Earnings, not orderbook, to fix construction cos valuations

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Earnings, not orderbook, to fix construction cos valuations

CRISIL Research has come out with its report on construction companies. The firm has coverage on ARSS Infra, C&C Cons, Era Infra, Marg Ltd and MBL Infra.

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ARSS Infra BSE | NSE 30/05/12 Are Mutual Funds betting on ARSS Infra? Other Stocks in this news C & C Constructions | Era Infra Engineering | Marg | MBL Infrastructures |

CRISIL Research has come out with its report on construction companies. The firm has coverage on ARSS Infra , C&C Constructions , Era Infra , Marg Ltd and MBL Infra .

CRISIL Research, India's leading independent and integrated research house, believes that earnings, not order book, will drive the valuations of Indian construction companies. Though most companies have a healthy order book, valuations have taken a beating due to muted earnings growth mainly due to execution hurdles, hardening interest rates and stretched working capital cycle. In the past one year, construction stocks have significantly underperformed - negative 55% return compared to S&P CNX NIFTY's negative 8%. Even though some of these concerns may continue to plague the industry in the near term, CRISIL Research believes that at current valuations, which are at historical lows, the riskreward ratio appears favourable given the growth potential of the sector.

After registering strong earnings growth of ~60% during FY05-08, construction companies reported just 2% growth during FY08-11 due to weak margins and high interest costs. While CRISIL Research expects earnings pressure to continue to cloud FY12 due to execution hurdles and high interest, it believes all is not lost. The silver lining: order awards and execution issues have started showing signs of easing up during Q2FY12, companies have a healthy order book of 2.5x FY11 revenues which provides good revenue visibility and interest rates are expected to peak in the near term. Additionally, one cannot ignore the long-term growth potential for companies in this sector given the large-scale infrastructure spending expected over the next 5 years. According to Mr Prasad Koparkar, Head - Industry and Customised Research, CRISIL Research, "The current state of infrastructure is increasingly becoming a bottleneck to the ambitious 9%+ GDP growth target. Hence, spending on infrastructure is imminent. We expect construction investments to grow at a CAGR of 13% to Rs 14.8 trillion over FY12-16.

During the strong growth years of 2005 to 2008, construction companies were valued on their order book position. Coupled with robust economy growth and high infrastructure spending, most construction companies traded at their all-time high. However, over the past two years, the order book has witnessed muted growth and profitability has weakened, resulting in re-pricing of construction companies. The construction companies' valuations are currently at a historical low with median oneyear forward price-to-earnings ratio (PER) of 6.5x and one-year forward price/book ratio (P/BV) of 0.5x. According to Mr Tarun Bhatia, Director - Capital Markets, CRISIL Research, "We believe that valuations will improve over the next 12 months as some of the concerns such as execution hurdles and interest rate are expected to fade out by the year-end, resulting in moderate earnings growth."

Companies under CRISIL's equity research coverage are trading at PERs of 4.2x-13.8x FY12E EPS. The P/BV ratio of some of these companies is below one, which given the expected healthy RoE offers a favourable risk-reward ratio. CRISIL Research has coverage on ARSS Infrastructure Projects (ARSS), C&C Construction Ltd (C&C), Era Infra Engineering Ltd (Era), Marg Ltd (Marg) and MBL Infrastructure Ltd (MBL). Of these, ARSS, Marg and MBL have a valuation grade of 5/5, indicating a strong upside (more than 25% from current market price); C&C and Era have a valuation grade of 4/5, indicating an upside (10-25% upside from current market price).