Road still potholed for infrastructure firms

Infrastructure stocks got some respite in January on the hope that interest rates would ease and benefit them in the form of lower interest costs and kick-start the capex cycle as well.

Rates have eased partially, but most stocks have corrected significantly after rising sharply. Since February 21, the day the Sensex closed at the highest levels in 2012, most of the stocks, including Hindustan Construction Company (HCC), Lanco Infra, Punj Lloyd and Nagarjuna Construction Company (NCC), are down 15-40 per cent.

Analysts say, "Initially, hopes were building up that economic recovery would start in 2012. But looking at the conditions on the ground like funding issues, slow execution, tepid flow of new orders and company-specific issues like stretched balance sheets, it has led to the belief that a recovery may not happen soon."

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Also, after the initial euphoria, it is perceived that the Reserve Bank of India may pause for some time before going for another rate cut. "I think the recovery could only happen in the second half of 2012-13," says Vinod Nair, vice-president, research, PINC Research.

Experts like Nair believe the current bearish sentiment that has gripped the space is an opportunity in itself.

"This should be the last fall to buy infra stocks," says Nair. Nevertheless, investors will have to be selective and should look at companies with higher revenue visibility and manageable debt levels, as uncertainties still prevail.

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Order inflow: Still to gain ground

Lack of new order inflows and slow execution are visible across the industry. The aggregate order book to revenue stood at about three times at the end of December 2011, almost similar to the year-ago period.

This is a reason that project execution is expected to remain soft over the next two quarters, leading to further pressure on earnings. Not just order inflow, companies have also blamed delayed payments from clients for the slowdown in construction activities.

Among the few bright spots is the roads and urban infrastructure space, which have shown some buoyancy, with fresh orders being announced.

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The National Highways Authority of India had set a target of awarding 7,300 km of road projects. It has already awarded projects for 6,500 km, remarkable from the historical perspective.

In the roads segment, the order pipeline for 2012-13 is strong and most companies are sitting on huge order books in the sector. Thus, many analysts believe the correction in some stocks in this segment could be used as an opportunity to invest from a one-three years' perspective.

In this space, Sneha Rungta of Sharekhan likes IL&FS Transportation Networks (India) Ltd (ITNL), due to its superior management and robust order book. ITNL has strong visibility and is trading at six times 2012-13 estimated earnings. Analysts also like Sadbhav Engineering, which has a strong balance sheet and order book.

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Pain not over

In the remaining segments, barring a few companies, inflows are still weak and may take another six-eight months to revive. "The only company, which even in these difficult times, is getting orders is L&T (Larsen & Toubro) and there are no major issues with the execution and balance sheet. This is why L&T remains among our top picks in the sector," says Nair.

L&T has good visibility, with an order book to sales of about three times. Analysts expect its earnings to grow 12-15 per cent annually over the next two years.

However, for a larger number of companies in the engineering space, analysts expect any recovery to be extended.

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On the other hand, Rungta says, "We expect order inflows in the water and irrigation, urban infrastructure and power sectors to revive, given the government's focus on infrastructure development as outlined in the recently announced Union Budget." However, he believes any meaningful revival in orders may take a few months.

Also, individually, many companies, including IVRCL, HCC, NCC and Lanco Infra, are facing problems as a result of stretched balance sheets and a high cost of interest.

In the December 2011 quarter, the aggregate interest cost as a percentage of total revenues stood at around six per cent, the highest in the last several quarters.

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"On the ground, the pressure is still there from the interest cost point of view, which I think could take some more time.

Anyway, in the first half (of 2012-13), we cannot expect much improvement due to the monsoon. But after another two quarters, the pressure on interest costs may ease out, which will be a good news from the execution point of view," says Amit Shrivastav, who tracks construction companies at Nirmal Bang Securities.