More pain for infra left, but L&T good: Angel Broking

Excerpts from Markets Midday on CNBC-TV18 Watch the full show » ALSO READ See what other experts are saying about markets See what FIIs are saying about the markets See what Udayan Mukherjee is saying about the markets Larsen BSE | NSE 01/06/12 Are Mutual Funds betting on Larsen? Other Stocks in this news Bharat Heavy Electricals | IVRCL | Jaiprakash Associates | Hindustan Construction Company | Sadbhav Engineering | IRB Infrastructure Developers |

Shailesh Kanani, senior research analyst at Angel Broking joins CNBC-TV18 to discuss the outlook of infrastructure stocks going ahead. He says that high interest cost and commodity prices weighed heavy on infra space, affecting capex, especially in the domestic front. "The pain is still there near-term, but L&T is poised to do well once the capex cycle revives," he says.

Below is the edited transcript of the interview. Also watch the accompanying video.

Q: Despite this quarter being a seasonally weak quarter, the topline growth has been better than expected. We have had worrying comments from L&T about the way forward and the kind of deferment in orders etc. Do you think that this topline growth may see some follow through?

A: Even if you see Larsen and BHEL , the numbers posted by the companies were decent. The problem is in the outlook. Operational matrix and outlook has deteriorated further. If you see L&T, the order inflow guidance has been reduced and the 5% order inflow growth what they are talking about is still very aggressive.

The second quarter revenues, we have seen that for an average 10 companies that we cover, topline growth has been decent. Comparatively, first quarter was very bad for the construction companies. But on the operational level, the EBITDA margins are clearly facing commodity and inflationary pressures. With interest rates being very high on the bottomline front, nothing is getting converted, and that is the reason you are seeing huge earnings de-growth for most of the companies.  

Q: Now we have seen a fairly sharp nick coming in the L&T price just for starters and it has moved in across the board. What would your view now be with more gloom being reflected in the capital goods space?

A: Order inflow has been a problem for quite sometime now, especially in the domestic area. For the first time, L&T has witnessed 25% of order inflow from the international front because normally international segment contributes around 8-10%. This time around, it's seeing a higher share and that is majorly because of the subdued performance on the domestic front. But guessing at current valuations of around Rs 1250, the stock is adjusted for its investments trading at around 10-12 times on FY13 earnings.

Definitely there are concerns, the interest rates are high, industrial capex is slow on revival front, but L&T is one stock which is diversified enough and has many sectors or segments to fall upon. In future, it is one of the stocks which would be better when the industrial capex again revives or the economy is good again. That is a reason we prefer still L&T in the infra space.

Q: In the last one or two weeks, the market has been very nasty towards companies that are highly leveraged. Could you give us a list of companies that you would stay away from because of their debt issues?

A: For capital goods, I think the debt exposure is decent. Their problem is indirect because of the high interest rates their clients are facing and on the financing front or expansion front or the demand front. So I think there are not many companies which are high on debt in this segment.

On infra side, especially the construction space, there are many companies which are having huge debt. To name a few, Jaiprakash Associates , Hindustan Construction ... these companies are loaded with debt and what we are seeing is that in spite of decent topline growth, they are posting huge de-growth on their numbers front.

Among companies that stand out from the construction side on the debt front would be L&T and Sadbhav Engineering . These two companies have been able to manage their debt pretty well. For L&T, its net debt is nearly zero. I think they have good amount of cash and current investments at hand.

Q: You are positive on IVRCL. Give us reason why? Even they have debt....

A: IVRCL is loaded with debt. The only thing that makes our stance positive on IVRCL is on the valuation front. It's trading at very low valuations of 0.3-0.4 times FY13 earnings on the price-to-book basis. If they are able to somehow monetize their money, either on the build-operate-transfer (BOT) front or on the real estate front, that would be a big catalyst for the stock.

Q: You have recommended IRB Infra as well in the development space and your argument is that the stock has been brought to a very attractive levels. Do you think that is reason enough for the stock to move up from here or because of the situation it's dealing with, it may not see a progressive move upwards?

A: IRB is one of the companies which have been performing well on the quarterly numbers. Primarily because they have good amount of order book, their revenue streams are quite constant and delivering very good numbers.

IRB was trading at little rich valuations, that is the reason we were downgrade in the stock because purely on the valuations front, the largecaps like L&T and BHEL are trading at such attractive valuations. When such stocks are trading at high valuations, they were bound to underperform.

But given the recent fall in the past 10-15 days, IRB has gone down from Rs 170-180 odd levels to less than Rs 140 and that is the reason why I am very optimistic on the business the company has. They have good revenues on the BOT toll as well. The only reason we were negative was because of valuations. Since that part has been taken care of, we have again become positive on the company.

Q: Do you think there is any scope of this sector getting back on its feet and see any kind of outperformance or do you think it will continue to reel under pressure?

A: We have mentioned in our report that it will be an underperformer, at least for the near term. Till the time interest rate cycles are at these levels, these stocks and these companies can't perform well. A thing to mention about L&T and BHEL as well, they have always commanded premium over the Sensex. That is basically because of the premium in growth earnings and high internal ratios. If you see, these companies are also facing problems on that end. So unless and until those things come back into the picture, we don't see these stocks being very good outperformers.