While a strong order book reflects near-term revenue visibility, Patel Engineering’s project execution will decide its long-term prospects.
The recent stock market meltdown has hit construction and real estate companies hard considering the mounting concerns over rising interest rates, input prices and probable slow down in the investments in the country.
The stock of Patel Engineering is no exception with its share price dropping 68 per cent from its peak of Rs 1,070 in January 2008 to Rs 342 currently.
The company offers a good investment opportunity as most of its businesses are centred around the growing infrastructure space such as construction of hydro power projects, and irrigation and transport sectors.
The company’s order book of Rs 6,000 crore, which is 3.2 times its FY08 revenue, provides strong revenue visibility and is good enough for the company to maintain its topline growth of about 25 per cent over the next 2-3 years.
Besides, its recent entry into the real estate business, where the company owns a land bank (at historical costs) could provide potential value unlocking as it starts generating revenue from FY09 onwards.
Core business
Patel Engineering’s core businesses includes construction of hydro power, irrigation and tunnelling projects, which are relatively high margin businesses enjoying operating margins of about 14 per cent as compared to 9-10 per cent in other segments.
Notably, the company enjoys about 22-25 per cent market share in construction of hydro power space. Given the huge growth opportunities, on the back of investments in the hydro power projects, Patel is likely to be a key beneficiary.
According to industry estimates about 30,000 mw of power will be added during the 12th five year plan (2012-2017). Additionally, projects equivalent to about 10,000-15,000 mw pertaining to the 11th five year plan ending 2012 are yet to be announced.
“Overall, including part work for the 11th five year plan and the flow of new orders for the 12th five year plan we estimate about 40,000 mw of new hydro projects would be announced over the next 7-8 years, which is substantially high and offers huge opportunity for us,” says Rupen Patel, managing director, Patel Engineering.
Typically, the construction cost of a megawatt of hydro-power capacity is about Rs 5.2 crore. Considering that many projects are delayed, and assuming that even if 50 per cent of the estimated capacities become a reality, the overall investments required will be over Rs 100,000 crore over the next 7-8 years. Clearly, there are huge growth opportunities for companies like Patel Engineering.
Real estate
Meanwhile, as its construction business is growing, the company has accumulated a land bank of 1,127 acres in different cities, including 811 acres of land in Hyderabad, 200 acres in Chennai, 89 acres in Bangalore and another 27 acres in Mumbai.
According to the company, it has purchased the entire land at historical prices; estimated cost of about Rs 250 crore with an average holding period of about 20 years. These properties will be developed in a span of about 4-5 years, in two phases.
In the first phase, which has already started in FY08, the company is developing about 11 per cent of its land bank or 15 million sq ft. The company has completed its first project, a corporate park at Jogeshwari, measuring 80,000 sq ft of built up area with estimated lease rent of Rs 10 crore per annum.
The company is further building another 10,00,000 sq ft, which could fetch Rs 120 crore as lease rent annually. However, its major project of the first phase, which is 12 million sq ft, will come up at Bangalore over the next 6-7 years and will include a residential complex and two SEZs.
However, since these projects involve large sums of investments, the company will raise funds for these projects, which will be through a mix of debt, internal accruals and private placement of equity. Barring that these projects would take time and substantial investment towards development, they hold huge revenue potential.
“According to our estimates, revenues from these ongoing real estate projects could be about Rs 120-130 crore in FY10 and about Rs 130-200 crore in the FY011,” says Ravi Dodhia, analyst, K R Choksey.
The company’s land bank has been valued at about Rs 2,100 crore, even factoring a discount of 40 per cent, concerns over rising interest rates and low property prices, the per share value of the land alone works out to about Rs 200 per share.
Power generation
A part of the additional cash flow from real estate business will be invested into the power generation business. The company has signed an MoU with the Gujarat government to set up a 1,200 mw thermal power plant in four phases of 300 mw each. However, the company is yet to finalise its coal linkages. The company will also develop a 120 mw hydro power plant in Arunachal Pradesh. These are large projects and could add substantially to the company’s revenue, however, since these are long gestation projects and will require another 3-4 years to reflect in the revenue, analysts have not factored it in the valuations.
Besides power, the company is also present in the growing irrigation and transport sectors, which together account for about 44 per cent or Rs 2,640 crore of the total outstanding order book. Its irrigation business, which includes the construction of dams and water-related projects, is growing on the back of investments under different schemes and plans such as Rajiv Gandhi Mission, programme for drinking water in rural areas, Bharat Nirman, repair and restoration and accelerated irrigation.
The company was recently awarded a Rs 696 crore order from the Andhra Pradesh government for the modernisation of the Krishna delta system to boost the irrigation potential along the river.
The company is also active in the construction of roads, bridges and tunnels. In these segments, especially in micro tunnelling, the company is the leader and is known for its superior technology. The company has technical support from its US-based subsidiary, Westcon Microtunneling.
Likewise, for the development of urban infrastructure such as underground works, foundations, dredging and other civil works, the company uses technology from its other US-subsidiary Michigan Engineering.
These subsidiaries helped Patel Engineering to increase its revenue from the overseas markets from about Rs 60 crore in FY07 to Rs 240 crore in FY08. The current order book also includes projects worth $100 million from the overseas markets.
In the transport segment, the company is executing two BOT road projects valued at Rs 1,040 crore, which Patel Engineering claims could provide regular revenue of Rs 100 crore over the next 18 years.
Valuations
A strong order book and better industry outlook should continue to drive the growth in the near-term. More importantly, since the company is developing new revenue streams, which are long-term in nature, one can expect value unlocking to take place in future. Relatively higher operating margins at 14.9 per cent also provides comfort.
| INFRA BOOST | |||
| Rs cr | FY08 | FY09E | FY10E |
| Net sales | 1,860.00 | 2,325.00 | 2,860.00 |
| OPM (%) | 14.90 | 14.50 | 14.50 |
| Net profit | 152.00 | 174.00 | 215.00 |
| EPS (Rs) | 25.44 | 29.20 | 35.93 |
| PE (x) | 13.40 | 11.70 | 9.50 |
| Mcap/sales | 1.10 | 0.90 | 0.70 |
At Rs 342, the stock is trading at 11.7 times its FY09 estimated earnings and 9.5 times FY10 earnings. Based on the sum-of-the-parts valuations, analysts assign a price target of about Rs 480-500 per share, which includes its real estate business worth about Rs 200 per share.
