HCC: Concrete gains

HCC's preferential issue will improve its debt-equity ratio

Hindustan Construction Company (HCC) is making a preferential issue of 2.9 million shares to three foreign institutional investors at Rs 450 a share. The offer, amounting to Rs 131 crore, would dilute the company's equity by almost 15 per cent.

But it would go a long way in improving its debt-equity ratio. On March 31, 2004, HCC's debt-equity ratio was as high as 2.5 times. The issue would bring it down to less than 1.5 times. Of course, the number could change by the end of FY05, depending on the addition to debt/reserves during the fiscal.

Also, thanks to the issue, FII holding in the company would jump from a mere 2.5 per cent to around 17 per cent. Needless to say, floating stock would also improve.

But all of these positives seem captured in HCC's current stock price, which discounts estimated FY05 earnings by over 20 times. For perspective, the stock traded at around Rs 120 just in July 2004, which means it has jumped by over 300 per cent in the last 8 months.

HCC is among the best placed to capture the boom in the construction industry. Although it's present in most segments, it's focused on high-value segments such as power, roads, ports and urban infrastructure.

As a result, the company enjoys an operating margin of around 11 per cent, higher than most of its peers. In the nine months till December, its net profit jumped by over 40 per cent, in line with the growth in sales, which is commendable given that raw material costs were higher.

What's more, with an order backlog of over Rs 4,100 crore, the strong growth is expected to continue for the next couple of years. Order wins continue to be strong "" the company recently won two orders cumulatively worth Rs 733 crore from the National Highways Authority of India.

Nevertheless, given the sharp rise in HCC's stock price in the recent past, further upside could be limited.

PSL Ltd

PSL Limited has bagged an order estimated at Rs 343 crore from Larsen & Toubro for pipe supply, coating and other related works pertaining to GWRDC and NWRDC projects of the Gujarat government.

The news led to a 5 per cent jump in its stock price, which now discounts FY05 earnings by around 12 times. This project is scheduled for implementation in FY06 and should strengthen the company's order book position, which was approximately Rs 900-Rs 1000 crore at the end of December '04.

Although the order would give a boost to the company's top line, margins from this project are not expected to be high for the company, given the rising cost of key inputs such as steel. In the last quarter, PSL's operating profit margin (excluding other income) had shrank 349 basis points to 3.79 per cent.

PSL manufactures specialised pipes such as spirally welded steel pipes, and exports form a significant portion of the company's total turnover. In the domestic market, key customers include projects of state governments to expand water supply networks and pipeline expansion projects of oil companies.

For the December quarter, the company reported a 87.8 per cent growth in its net profit to Rs 12.62 crore, helped by net sales expanding 62.2 per cent. However, the underlying concern has been the high cost of steel "" raw material cost as a percentage of net sales jumped 1343 basis points to 85.18 per cent in Q3 FY05.

The company has been able to recover part of the escalation in costs from its customers. The company is shortly planning to issue shares on a preferential allotment basis, which would dilute equity by over 17 per cent. At current prices, the company should be able raise close to Rs 80 crore.

UB-Herbertsons

The UB group has bought out Kishore Chhabria's 49 per cent stake in Herbertsons for Rs 131 crore, taking its stake in the company to around 93 per cent. The deal accords a value of approximately Rs 267 crore for the company as a whole. Herbertsons owns the country's largest selling whiskey brand, Bagpiper, which sells over seven million cases a year.

Chhabria gets to keep BDA Ltd, which owns the Officer's Choice brand. Herbertsons' equity of Rs 9.5 crore imputes a per share value of the deal at Rs 281. The market price of Herbertsons, (which has a book value of Rs 38), as on February 23, was Rs 180 "" the stock had touched a high of Rs 204 in December last.

Looking at it another way, the UB group has paid 0.7 times sales for the stake "" Herbertsons had sales of Rs 374 crore as of March 2004. However, Herbertsons had a profit after tax of just Rs 4.3 crore, valuing the company at 62 times FY04 earnings.

It is not clear whether the increase in the stake to 93 per cent would trigger a delisting through a reverse book building. The UB group plans to merge Herbertsons with McDowell and Triumph Distillers and Vintners. If the plan goes through, shareholders will end up with a share of the merged entity.

In the long term, the liquor business will no doubt flourish but in the interim the huge cash outflow for the UB group "" McDowell is also making an open offer for 20 per cent of Shaw Wallace & Company at Rs 250 per share "" will no doubt put some pressure on the company's balance sheet.

Although the stock has run up after news of the Herbertsons buyout, the UB stock, at Rs 410, trades at a considerable discount to the highs of Rs 502 hit in December.

With contributions from Mobis Philipose, Amriteshwar Mathur and Shobhana Subramanian