Credit rating agency Crisil expects construction companies to continue facing pressure on earnings throughout current financial year due to execution hurdles and high interest rates.
The agency said that earnings and 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,” said Crisil in a note today. In the past one year, construction stocks have significantly underperformed with negative 55% return compared to S&P CNX NIFTY’s negative 8%.
However, given the large-scale infrastructure spending expected over the next 5 years, the long term growth potential of these companies remains intact.
Prasad Koparkar, head (industry and customised research) at Crisil Research said, “The current state of infrastructure is increasingly becoming a bottleneck to the ambitious more than 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 2005-08, construction companies were valued on their order book position. 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 one year forward price-to-earnings ratio of 6.5x and one-year forward price/book ratio of 0.5x,” said Crisil in the note.
The agency expects 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.
