VA Tech Wabag – difficult FY18 but promising long-term outlook available at a decent valuation

Va Tech Wabag | Porinju Veliyath-owned Equity Intelligence India Pvt Ltd & EQ India Fund sold over 7.64 lakh equity shares or 1.23 percent stake in Va Tech Wabag via open market transaction on June 10, reducing shareholding to 0.64 percent from 1.87 percent earlier.

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Madhuchanda DeyMoneycontrol Research

VA Tech Wabag (VATW) is one of the world’s leading companies in the water treatment field. VATW’s key competencies lie in the design, completion and operation of drinking water and wastewater treatment plants for both municipal and industrial sectors.

FY18 turned out to be a difficult year for the company, marred by misses both in the topline and order intake. In addition, the decision to complete the APGENCO projects increased receivables and from a net cash company it turned into a net borrower.

The company had forecast revenues of Rs 3800-4000 crore and order intake of Rs 4300-Rs 4500 crore for FY18. The company recorded revenues of Rs 3457 crore and got Rs 3193 crore of orders. The working capital cycle worsened to 98 days in FY18 from 68 days at the end of FY17.

Consequently, the reported numbers were uninspiring

Source: Company

The management attributed GST-related disruptions and lack of clarity on GST payment behind the underperformance. Lower revenue coupled with nil margin on APGENCO orders hurt margins.

Genesis of the APGENCO problem

Andhra Pradesh Power Generation Company (AP GENCO) had placed orders for two 600 MW thermal power plants to a consortium in which VATW was joint partner responsible for Water Systems Package only. However, due to financial issues with the consortium leader, VATW had to assume the role of the consortium leader from mid‐2014 and took over the overall responsibility of completing the project.

The first of the 600 MW Kakatiya thermal power projects was completed successfully and the plant was commissioned in January 2016. The other 600 MW Rayalaseema thermal power plant has achieved the COD recently (Commercial Operation Date) and the plant is generating power.

The APGENCO project had 20 percent retention norms as per the original agreement. The retention money pertaining to Kakatiya project (Rs 100 crore) are now collectible once PGTR (performance guarantee test run) is done.

Out of the Rs 600 crore due from the APGENCO project, the management expects to recover close to Rs450 crore in FY19 – close to Rs 200 crore in first half and the balance in second half of FY19.

The net debt of Rs242 crore is largely on account of APGENCO project and the company expects to become net cash again by end FY19 once these receivables are recovered.

Aside of this short-term disappointment, the long-term prospects still look encouraging

There is huge opportunity in desalination projects, treatment of waste water and sewage. Demand for recycling of water and sludge management for industrial and sewage water is increasing given limited availability of fresh water.

On the industrial side there is large opportunity from oil and gas industry as well as power where recycling of water will be made mandatory.

Opportunity from Namami Gange and Amrut

The Namami Gange project envisages total investments of Rs 20,000 crore and the management guided that almost 75 percent of the order awarding is expected over next one year before the general elections. There is a large (Rs 5000 crore) opportunity for projects in cities like Kanpur, Allahabad, Patna and Kolkata wherein project for entire city may be awarded to one company. VATW is eyeing at least two such projects in FY19. The company has already won a few projects pertaining to Namami Gange for sewage treatment in Bihar. Some of these projects may be awarded on a HAM (hybrid annuity model) which can increase some leverage on the balance sheet or require fresh equity investments.

Under the Amrut Scheme, order inflow is expected from state governments and public utilities for waste water treatment. The Mumbai project of six sewage treatment plants and upgradation of existing treatment facilities worth Rs 11,000 crore has been delayed and is expected to be awarded in FY19. Similarly opportunities are coming up from other cities as well.

Desalination too is a big opportunity and the company has a successful track record of building one such at Chennai. The company is eyeing a strong pipeline that includes 550 million litres day desalination plant at Chennai, 100 mld plant at Ramanathouram and 200 mld plant in Mangalore. Also multiple cities in Gujarat would be setting up such plants.

The company has sizeable presence in overseas geographies with 47 percent of the revenue in FY18 coming from overseas. For VATW, Saudi Arabia offers large opportunity given its national transformation program and Vision 2030. The company is eyeing the sub-Saharan Africa market as well as Latin America.

Aggressive guidance

The management said the order intake was lower as some large orders were deferred. Consequently the company has given an aggressive order inflow guidance of Rs 5300 –Rs 5700 crore and revenue guidance of Rs 4000 – 4200 crore for FY19.

Source: Company

Although the share of relatively better margin O&M (operation & maintenance) has fallen in the order book, the company is confident of improving margin on the back of improvement in size of individual orders, richer specifications of orders and overseas orders. VATW is conscious about profitability and said it would not chase orders at the expense of margins.

Source: Company

Near-term trigger

Recovery from APGENCO remains a key near term trigger, as also some large order wins. Should the company successfully manage the receivable issue in FY19, we see decent uptick in earnings in FY20.

The stock has corrected significantly and is close to its 52-week low. While the stock performance in the near-term is largely contingent on resolving the receivable issue and traction in large orders, we see limited downside and significant upside should these events pan out. We therefore find the current valuation of 11.4 times estimated FY19 earnings attractive for long-term investors.

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