9, Individuals 4.4, others 2.9%.

Fig 1 – FY17 Order Book/ Fig 2 – State wise BOT portfolio

Business Model

• In Build, Operate and Transfer (BOT) it constructs a road and then maintains it for a ‘concession’ period (15-30 years) while collecting toll, before handing it back to the govt. BOT projects involve upfront premium payment; revenues start once toll collection starts, and construction is internally funded, so loans have to be tied up (financial closure).
• The Engg., Procurement and Construction (EPC) model involves the construction firm executing the project and collecting payments on achieving milestones of quantity and quality. On completion, the firm hands over the asset and collects all payments.
• However the BOT model which was common earlier has faced high failure rates recently. To revive the road sector, the govt. decided to switch back to the proven EPC model. In Apr 2015, the govt. launched a hybrid annuity model. Under this, the govt. provides 40% of the project cost to the developer to start work while the remaining investment will be made by the developer.

IRB Infrastructure Investment Trust (InvIT) IPO

• SEBI introduced infrastructure investment trust (InvIT) regulations keeping in mind the huge funding needs for infra.  InvIT enables developer-owners of infra assets to monetize their assets by pooling projects into a Trust, having an IPO and attracting better investors.
• InvITs have to distribute 90% of their net cash flows to the unit investors. There is a cap on exposure to under-construction assets for publicly placed InvITs. The sponsor of the InvIT is responsible for setting up the InvIT and appointing the trustee. The sponsor (say IRB) has to hold minimum 15% of the units issued by the InvIT with a lock-in period of 3 years from the date of issuance. The InvIT regulations specify 80% of investments in completed and revenue-generating assets.
• The IPO of IRB InvIT Fund opened on 3^rd May, 2017. IRB InvIT was the first Indian company to list an InvIT. It was subscribed 8.57 times. Institutional investors who participated in the anchor book allocation included foreign investors such as the govt. of Singapore, Schroder Asian Asset Income Fund, Deutsche Global Infra Fund and Jupiter South Asia Investment Co. as well as DIIs such as Birla Sun Life MF, HDFC Standard Life and Birla Sun Life Insurance.
• IRB received Rs. 2,600 cr. for sale of equity in 6 project SVP’s transferred to IRB InvIT fund. The consideration was as follows: 1) Rs. 1,681 cr. upfront 2) Units in IRB InvIT Fund worth 889 cr.
• The funds will be used for new projects and to reduce debt. Post the launch of InvIT, IRB’s net debt to equity fell from 3:1 to 1.8:1. IRB expects a rating upgrade because of the same.
• The following operational project assets were transferred to the InvIT:

Exhibit 3 – Operational projects transferred to IRB InvIT

• InvITs have a minimum investment limit of Rs. 10 lakh per investor. The InvIT generates income on these assets is in the form of toll collection from road assets and interest on cash in the books. The Trust distributes at least 90% of this cash to the unit holders in the form of dividend, which is tax free. The dividend yield was estimated to be close to 12% at the upper price band of IPO (Rs. 102).
• IRB has a 15% stake in IRB InvIT. Future projects by IRB can also be sold to InvIT.

Industry Outlook

• The transport sector constitutes 6% of the country’s GDP. India has an extensive road network of 33.4 lakh kms. which is the 2^nd largest in the world.
• According to the 12^th Five Year Plan, India transports 57% of goods by road, as compared to 22% in China and 37% in USA. Despite the performance of the road transport sector, the sector faces slow technological development, low energy efficiency, pollution and slow movement of freight and passenger traffic. GoI has now launched an initiatives to upgrade & strengthen highways.
• There are 96,261 km of national highways in India, constituting less than 2% of India’s entire road network but carrying approximately 40% of total road traffic.
• The National Highway Authority of India (NHAI) and the Ministry of Road Transport & Highways had sanctioned projects for 3,161 km’s in 2014-15. & 2,337 km’s in 2015-16. A solid 10,098 km’s and 16,031 km’s, respectively, were awarded during FY16 and FY17.
• The list of Peers of IRB is over 50 Listed firms, plus diversified and unlisted firms. Competition includes Reliance Infra, Jaypee Infra, IL&FS Transportation, GMR Infra, Lanco Infra, L&T, IVRCL, Ashoka Buildcon, etc. However in the BOT segment, we believe qualified firms are few.
• Our 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.
• For FY16, an outlay of US$3.8 bn. was provided for the highway sector.

Business Notes, Recent events and Strategies

• Recently after the listing of IRB InvIT, other sector players like GMR, IL&FS Transp. Networks and L&T also plan to set up their InvITs.
• The Q1 FY18 Revenues and PAT were Rs 1870 cr. (up 21% YoY), and 238 cr. (up 31% YoY) resp. The results were good largely on account of execution pickup and InvIT listing.
• D/E Ratio is reduced from 3:1 to approx. 1.8:1; this may lead to a credit rating upgrade. IRB had declared an Interim Dividend of Rs. 2.5/- per share for FY18. The board approved offering of Pathankot – Amritsar project to IRB InvIT Fund.
• IRB and MSMRM were registered under a case for not taking safety measures while carrying out widening work on NH66 in March 2016.
• In Jan 2016 IRB bagged the Rs.10,050 cr. Zojila Pass tunnel road project in J&K, the country’s biggest road project. But in Mar 2016 the project was cancelled, due to some political issues. Now the project has opened for re-bidding. Reliance Infra, Jaypee Infra, IL&FS Trans. and L&T are bidding.
• In Nov 2016, currency notes of 500/- and 1000/- were demonetized and the govt suspended the user fee collection on National Highways from 09^th Nov to 2^nd Dec 2016. NHAI had later said that they would compensate infra companies for the loss of toll collections. IRB received Rs. 30-35 cr. cash compensation in Q3 FY17 itself which was adjusted against payment to NHAI. A similar amount of compensation is expected to be received soon.
• IRB has guided that revenue and EBITDA would be flat for FY18 as 6 operational assets have been transferred to the InvIT, however PAT may go up because of reduction in interest payment on lower debt. IRB has also guided that they have identified 18,000 cr. of projects where they are qualified to bid and they will do so as and when it comes up for bidding.
• They have guided a 6-7% traffic growth in FY18 and a 10% revenue growth in construction order book for FY18. Also a 2-2.5% inflation in ticket prices could be witnessed.
• IRB approved acquisition of 34% stake in its arm Aryan Infrastructure Investments Pvt Ltd (AIIPL) from promoters to make it a wholly-owned subsidiary in Mar 2017.
• About 0.14% of the equity base has been pledged by the Promotor & Promoter Group.

Stock evaluation, Performance and Returns

Fig 4 – Price History / Fig 5 – Quarterly Financials 

 

• The price history in Fig 4 shows that the share price had touched a 1 year high of Rs. 272.
• This was ahead of the launch of the InvIT and the share had a low of Rs. 178 post demonetization. The share price is currently 21.7% below the peak and 19.7% above the low.
• Investors in IRB have got a return of 9.7% CAGR over 5 years and -4.5% CAGR in the last 2 years.
• Revenues, EBITDA and Profits of IRB are up by 25.1%, 23.8% and 21.2% CAGR over 10 yrs., see Fig 5. EBITDA is in 50% range while Profit margins are in 12% range.
• Fig 6 indicates Free Cash Flows for the period FY09-16. The company has not been able to generate free cash flows to equity shareholders given the nature of business. This is a negative. However the cash flow situation should improve as the capital investments get freed under the InvIT ownership.
• Current P/E is 9.9 of TTM earnings, while the Price/ Book is 1.35 times. This is low and attractive.
• Debt equity ratio is 1.8:1 (May 2017) which has reduced drastically after the launch of InvIT.
• Beta of the stock is 2.12 (Reuters) indicating high volatility. Thus any positive or negative news can move the share price sharply in those directions.
• Dividend yield of 1.88% currently is good as compared to its peers.

Fig 6 – Cash Flow / Fig 7 – Booked to Billing ratio

• The Orders Booked to Billing ratio (BTB) for IRB is in Fig 7. Order Booked position at IRB was 9,959 cr. (FY17), and the 1.7 years of Booked to Billings is low. This may improve in the near time. The Zojila tunnel project cancellation severely impacted the ratio. IRB has guided that there are Rs 18,000 cr. of projects where they are qualified to bid and they will do so as and when it comes up for bidding.
• The PE ratio has a historical range of 5-25 over 9 years, and the average is 15 times. It is now at 9.9 (Fig 8) and so IRB appears undervalued. The EPS charts in Fig 9 shows that EPS grew rapidly in 2008-11, then flattened out in the high interest rate / low economic growth situation of 2011-14 and now appears to be recovering on the backdrop of govt. initiatives coupled with favorable macro-economic factors. The recent fall in PE is caused by good growth in EPS and flat market price range.

Fig 8 – Price and PE graph / Fig 9 – Price and EPS graph

 Strengths of IRB

• IRB has a good reputation with high quality BOT assets and financial and execution capabilities.
• The InvIT model is excellent for IRB to monetize its operational BOT assets. With the only successful InvIT in India in place, IRB has been able to reduce debt substantially. BOT assets will also attract right investors who are looking for steady returns over 10-30 years.
• IRB is in a unique position to sharply focus on construction efficiencies. With a sharp reduction in debt and improvement in reserves, IRB is in a position to reduce interest costs compared to earlier and to bid for new BOT projects without funding constraints.
• IRB has a diversified project portfolio and revenue base currently spread over 8 states.
• Current valuations look very attractive for fresh investments.
• The Roads sector is on a big upswing with NHAI and govt. ramping up on an infra push.

Weaknesses and risks with IRB

• Even at 1.8 times, D/E is high for IRB, and the focus needs to be to sell assets to the InvIT.
• In BOT projects, toll revenues depend on toll receipts, which, in turn, depend on toll fees and traffic volumes on the toll roads, and factors which may be outside of IRB’s control, including, fuel prices in India, the frequency of traveller use, the number and affordability of automobiles etc.
• There is a 2009 pending criminal investigation – a case was registered at Lonavala police station against IRB top executives, alleging illegal purchase of govt. land in villages Pimploli & Ozarde, District Pune on the basis of fake and forged documents. Later on 13^th Jan 2010, the related RTI Activist was murdered. In the event that there is any adverse finding in the land acquisition matter or in the murder case, the reputation of the IRB and its business may be adversely affected. However roads is a tough sector, and there will be much litigation as part of the business.
• Political and legal risks are high in this sector.
• There have been periodic protests against toll collection on some roads.
• So far, IRB has only bid for larger and more profitable projects. In future, to keep its growth trajectory in place, it will have to bid aggressively for more projects.
• So far IRB has been strong in West India: Mah., Raj. & Guj. It has to develop a more national profile.

Benchmarking

In a Benchmarking exercise, we have compared IRB to other infra companies, in Exhibit 10.

Exhibit 10 – Benchmarking

• We can see that a few of the companies in the roads sector are in financial distress. We added Adani Ports to bring in the perspective of a well-run Indian infra company.
• IRB stock appears to be on the attractive side in terms of P/E and to a lesser extent P/B.
• It also leads on margins. It has performed average in terms of growth of sales and profits. However this can change with a good business outlook. Dividend yield is good. Asset turnover may improve as more operational BOT projects are handed over to InvIT.

Opinion, Outlook and Recommendation

• There is an urgent need to upgrade Indian infrastructure such as roads and highways. This was reflected in the Feb 2017 Indian budget announcements. We can see that on one side highways have improved a lot in the last decade. At the same time it seems that in a short while after new roads are opened, they seem to be crowded and used to capacity!!
• The sector is seeing clear signs of improvement with the govt. making progress in reviving old stuck projects as well as opening bidding for many new ones.
• IRB has a good reputation in the roads sector, with an excellent portfolio. It bids for larger projects and is able to execute within timelines. It is well managed financially with a fair balance sheet.
• The roads sector recovery has been slow so far with bottlenecks, but we believe that the introduction of the InvIT structure is a game changer.
• IRB is the first to successfully launch InvIT fund. It has been able to bring down the debt which will help in freeing up capital for fresh investments. In the last 3 years, the average earnings growth stands at 16% p.a. Reduced interest cost, traffic volume growth and faster churn of new projects is likely to aid earnings growth.
• The valuations are attractive at a P/E ratio of 9.9.
• IRB is a Medium Risk, High Gain stock. BUY with a 2 year investment horizon.

Disclaimer

This document has been prepared by JainMatrix Investments Bangalore (JM), and is meant for use by the recipient only as information and is not for circulation. This document is not to be reported or copied or made available to others without prior permission of JM. It should not be considered or taken as an offer to sell or a solicitation to buy or sell any security. The information contained in this report has been obtained from sources that are considered to be reliable. However, JM has not independently verified the accuracy or completeness of the same. Punit Jain has been a long term investor in IRB Infra since Feb 2008. Other than this, JM has no known financial interests in IRB Infra or any related group. Neither JM nor any of its affiliates, its directors or its employees accepts any responsibility of whatsoever nature for the information, statements and opinion given, made available or expressed herein or for any omission therein. Recipients of this report should be aware that past performance is not necessarily a guide to future performance and value of investments can go down as well. The suitability or otherwise of any investments will depend upon the recipient’s particular circumstances and, in case of doubt, advice should be sought from an Investment Advisor. Punit Jain is a registered Research Analyst under SEBI (Research Analysts) Regulations, 2014. JM has been publishing equity research reports since Nov 2012. Any questions should be directed to the director of JainMatrix Investments at punit.jain@jainmatrix.com.