Indian Roads Sector – A Delightful Drive Ahead?

  • Date 26th April  
  • Industry – Roads Construction 

Summary

Here is a snapshot of the interesting Roads Sector. We sense a revival, and a number of players are active here.

Additional Roads Sector Reports from JainMatrix Investments

  • Please read our Feb 2018 report on HG Infra IPO by clicking on LINK.
  • And our July 2017 report – IRB Infra Developers – In Invit We Trust – LINK
  • Additionally do read our Aug 2016 report on Dilip Buildcon IPO by clicking on LINK.
  • We share a Nov 2015 Roads sector report – LINK

Introduction

  • The development of any nation depends on transportation networks, and this is applicable to India with its varied terrain ranging from mountains to plains to coast. Transportation includes Roads, Railways, Airlines and Shipping, however in this note we will focus on Roads.
  • India has the 2nd largest road network in the world, aggregating to 61 lakh kms. Roads are the most common mode of transportation and account for 86% of passenger traffic and 65% of freight traffic. In India, NHs with length of 1.04 lakh km are just 1.7% of the road network, but carry about 40% of the total road traffic. On the other hand, state roads and major district roads at the next level carry another 60% of traffic and account for 98% of road length.
  • There are 2 Govt. bodies which award road projects at the central level, NHAI which is in charge of the National Highway Development Programme (NHDP) and the Ministry of Road Transport and Highways (MoRTH), which covers those highways not under NHDP. In addition, it also awards projects under Govt. schemes like Left Wing Extremism (LWE) scheme (road development in Naxalite areas), Special Accelerated Road Dev. Programme for North-East Region (SARDP-NE), NH Interconnectivity Improvement Project (NHIIP), etc.

jainmatrix investments

Road Projects Progress

  • From Fig 1 and 2, we can see that road projects awarded and completed flattened out during FY12-FY14. Delays in land acquisition & receipt of environment/forest clearances, economic slowdown and cash flow issues faced by developers had adversely impacted the sector. From the Fig 3 below we can see the transition of project awarding to new modes over the last few years.

jainmatrix investmentsFig 1 – MoRTH projects Awarded / Fig 2 – NHAI projects / Source: MoRTH / NHAI ARs 

  • In FY16, the NHAI introduced the Hybrid Annuity model (HAM) as the earlier BOT-Toll based awarding caused financial distress to the developers and the EPC model involved high upfront investment of funds. In HAM, 40% the Project Cost is to be provided by the Govt. as ‘Construction Support’ to the developer during the construction period and the balance 60% as annuity payments over the operations period along with interest on outstanding amount. This model has received good response from industry and investors.

jainmatrix investmentsFig 3 – NHAI project awarded

  • CRISIL Research expects investment in road projects to double to Rs. 10,70,000 cr. over 5 years.
  • Investment in state roads are expected to grow steadily, and rise at a faster pace in case of rural roads, on account of higher budgets for Pradhan Mantri Gram Sadak Yojana (PMGSY) since FY16.
  • The GoI approved the Bharatmala program under which 53,000 kms of national highways have been identified to bridge critical infra gaps. It will give the country 50 national corridors as opposed to 6 at present. Phase I will be implemented from FY18-22 with 24,800 kms of construction expected.

Key Players

  • In Q4 FY18, the MoRTH had aggressively awarded projects to further accelerate the pace of road infra development. See the order book position of a few listed road developers, Fig 4 and Fig 5.

jainmatrix investmentsFig 4 – Order Books of Roads players / Fig 5 – Order Book FY18 / Fig 6 – Benchmarking 

  • Note: FY18# is the order book basis 9M FY18 data and documents available on the exchange.
  • In Fig 6, we have done a benchmarking exercise to compare a few sector players.

Conclusion

  • The development of road infra in India is witnessing great momentum. Robust demand, higher investments, favourable policies and government’s willingness has changed the face of the road sector in the country. The construction of roads per day hit a new high of 27 kms/day for FY18, which is much higher than what was achieved earlier.
  • The momentum of building a stronger road network in India is likely to improve as it generates mass employment and leads to significant growth in contribution to the GDP. Given the current roads sector scenario, investors should definitely not miss this exciting opportunity.

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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 positions in IRB Infra since Feb 2008 and H G Infra post listing. Other than this, JM has no known financial interests in IRB Infra or any other firm mentioned in the article. 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 JM at punit.jain@jainmatrix.com.

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H.G. Infra IPO – An Exciting Road Ahead

  • Date 23rd Feb 
  • IPO Opens 26-28th Feb with price range Rs. 263-270
  • Small Cap: Rs. 1,760 cr. Mkt cap
  • Industry – Roads Construction
  • Valuations: P/E 32.9 times TTM, P/B 3.7 times (Post IPO)
  • Advice: SUBSCRIBE 

Summary

  • Overview: HGI is a Jaipur based infrastructure construction, development and management firm with a focus on road projects, including highways, bridges and flyovers.
  • Revenues and profit for FY17 were Rs. 1,059 cr. and Rs. 53 cr. HGI’s revenues, EBITDA and PAT grew at 34.3%, 27.5% and 37.0% CAGR in 5 years.
  • HGI has a good 5 years performance where it has emerged as a rising star. The healthy order book, roster of completed roads projects and fair financial controls are impressive.
  • At a P/E of 32.9 times (adjusted post IPO), the valuations of the IPO appear to be high. However earnings growth is likely to be at a faster pace due to reduced interest costs, better efficiencies and sectoral traction. Good track record, robust financial performance, sectoral tailwinds and an experienced management team makes this IPO attractive.
  • Key Risks: 1) Project execution delays 2) Labor unavailability 3) Intense competition.
  • Opinion: Investors can SUBSCRIBE to this IPO with a 3 year perspective.

Here is a 5 minute video on HG. Infra Engineering IPO.

Here is a note on H.G. Infra Engineering (HGI) IPO.

IPO highlights

  • The IPO opens: 26-28th Feb 2018 with the Price band: Rs. 263-270 per share.
  • Shares offered to public number 1.71 cr. The FV of each is Rs. 10 and market lot is 55.
  • The IPO will raise Rs. 462 cr. by selling 26.26% of post IPO equity. The offer will be completed via an Offer for Sale (OFS) of Rs. 162 cr. and also by issuing fresh shares of Rs. 300 cr.
  • The promoter group owns 100% (no private equity ownership) which will fall to 73.7% post-IPO.
  • The selling shareholders are Hodal Singh, Harendra Singh, Vijendra Singh and Girish Singh of the Promoter family. They are selling 8.85% of their pre-IPO stake in HGI and are only part exiting.
  • The net proceeds from fresh issue of shares will be utilized as follows:

Exhibit 1 – IPO proceeds

  • The IPO share quotas for QIB, Non Institutional Buyer (NIB) and Retail are in ratio of 50:15:35.
  • The unofficial/ grey market premium for this IPO is Rs. 20-25/share. This is a positive.

Introduction

  • HGI is a Jaipur based infrastructure construction and development firm with a focus on road projects like highways, bridges and flyovers. Their main segments are (i) providing engineering, procurement and construction (EPC) services on a fixed-sum turnkey basis and (ii) EPC work for components of projects, primarily in the roads and highway sector.
  • HGI’s FY17 revenue, EBITDA and PAT were Rs. 1,059 cr., Rs. 124 cr. and Rs. 53 cr. resp.
  • HGI has also currently undertaking 2 water supply projects in Rajasthan on turnkey basis which includes the designing, construction, operation and maintenance of the project.
  • HGI is active across various states like Rajasthan, UP, Haryana, Uttarakhand, Maharashtra and AP. During the last 5 years, HGI has completed 13 projects above the contract value of Rs. 40 cr. in the roads and highways sector aggregating to a total contract value of Rs. 1,675 cr., which included construction, improving, widening, strengthening of 2 and 4 lane highways, construction of high level bridge and of earthen embankment, culverts and cart track underpasses.
  • As on Nov 30, 2017, HGI had 21 ongoing projects in roads & highways which includes construction, improving, widening, strengthening, upgradation and rehabilitation of 2, 4 and 6 lane highways, construction of high level bridge and construction of road network. This order book was Rs. 3,585 cr.
  • HGI is pre-qualified to bid independently on an annual basis for bids by NHAI (National Highways Authority of India) and MoRTH (Ministry of Road Transport and Highways) for contract values of up to Rs. 806 cr. based on HGI’s technical and financial capacity as on FY17.
  • HGI’s public sector clients include NHAI, PWD, MES and Jaipur Development Authority. They have also executed road construction contracts as a sub-contractor for private sector clients such as Tata Projects and IRB-Modern Road Makers.
  • HGI’s equipment base comprised of 1,064 construction equipment. Also HGI has employed 2,447 employees which includes 2,130 skilled workers like engineers and managers.
  • As of Nov 30, 2017, HGI had a total order book of Rs. 3,709 cr., consisting of 21 projects in the roads and highways sector, 4 civil construction projects and 2 water supply projects. See Fig 2.

jainmatrix investments, HG Infra IPO

Fig 2 – HGI’s order book by state and client type

  • Leadership is Harendra Singh (CMD), Vijendra Singh (Whole Time Director) and Rajeev Mishra (CFO).

News, Business Model and Strategies of HGI

  • Some impressive completed projects are 1) Yamuna Expressway in Noida, UP, 2) 4 laning of Jaipur-Tonk-Deoli project (Raj.) 3) Construction of Kuberpur to Fatehabad Road, Agra-Inner Ring Road (Phase-I) Agra, UP and ongoing 4) Rehabilitation and Up-gradation of Amravati-Nandgaon-Morshi-Warud-Pandhurna NH-53 (Mah.)
  • HGI’s business strategies are:
    • To focus on the EPC business in roads & highways sector and enhance execution efficiency.
    • Selectively expanding its geographical footprint in states such as Gujarat, Punjab and MP, which have favorable geographic and climatic conditions, other than Rajasthan and Mah.
    • Selectively explore hybrid annuity model (HAM) to grow its project portfolio.
  • Business Model: HGI follows a evaluation process during pre-bidding stage, which involves technical surveys, feasibility studies and analysing the technical and design parameters and the cost involved in undertaking the project. This approach enables them to bid at competitive prices and successfully win projects. Once they win a bid, their focus is to ensure high quality of construction during execution, as a result of which, they are able reduce maintenance and repair costs and realize higher margins during the operation & maintenance stage.

Roads Infrastructure Industry Outlook in India

  • India has the 2nd largest road network in the world, aggregating to 61 lakh kms. Roads are the most common mode of transportation and account for 86% of passenger traffic and 65% of freight traffic. In India, national highways with length of 1.04 lakh kms constitute a mere 1.7% of the road network, but carry about 40% of the total road traffic. On the other hand, state roads and major district roads at the next level carry another 60% of traffic and account for 98% of road length.
  • In FY16, the road transport sector contributed 3.2% to the Indian GDP.
  • Road transport is the most widely used mode of transport for freight and passengers. In Fiscal 2017, 64.5% of freight was carried by roads as compared to railways, from 56% in FY2010.

Key growth drivers for road sector are as follows:

  • Rise in GoI investments, reforms and higher budgetary support. CRISIL Research expects investment in road projects to double to Rs. 10.7 tn. over the next 5 years. Investment in state roads is expected to grow steadily, and rise at a faster pace in case of rural roads, on account of higher budgetary allocation to Pradhan Mantri Gram Sadak Yojana (PMGSY) since FY16. The GoI has approved the Bharatmala programme under which 53,000 kms of national highways have been identified to bridge critical infrastructure gaps. Bharatmala will give the country 50 national corridors as opposed to 6 at present and Phase I will be implemented from 2017-18 to 2021-22.
  • Policy changes to drive execution of national highway projects. Execution of national highway projects declined in the past two years on account of the private developers’ weak financials and unwillingness of lenders to provide further credit to infra companies. To clear this backlog, NHAI terminated projects and accordingly, work on 5,500 kilometers of length was stalled. To put execution back on track, the NHAI re-awarded almost 1,000 kilometers of the terminated projects.
  • New region-specific initiatives to drive growth in road network. The GoI has taken new initiatives to build state roads. MoRTH has set up the National Highways and Infra Development Corp which will award national highway projects in border areas and in the north-east states. Apart from these projects, the Bharat Mala programme has also been proposed to build new roads along the border.
  • Between FY18 and FY22, it is expected that an investment of Rs. 4.30 tn. would be made in the next 5 years for national highways, up 2.9 times compared with the past 5 years. Notably, the government will account for more than half of the investment.

Financials of HGI

  • HGI’s revenues, EBITDA and PAT grew at 34.3%, 27.5% and 37% CAGR in 5 years, see Fig 3.
  • The margins fell significantly in FY14-15 impacting profitability, because of rising commodity prices (for fixed-price contracts) and idling of capacities as execution could not begin on many new projects. The slowdown was common across the industry.

jainmatrix investments, HG Infra IPO

  • Fig 3 – Financials
  • HGI had a RoE of 30.3% in FY17 while the 3 year average RoE stood at 25.7% (FY15-17). The RoCE stands at 36.4%. These return ratios are high.
  • HGI has been Operational Cash flow positive in all the last 5 financial years from FY13-FY17. This is a positive. Over FY13-15, HGI repaid its borrowings and funded CAPEX from internal accruals. However since FY16, CAPEX rose sharply and were funded by borrowings. See Fig 4.
  • The current D/E ratio is 1.72:1 which is high which will fall to 0.70 post IPO.

jainmatrix investments, HG infra

  • Fig 4 – HGI Cash Flow  
  • Because of high Capex, HGI has not declared any dividends in the last 5 years.
  • Remuneration paid to the Key Management Personnel (KMP) +1 was Rs. 6.27 cr. for FY17, and 11.75% of PAT. Another Rs. 1.54 cr. was spent on insurance premiums for KMP. See Exhibit 5.

jainmatrix investments, HG infra

  • Exhibit 5 – Renumeration
  • HGI had an equity base of 5.4 cr. shares pre-IPO. Post the issue of fresh shares, the equity base will stand at 6.51 cr. (assuming fresh shares are issued at UMP of Rs. 270/share). This means the asking FY17 P/E is 27.4 (pre-IPO) and 32.9 (diluted post-IPO).

Benchmarking

We benchmark HGI against other listed infrastructure construction companies. See Exhibit 6.

jainmatrix investments, HG Infra IPO

  • Exhibit 6 – Benchmarking
  • The PE post IPO is high, so pricing appears aggressive, as seen with IPOs, a negative.
  • The sales growth is excellent, comparable to sector leader, Dilip Buildcon. Profit growth is good also, partly due to a recovery from a slowdown in 2014.
  • The post IPO D/E looks reasonable and is much better than a few of its other peer members. The IPO being partly fresh issue will help to reduce debt burden.
  • The RoE at 30.3% and RoCE at 36.4% is excellent, high in the industry. This is a positive.
  • HGI had the lowest EBITDA margin in the industry. However in H1 FY18, EBITDA margin is improving, due to better scale and efficiency in operations.
  • PAT margins may improve due to lower interest costs going forward.
  • Orders booked to Billings looks healthy and indicates over 3 years of revenue visibility.
  • Putting it together HGI looks like a firm at the start of a high growth phase that can be accelerated by this IPO.
  • Dilip Buildcon has done very well in last 2 years since IPO, and so is the sector leader. IRB looks undervalued and profitable. See our recent IRB report – In INVIT We Trust 
  • Also see our Roads Sector Note – THE ROADS SECTOR – IS IT A REVIVAL?

Positives for HGI and the IPO

  • HGI has strong project management and execution capabilities. It also owns its construction equipment needed for ongoing projects. This helps control costs, and improves reliability.
  • We can see a healthy order book; also HGI is pre-qualified to bid independently for project tenders by NHAI and MoRTH. This provides enough head room for faster growth.
  • HGI’s management team is qualified and experienced in the construction industry. The Promoters Girish Pal Singh, Vijendra Singh and Harendra Singh have 20 years of infra sector experience.
  • HGI has evolved from a sub-contractor to independent EPC firm, and subcontracting work has reduced to about 30% of revenues. Thus HGI is successfully moving up the value chain.

Risks and Negatives for HGI and the IPO

  • The valuations appear on the higher side among peers as P/E is 32.9 times (adjusted post IPO).
  • As HGI takes up projects on HAM in future compared to EPC, its working capital may increase.
  • With no private equity ownership, HGI will transition from a family owned firm suddenly to a public listed firm. This change will have to be handled carefully, including disclosures.
  • All firms in the sector face business risks like high working capital requirement, long project gestation periods, govt. clearances, local public opposition and PIL/ litigation issues.
  • Delays in the completion of construction of current and future projects is a risk. A significant part of business is with GoI and any change in govt. policies or delays in payment are a risk.
  • The firm has a business concentration in Raj. and Mah. with 96% of orders from there. But HGI is quite capable of growing a pan India footprint given good opportunities and projects.
  • Competition is intense in road projects, particularly in EPC projects rather than BOT.
  • HGI’s business is manpower intensive and any nonavailability of employees or labor issues can have an adverse impact on operations.

Overall Opinion and Recommendation

  • The GoI has over the last few years and in Budget 2018 emphasized the roads and infra push in terms of budgets and ministry focus. This long suffering Roads sector has seen a revival in last 2-3 years is now expected to be a significant beneficiary of govt. spending.
  • HGI has a good 5 years performance where it has emerged as a rising star. The healthy order book, roster of completed roads projects and fair financial controls are impressive.
  • At a P/E of 32.9 times (adjusted post IPO), the valuations of the IPO appear to be high. However earnings growth is likely to be at a faster pace due to reduced interest costs, better efficiencies and sectoral traction. Good track record, robust financial performance, sectoral tailwinds and an experienced management team makes this IPO attractive.
  • Key risks are 1) Project execution delays 2) Labor challenges 3) Intense competition.
  • Opinion: Investors can SUBSCRIBE to this IPO with a 3 year perspective.

JainMatrix Knowledge Base:

See other useful reports on the right side panel and See Reports sections of the Menu.

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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. JM has no stake, ownership or known financial interests in HGI or any group company. 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.

Dilip Buildcon IPO – This is a Rough Road

  • Date: 1st Aug 2016 
  • IPO Period: 1st – 3rd Aug, IPO Price range: Rs. 214-219 
  • Mid Cap: Rs 2,995 crore Mkt cap 
  • Industry – Roads Construction EPC 
  • Advice: The DBL IPO is an AVOID

Summary

  • Overview: DBL is a construction firm undertaking projects in the roads and irrigation sectors like national and state highways, city roads, culverts and bridges.
  • DBL had revenues and profits of Rs 4,315 crores and Rs 197 cr. resp. in FY16. Its revenue, EBITDA and PAT have grown 58.1%, 61.0% and 38.1% CAGR over 6 years.
  • DBL has a policy of no subcontracting and no equipment on rental. It owns the equipment fleet of 7,345 vehicles and is a large employer with 19,746 employees. In this sector Dilip Buildcon has built a good momentum of business, and is growing from an MP centric firm to an all India operating entity. It has good policies and business model. It has a 3.9% market share in its industry.
  • Valuations, with a PE of 15.2 times, look expensive compared to quality peers such as IRB.
  • Sector specific challenges like cash flows, debt, litigation and regulatory issues worry us. The roads construction sector by its very nature currently offers very few attractive opportunities. Investors need to look at profitable / high certainty sectors other than real estate.
  • Outlook: As an investment, we recommend an AVOID on DBL IPO.

Here is a note on Dilip Buildcon Ltd (DBL).

IPO highlights

  • IPO opens: Monday 1-3rd August 2016 with Issue Price band: Rs. 214-219 per share.
  • Shares offered to public: 2.99 crores of Face Value: Rs. 10 / share, Market Lot is multiples of 65.
  • Shares offered are 21.8% of post IPO equity. The offer is of Rs 654 cr. (upper band) which is a sale by current shareholders (Rs 224 cr.) and fresh issue of shares (Rs 430 cr.)
  • The promoters of DBL are Dilip & Seema Suryavanshi and Devendra Jain who holds 90.25% stake, (post IPO 75.6%). PE fund Banyan Tree Growth Capital holds 9.75% (post IPO 2.53%).
  • The shares quotas to QIB, NIB and retail are of 50:15:35. Objects of the issue – repayment of term loans (Rs 202 cr.); working cap. funds (Rs 200 cr.) and general corp. purposes (Rs 252 cr.)
  • Post IPO holding % are Promoter 75.6, Banyan Tree GC 2.5, IPO -QIB 10.9, NIB 3.4, retail 7.6%
  • The IPO grey market premium on DBL is Rs 17-19, a positive indication (on 29th July).

Introduction

  • DBL is an EPC firm into construction projects for roads, irrigation and commercial buildings.
  • DBL had revenues and profits of Rs 4,315 crores and Rs 197 cr. resp. in FY16. Its revenue, EBITDA and PAT have grown 58.1%, 61.0% and 38.1% CAGR over 6 years.
  • DBL owns a fleet of 7,345 vehicles and other construction equipment. DBL is one of the largest employers in construction in India with 19,746 employees in FY16.
  • DBL’s business comprises of: (i) construction business, where they undertake roads, irrigation and urban development projects on an EPC basis; and (ii) infrastructure business, under which they undertake road projects on a BOT basis with a focus on annuity projects. See Fig 1.
  • For FY16 govt. contracts accounted for 76.3% and private contracts 23.7% of the order book.
Dilip Buildcon, Revenues and Order book, JainMatrix Investments

Fig 1 – Revenues by Vertical/Fig 2 – State wise order book for FY16 (click to enlarge images)

  • Mr. Dilip Suryavanshi is the CMD. He has 32 years’ experience in construction, and is President of the MP Builders Association. Devendra Jain is the CEO & ED of DBL has 17 years’ experience in construction. Prior to joining DBL, he was an assistant professor.
  • The DBL Directors pay is detailed in Exhibit 3.
Remuneration, JainMatrix Investments

Exhibit 3 – Director Remuneration in FY16

  • DBL’s marketing and business development for construction are carried out centrally in Bhopal, MP. DBL is currently pre-qualified to bid for BOT projects with a contract price up to Rs 2,140 cr. and EPC projects with a contract price up to Rs 1,253 cr. The pre-qualification has helped increase their target market size and maintain the order book growth.
  • As of FY16 end, DBL had an order book of Rs 10,778 cr., consisting of 50 third party road EPC projects – 6 own road BOT, 3 irrigation, 1 mining, 1 cable-stayed bridge and 3 urban development. The construction order book was 84.6% of total in FY16. Also see state wise break-up in Fig 2.
  • In the last 5 years, DBL has completed 47 road projects in MP, Gujarat, HP, Rajasthan and Maharashtra, with an aggregate length of 5,612 lane km.

Business Model, News and Updates for DBL

  • DBL has a policy of no subcontracting and no equipment on rental. This has helped it build in house human resource capabilities as well as own and maintain capital equipment.
  • DBL carefully selects projects and strives for geographical clustering of these outside MP. This helps in utilization of construction assets and reduce environmental and forest clearance risks. It also paves the way for regional strengths. DBL leverages its manpower, equipment and materials and saves transportation costs, thus achieving economies of scale.
  • DBL has a good record for projects completed on time. DBL received early completion bonuses of Rs 192 cr. for 11 of its BOT projects and Rs 28.6 cr. for 10 govt. EPC projects over the last 5 years.
  • DBL won a contract to build India’s second largest cable bridge on Zuari river in Goa.
  • DBL is targeting to realize around Rs 11,000 cr. revenue by FY18.
  • In June 2012 Income Tax dept. conducted raids on promoter Dilip Suryavanshi, teacher-turned local business tycoon Sudhir Sharma and associates at 10 locations, including Indore and Bhopal in MP. The IT officers found incriminating documents related to tax evasion that were seized. The ED later sought details from the IT dept. regarding an alleged Rs 140 cr. FEMA violation from South Africa. (TOI news).
  • DBL on 29th July raised ₹196 crore from anchor investors ahead of the IPO. It allotted 89.6 lakh shares at ₹219 apiece to 10 anchor investors. They include SmallCap World Fund, American Funds Insurance Series, Abu Dhabi Investment Authority, Nomura Singapore, Grandeur Peak Emerging Markets, DB International (Asia), HDFC Trustees Company and IDFC Infrastructure Fund.

Roads Industry Outlook

  • We are skeptical of the sector as it faces risks like high working capital, long project gestation, poor and expensive funding options, land acquisition issues, PIL & litigation pressures and many govt. clearances.
  • The transport sector constitutes 6% of the country’s GDP and 70% of this is from roads. India has an extensive road network of 52.3 lakh km which is the 2nd largest in the world.
  • Roads form the most common mode of transportation and are the main arteries for travelling across India. It is estimated that 60% of the freight and 85% of the passenger traffic is carried by roads.
  • National highways (NH) which account for 2% of the total road network length in India, carry 40% of the road traffic volume. Additionally, state and major district roads carry another 40% of traffic volume and account for 20% of road length (adding up, the 80-20 rule applies).
  • Under NDA rule, GoI has launched initiatives to upgrade and strengthen highways and expressways. The NHAI and the Ministry of Road Transport & Highways sanctioned projects for 2,337 km in FY16. An outlay of Rs 26,600 cr. was provided, and 6,300 km of NHs & 8 bypasses were to be completed.
  • GoI aims to develop 57,653 km of National Highways under programs like NH Dev. Project (NHDP), Special Accelerated Road Dev. Program for NE (SARDP-NE) and NH Interconnect Improvement Project (NHIIP).
  • In the BOT model private developers invest funds for constructing roads, and recover this through toll collection. However the BOT model has in 2010-15 faced high failure rates. To revive the sector, the new govt. reverted to the EPC model, where the road construction is funded by the govt. In Apr 2015 the govt. launched a hybrid annuity model where project costs are shared with developer in a 40:60 ratio. So govt. provides 40% of the project cost to start work while the rest of investment is from developer.
  • IRB Infra Ltd and Sterlite Power Grid are preparing to list their Infra Investment Trusts (InvITs). These Trusts hold income-generating infra assets, and offer regular yields and liquidity to developers. They may attract longer duration funds, allowing better asset – liability matching. InvITs are expected to encourage higher FDI in the infra sector, reduce the burden on bank funding and allow developers to unlock tied-up capital. This is a positive sign for the industry including Dilip Buildcon.
  • Over the next 5 years, it is expected that NHAI would award more than 22,500 km of projects. With BOT projects losing favour, NHAI has been awarding more EPC and hybrid projects.
  • It is expected that investments in road projects will grow 2X to Rs 8.6 lakh crores over the next 5 years. Investments in state roads are expected to grow steadily, while those in rural roads will rise at a slower pace, impacted by a drop in budgetary allocations and funding constraints. Source: RHP/CRISIL Research.
  • As per IBEF (GoI), the Roads and Bridges construction sector size in 2016 was Rs 1,11,209 cr. So the market share of DBL in the sector is 3.9%. 

Financials of DBL

  • DBL’s revenue, EBITDA and PAT have grown 58.1%, 61.0% and 38.1% CAGR over 6 years.
  • The revenues have grown steadily, however the margins of DBL are volatile. The years 2014-15 saw poor financials (the entire sector was underperforming). Most contracts awarded earlier faced implementation and cost & time overruns. See Fig 4.
Fig 4 – DBL financials, JainMatrix Investments

Fig 4 – DBL financials

Fig 5 – DBL cash flows, JainMatrix Investments

Fig 5 – DBL cash flows

  •   DBL paid a dividend of Rs 0.025/share (Rate of 0.25%) in FY16, a yield of 0.01% which is very small. Dividend has been paid for several years but the rates have been falling.
  • DBL has been able to generate free cash flows only in FY16 of the last 6 years. DBL could be on a strong revival backed by govt. policy initiatives and growing order book size. Fig 6.
  • The cash per share including Reserves & Surplus and Cash in Balance sheet is Rs 73/share (post IPO). This indicates that the current operations of DBL are available in IPO at (219-73) = Rs 146/share.
  • DBL has a ROE of 19.6% in FY16 (source RHP) making it the industry leader. This is a positive.
  • It has a booked to bill ratio of 2.5 (FY16) – is good and improving  over 3-4 years, Fig 6.
Order book position, JainMatrix Investments

Fig 6 – Order book position

Benchmarking                                                         

Benchmarking, JainMatrix Investments

Fig 7 – Benchmarking (Click Image to enlarge)

We benchmark DBL against peer Infra companies like Ashoka Buildcon, IRB Infra, etc. See Fig 7.

  • DBL appears to be available at slightly expensive valuations in terms of P/E and P/B.
  • High RoE, RoCE and 3 year sales growth are positives.
  • Employee costs are good in proportion to profits.
  • D/E is moderate to high. Margins are average in line with other industry players.

Positives for Dilip Buildcon Ltd and the IPO

  • DBL has a good presence in MP, its home state. Beyond MP, it operates in geographical clusters for projects which helps with efficiency and asset utilization. DBL has an efficient business model. The execution through strong operations helped DBL receive early completion bonuses for many projects.
  • Large employee strength and construction assets. It also has a fine factory/ campus in Bhopal.
  • Strong growth in financials and order book. Their O/B grew at 48.1% CAGR over 4 years.
  • Promoters Dilip Suryavanshi and Devendra Jain have solid experience profiles.

Internal Risks

  • The firm has a business concentration in MP with 40% of the O/B coming from there Fig 2.
  • All firms in the sector faces business risks like high working capital requirement, long project gestation periods, govt. clearances and PIL/ litigation issues. DBL is no exception.
  • We worry about allegations of political connections in MP and the litigations listed in the RHP. While we understand that in a business such as infra development, there are always going to be legal, law and order and regulatory challenges, but DBL appears to having an excessive number of such issues.
  • The 2012 IT Department case of tax evasion and FEMA is an issue. While the firm is attempting to settle this issue, there is no clarity on addl. tax liabilities, or even more such cases against the firm.
  • The top 3 promoters were paid high salaries – 10% of FY16 profits. This is not shareholder friendly.
  • DBL has an accounts receivable period of 108 days, higher than industry average of 80-90 days. This is partly because the govt. is the major customer.
  • A promoter has pledged 54.1 lakh equity shares, 4% of the post IPO share capital, to raise funds. We understand this is a norm in Real Estate/ construction sectors. But its a negative.
  • DBL’s revenues from projects are unpredictable and subject to seasonal variations. However the firm records revenues using % completion method and revenues are not recognized until there is reasonable progress on a contract. This is a good/ conservative method.

External Risks

  • A political regime change in MP may affect their current projects and orders booked pipeline.
  • Competition is intense in road projects, particularly in EPC projects rather than BOT.
  • The Land acquisition Act in India specifies the process and compensation. It has undergone several changes recently, and we expect more changes. The uncertainty affects the roads EPC industry.
  • BOT projects are evaluated based on traffic projections. In this sector, many BOT companies are facing financial pressures due to rosy projections during evaluation and high competition during bidding.

Overall Opinion

  • There is an urgent need to upgrade Indian infrastructure such as roads and highways. This was reflected in the Feb 2016 Indian budget announcements. We can see that on one side highways have improved a lot in the last decade; at the same time most newly launched capacity is quickly at a high utilization!!
  • There are signs of revival in old stuck projects as well as momentum in bidding for new ones.
  • In this sector Dilip Buildcon has built a good growing business, and is expanding from an MP centric firm to an all India operating entity. It has good policies and business model.
  • However valuations for DBL are expensive compared to higher quality peers such as IRB.
  • Sector specific challenges like cash flows, debt, litigation, pledging and regulatory issues worry us. The roads construction sector by its very nature today offers very few attractive opportunities. Investors can look at profitable / high certainty sectors other than infra EPC.
  • As an investment, we recommend an AVOID on DBL IPO.

JAINMATRIX KNOWLEDGE BASE 

See other useful reports:

  1. IRB Infrastructure – May 2012 report
  2. Do you want to be a value investor?
  3. Mahanagar Gas IPO 
  4. How will Brexit impact Indian investors?
  5. A Repurpose for our PSUs
  6. How to Approach the Stock Market – A Lesson from Warren Buffet
  7. An IPO Roundup and Update 
  8. JainMatrix Track Record May 3rd, 2016
  9. Thyrocare IPO – Wellness for your Wealth
  10. New Banks: Big Changes in Small Change
  11. Equitas IPO – Leader in SF Banks
  12. Announcement – SEBI approval as a Research Analyst
  13. Alkem Labs IPO
  14. Goods And Services Tax (GST): Integration And Efficiency
  15. Syngene IPO: Good Pharma R&D spinoff from Biocon

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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. JM has no known financial interests in Dilip Buildcon 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.

BGR Energy Systems – Time to Re-energize

  • Date: December 2, 2011
  • CMP: Rs 269; Small Cap – Market Cap 1952 crores
  • Advice:  Invest at lower levels. Target – Rs 800 in 24 months.

BGR Energy is a leader in the Power Plant EPC space. However the industry headwinds have pulled down the business performance. BGR shares have fallen sharply to current under priced levels, and may stay around these level for 2 quarters. Thereafter the stock is expected to rise and recover lost ground.

Warning – Extreme volatility – this stock is not for the faint hearted.

BGR Energy – Description and Profile

  • ‘Water water everywhere, but not a drop to drink’. For BGR, the line needs to be – electricity shortages everywhere, but no orders for generation :-)
  • BGR Energy is primarily a Power Sector focused Engineering- Procurement- Construction (EPC) company. It builds Power plants for Utility companies and commissions and hands over the plant. It is Chennai based, with 2010-11 revenues of 4747 crores; market cap 1894 crores and 2200 employees.
  • Power Plant work can be in a Turnkey EPC mode, responsible for entire plant, or BoP (Balance of Plant) other than the BTG (Boiler Turbine Generator), or only BTG.
  • BGR has domain capabilities in power, and the ability to plan, design, procure/ build, execute and commission projects. Thus experienced personnel are the main resource of this firm.
  • Shareholding pattern is: Promoters – Individual and Corporate: 81.1%, DII 5.1%; Bodies Corporate 1.9%; Individuals – retail plus others 11.9%. Thus Promoters hold significant stake – a good sign.
  • By nature, the firm is paid in terms of milestones achieved in the project execution, so revenues tend to be lumpy. Also the Orders booked for this firm as a proportion of current revenues indicates the safety and visibility of the current business.

Strategies executed by BGR

  • BGR has extended its offerings to other verticals like Oil & Gas, Electrical projects (substations), environmental engineering projects and air fin coolers.
  • In recent years, it has diversified into manufacture of BTG as well as key technology components with partners/ JVs, thus capturing a larger share of the Turnkey project budget. This also gives it an edge in terms of cost and timely execution of projects.   It has set up a number of collaborations, subsidiaries and JVs to assemble the Plants and machinery:
  1. With Hitachi, it has Turbine and Boiler JVs. These two firms are setting up manufacturing facilities in Tamil Nadu, near Chennai
  2. Group companies with GEA Energietechnik of Germany give access to Cooling systems technologies and specialized tube cleaning systems
  3. Other group companies – Progen Systems – focuses on Design and manufacture capability for Process equipments. Also Cuddalore Powergen Corp Ltd is setting up a Power Plant.
  • It can be seen that BGR is over time going to straddle the entire Power Generation lifecycle, from BoP to EPC to BTG/ key components manufacture, to the Plant Operator (Generation) and the Utility play.

Industry Note:

Classification of Indian Industry players

  • Power Industry is at a high level divided into Generation, Transmission and Distribution. The Public sector dominates the industry, owning 70-80% of current assets. However the government is opening up to the Private sector. In future, 50% of investments are expected to be from Private investments
  • The key players in the Power Plant EPC market are NTPC, BHEL, L&T, and AIA Engineering. But it is a crowded market. The competition also includes Reliance Infra and Tatas.
  • Sub-segments are BoP and BTG manufacturers. Chinese manufacturers of BTG have a price advantage in India compared to locals. This anomaly should soon be corrected by the government.
  • The government has just come out with an order compelling open access, in line with the Electricity Act, 2003. This will allow all consumers of >1 MW freedom to choose the supplier, and only inform their current distributor. This will be a game changer for the Power industry if correctly implemented.

Stock valuation, performance and returns

  • BGR Energy had its IPO in Dec 2007. In a blockbuster offering, it was oversubscribed 119 times. Hoping to generate 438 crores, they attracted 52,000 crores.
  • However, from its IPO price of 480, it has now fallen to 269 a fall of 14% per year. See Fig 1.
BGR Energy, JainMatrix Investments

Fig 1 – Investment and Returns

  • As compared to share price, we can see that in the last 4 years, sales have grown at an average of 57% CAGR. See Fig 2 – Quarterly Sales and Profits.
  • Both EBITDA (53%) and Net Profits (69%) are growing rapidly.
BGR Energy, JainMatrix Investments

Fig 2 – Quarterly Sales and Profits

  • We can see from EPS and Cash Flow – Fig 3, the unevenness of the business model of BGR. Cash flow is unpredictable and lumpy.
  • EPS however is growing fast at 57% CAGR. Again this is a good data, but from a low base.
BGR Energy, JainMatrix Investments

Fig 3 – EPS and Cash Flow

BGR Energy, JainMatrix Investments

Fig 4 – Gross Debt

  • Debt is the big issue with BGR. It has increased significantly in the recent past. Gross Debt also stems from two sources – Net working capital and Debtors.
  • Working capital increased from 103 days (end FY11) to 206 days (end 2QFY12). This could be due to execution delays across the ongoing projects.
  • Debtors went up from 243 days (end FY11) to 341 days (end 2QFY12). This was due to a sharp rise in Retention Money, which was 1300 crores (end 2QFY12). Of this 900 crores is due to projects under execution and 400 crores against completed projects v/s 1100 crores (end FY11).
  • Retention Money is generally Bank deposits/guarantees for performance on projects. The completed project Debtors is certainly payment issues faced from some customers, possibly State Electricity Boards that are themselves in financial stress.
  • BGR expects debt to fall from 2300 crore (see Fig 4) to 2000 crores by the end of FY12 as the retention money is realized. And Debt equity is expected to increase from 1.4 (FY11) to 2.0 (FY12 Estd).
  • An important ratio for BGR analysis is the Orders booked to Revenues ratio (BTB). This has shown a cyclical nature, and by indications, is on an upswing now.
BGR Energy, JainMatrix Investments

Fig 5 – Orders Booked and Billings

Financial Projections, with FY14 estimates

The financials and PE of BGR has been projected for the next 3 years. See Exhibit 6.

JainMatrix Investments

Exhibit 6 – Key Financials and Projections

  • The current PE of BGR Energy is 6.7, below the industry average of 9.9. The average PE in the last 4 years has been 17.5. Certainly today BGR is at the lower end of the pricing range.
  • The Price and PE chart Fig 7 – shows that the successful IPO gave big valuations, but this fell rapidly in the 2008-09 global financial crisis. The view of the EPS chart – Fig 8 shows that EPS continued its rise thereafter, and the share price smartly recovered, only to fall again in this current situation. Certainly the fall in share price is very steep compared to EPS, so the share is today underpriced.
BGR Energy, JainMatrix Investments

Fig 7 – Price and PE trends

  • The EPS of BGR is on a growth path, and is expected to stay in the defined Trend line range.
BGR Energy, JainMatrix Investments

Fig 8 – Price and EPS trend

Risks:

  • Industry: 3-4 years ago the Electricity sector was the darling of Entrepreneurs and Investors. The yawning gap between demand and supply gave a demand assurance. Investors believed that they will be able to sell power at Merchant rates, and planned for large generation addition. Government too encouraged this with the Electricity Act, 2003 that threw open the sector to Private investors.
  1. Today systemic flaws are appearing in the sector. There is financial stress among Utilities, particularly State Electricity Boards that are facing Tariff inflexibility and Collection issues.
  2. Power Plants in India are facing an issue with fuel linkages and a shortage of Coal/ Natural Gas. This has affected the investment climate in this sector. The projects under execution by BGR may also be affected, and execution/commissioning may be delayed. See Notes on Petronet LNG and Bharat Forge.
  3. Project execution delays due to government clearances like environmental, land acquisition, etc.
  • Interest rates increases in the Indian economy are certainly impacting the balance Sheet of BGR
  • BGR: BGR is certainly facing a shortfall in Order Bookings due to this environment.  However, as seen in Fig 5 this is reversing, and we expect recovery in the next 6-12 months.
  • Vertical focus Risk, as revenues are essentially from the Power Gen. vertical. However, this is being addressed by BGR extending its EPC, manufacturing and technology strengths to other verticals.
  • BGR share has fallen by 67% from 843 in Sept 2010 to today’s 270. This is massive value destruction. It is partly because BGR has also been in the news for all the wrong reasons in the last 12 months:
  1. In Nov10, BGR was in the news for a Finance bribery scam. The company clarified that it has no dealings with LICHF and Money Matters, and cooperated with the authorities.
  2. In Oct 2011, BGR received a notice from the Central Excise Department, for tax evasion of Rs 107 crore. The company is confident that it has not evaded taxes, and will clear these charges.

Opinion, Outlook and Recommendation

  • India has a surging growth in electricity demand, and there is a 9-13% power deficit today. This will widen in the next few years.
  • As a leading EPC company, BGR’s fortunes are closely linked to the improvements in the regulatory environment and overall industrial climate of the Indian power sector. In a stable environment, BGR should perform excellently based on current skill sets and manufacturing and execution capacities.
  • The core undeniable strengths of BGR will take around 2 quarters to emerge in the form of business metrics like Orders booked, billings, profitability and EPS, as the government addresses industry systemic issues.  BGR also needs to repair the Balance Sheet and manage the debt levels. A good sign is that Merchant power rates are now on the upswing in India.
  • FY2011 was an excellent year, and BGR will not be able to show any significant improvements in FY12. However the demand gap will catch up, and FY13 will be a good year for BGR.
  • BGR is a High Risk, High Gain stock. Share may even fall from current levels. Investors with a risk appetite and a 2-3 year time horizon can accumulate BGR at 220-270 levels over next 6 months.
  • The 24-month projection (Sept 2013), for BGR is Rs 800, a 310% appreciation from CMP.
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Disclaimer:

These reports and documents are prepared by JainMatrix Investments Ltd. They are not to be copied, reused or made available to others without prior permission of JainMatrix Investments. Any questions should be directed to the director of JainMatrix Investments at punit.jain@jainmatrix.com

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