IRB & ITNL: Strong execution drives third quarter performance

With rate cycle easing, many under-construction projects expected to go on stream and new road project awarding seen picking up, analysts expect the two companies to do well

The top two players in the road construction and management space, IRB Infrastructure Developers and IL&FS Transportation Networks Ltd (ITNL) have reported better-than-expected results for the December 2012 quarter. Post-results, the Street is upbeat about the prospects of the two companies considering strong earnings growth, attractive valuations and easing challenges in the sector. There are certain issues such as lack of new orders and high debt in the books, but analysts believe these could be resolved in the medium term. Besides, it will be compensated by higher contribution from the construction business. They also expect awarding of new road projects and traffic growth to improve in the next fiscal year. Importantly, at current levels, both the stocks are trading at seven times FY14 estimated earnings, which is reasonable considering that earnings are estimated to grow by about 15 per cent annually over the next two years.

During the December 2012 quarter, both companies have shown strong execution in the construction business (growth of 29-38 per cent year-on-year, or y-o-y) leading to robust growth in overall revenues. The growth in construction business was led by strong order book for both the companies. This is also a reason that with the rise in contribution from this low-margin business the players saw some pressure on overall margins. While IRB’s earnings before interest, tax, depreciation and amortisation (Ebitda) margins are down both y-o-y as well as sequentially, ITNL’s is down 750 basis point to 25.5 per cent (on y-o-y basis though ITNL has done relatively better with margins up slightly). Notably, for both companies, the build-operate-transfer (BOT) or toll-based business, which enjoys high profit margins, has seen marginal growth as a result of lower traffic growth.

On the other hand, interest expenses relating to recently executed projects have been going up. ITNL, which is more leveraged than IRB with a debt-equity ratio of about 3.8 times, has seen its interest cost go up by 53 per cent y-o-y to Rs 284 crore in the December 2012 quarter (IRB’s was up about 12 per cent). Thus, growth at the net profit level has been lower.

  Meanwhile, despite these issues the companies remain in good position. For one, the rate cycle has peaked and interest rates are expected to go down. On the other hand, economic growth cycle has also bottomed out with a pick-up in growth expected in FY14. And, the companies are also doing their bit.

“With 10 projects becoming operational over the next 18 months, toll/annuity collections are set for an upswing. Declining interest rates will provide a further fillip to the stock (ITNL). A 100 basis points decline in interest rates increases our SOTP by 13 per cent,” says Parvez Akhtar Qazi, who tracks ITNL at Edelweiss Securities.

The construction business, which accounts for almost 70 per cent for both the companies, is expected to report strong revenue growth in the coming quarters given the existing order book. ITNL’s current order book is almost three times its construction revenues in FY12. Similarly, IRB has strong order book to sales of four times, which should help sustain growth.

Meanwhile, in the first nine months of the current fiscal, NHAI has awarded projects worth just 1,000 km compared to the annual target of 9,500 km, which has rubbed off negatively on the stock valuations of road project companies like IRB and ITNL, say analysts.

“IRB’s valuations look attractive with the current portfolio of projects (excluding Goa-Kundapur) contributing Rs 121 a share. Valuations appear to be factoring in the current slowdown in traffic growth and other concerns,” says Atul Tiwari of Citi Research in a note on the company.

But, with the order flows expected to improve in the following years, sentiments should get a boost. Any positive development on the traffic front and flow of new orders could help these companies gain higher valuations. Analysts are hoping for a revival in FY14 as the government is now taking steps to boost investments and NHAI is also sorting out its issues pertaining to clearances and land acquisition.