High powered growth

SPECIAL REPORT

With an order book nearly six times its turnover and return on equity over 30 per cent, Patel Engineering looks like a promising growth stock.

The abysmal state of the infrastructure in the country and the government's ambitious plans to set it right should mean a brighter future for companies like Patel Engineering (PEL). The Rs 750-crore company derives about 85 per cent of its revenues from hydro power and water supply projects, which is likely to see some mega investments.

Consider this: the government has identified 162 projects across 16 states with an aggregate hydroelectric capacity of 50,000 MW to be executed over the next 20 years. Out of this, 14,000 MW and 20,000 MW of new capacity is targeted in the tenth and the eleventh plan respectively.

By 2025, the government envisages exploiting the full hydro potential of 1.5 lakh MW with an investment of about Rs 6 lakh crore which means companies of all size and shares engaged in such project development should see roaring business for the next decade.

PEL currently earns 50 per cent of its revenues from hydro power - dams, tunnels and powerhouses, another 35 per cent from irrigation and water supply-dams, construction of pump stations and canals and the balance from transport-roads, railways, bridges and miscellaneous activities including micro tunneling.

The higher proportion of the hydro power projects augurs well as generally it fetches better margins among all its businesses. Besides, it is also involved in implementing marine engineering projects and construction of thermal power plants and other industrial and civil structures.

Since its inception, PEL has executed 75 dams, 30 hydroelectric projects, 30 micro tunnelling projects and 130 kms of tunnelling across the world. Its business is spread across the US, Chile, Africa, Europe, Nepal, Bhutan and China.

Its clientele includes National Hydroelectric Power Corporation (NHPC), National Highways Authority of India, Brihanmumbai Municipal Corporation and state governments in addition to international clients like Piedmont Triad Regional Water Authority and US Army Corps of Engineers both from the US, Public Power Corp, Greece and the government of Eritrea in North Africa.

At the end of 2005, PEL had orders totaling Rs 4,300 crore, almost six times its turnover in the past 12 months, which lends enormous visibility to its future earnings. Of this, 40 per cent was from hydro power projects, 40 per cent from irrigation and the balance from roads and other activities.

Some significant orders include the Parbati hydroelectric project (Stage 3) worth Rs 340 crore from NHPC, which is being implemented through a joint venture with Larsen & Toubro, where PEL has 60 per cent stake. The company has recently bagged the Sewa (Rs 100 crore), Kameng (Rs 289 crore) and Priyadarshini Jurala (Rs 392 crore) hydroelectric projects.

Thanks to the growing opportunities in agricultural infrastructure through lift irrigation, the company has forayed into EPC and turnkey contracts for lift irrigation projects in Andhra Pradesh.

In lift irrigation scheme, water from a lower level reservoir is lifted to a higher level by pumping. The scope of work in such projects includes impounding the reservoir, connecting the pumping station and construction of water conducting system like canals, pipelines and tunnels. The Bhima, Kalwakurthy and Jawahar lift irrigation projects are some of the recently bagged projects worth Rs 1,000 crore.

PEL is the only player in the country to offer micro-tunneling and dam construction using Roller Compacted Concrete (RCC), both of which require superior technical expertise and earn higher margins. PEL has been able to provide these technologies thanks to its foreign acquisitions ASI RCC and Westcon Microtunnelling.

In the past year, the two subsidiaries contributed to about one-fifth of PEL's consolidated revenues. RCC is a new technology that makes construction of dams faster and cheaper. The company is building the first RCC dam at Ghatghar for the Maharashtra government. The project will add 250 MW of power generation capacity within a period of three months.

Micro tunneling, a new concept, is used in urban areas for augmenting the water, sewage and telephone services.

Company managing director Rupen Patel says, "Micro tunneling is the technology that will play a major role in the construction industry going forward. With increasing concretisation of roads and the Golden Quadrilateral project we see a huge potential for these operations."

PEL is currently bidding for micro-tunneling projects worth Rs 200 crore. Even though new players are likely to enter the fray, PEL believes that the company would benefit from being the first-mover. "Once the segment picks up, we could expect much better margins too," Patel adds.

Financially, the company is sound with consistent rise in sales and profits every year except in 2004-05 when the sales were flat because the Parbati project in the Himalayan region was delayed due to flood and heavy snowfall.

While profits have risen backed by growth in the volume of business, operating margins have improved too.

In the nine months ended December 2005, the company's sales have increased 61.79 per cent year-on-year at Rs 500.25 crore. The operating profit shot up 69.92 per cent at Rs 78.93 crore and margins improved by 76 bps to 15.78 per cent.

Similarly, net profit registered a spectacular increase of 95.06 per cent and margin improved by 167 bps to 9.79 per cent. In the December quarter, the company posted growth of 20.55 per cent at Rs 169.68 crore. Operating profit improved 72.42 per cent at Rs 40.76 crore. Net profit also increased a whopping 98.42 per cent at Rs 25.06 crore.

VALUATIONS
PEL is planning to come out with a follow-on public issue aggregating Rs 425 crore in the next two months to finance its growing business. The company has planned a capex of Rs 80 crore in next two years to acquire construction equipment.

It is planning to acquire technology intensive overseas construction companies to bring new technologies. If PEL issues shares at Rs 470, a 10 per cent discount to the current market price of Rs 521, then 90 lakh additional shares would be issued which means equity dilution of 18 per cent. 
 

ENGINEERING GROWTH
In Rs crore (TTM)	Patel	Jaiprakash	Gammon	HCC
Net sales	728.49	3006.00	1190.98	1731.41
Operating profit	95.80	601.00	157.91	162.85
Opm	13.15	19.99	13.26	9.41
Net profit	59.43	257.37	75.44	90.43
Npm	8.16	8.56	6.33	5.22
EPS TTM	11.89	13.81	8.63	3.94
CMP	521.00	515.00	535.00	173.60
P/E TTM	43.82	37.29	61.99	44.06
P/E 07	25.79	22.95	32.04	33.84

The stock trades at a trailing 12-month P/E of 47 times on diluted earnings per share of Rs 10.06. While this may seem on the higher side, the price of Rs 470 discounts its estimated FY07 earnings on the higher equity about 27.5 times, which is not very expensive.

According to an analyst, "The outlook on the company is positive and has substantial potential for an upside taking into consideration the future growth opportunities. The company enjoys higher margins than its competitors due to a larger proportion of high margin hydro power business."

Moreover, it also enjoys a return on equity of 32 per cent, much higher than the industry average of 23 per cent.

At the current market price of Rs 521, the stock trades at a estimated P/E of 25.8 times for FY07 (without considering the forthcoming follow-on issue). Its competitors Jaiprakash Associates, Gammon India and HCC trade at price multiples of 22.95, 32.04 and 33.84 s the estimated FY07 earnings.