Punj Lloyd

Pricey but Solid

Punj Lloyd is one of the largest engineering construction companies in India. It provides integrated design, engineering, procurement, construction and project management services for (a) energy industry (onshore and offshore pipelines, gas gathering systems, oil and gas tanks and terminals including cryogenic LNG and LPG storage terminals, process facilities in the oil and gas industry including refineries for power plant projects); and (b) infrastructure sector projects (highways, flyovers, bridges and elevated rail roads). Other services include comprehensive plant and facility maintenance and management.

Punj Lloyd has also executed small orders for laying optic fibers for the telecom sector. The company's operations are spread across the Middle East, the Caspian, Asia Pacific, Africa and South Asia with 12 project and marketing offices and 13 subsidiaries. With over 20 years of experience in construction projects Punj Lloyd has erected more than 5,300 kilometers of pipelines and four million cubic meters of tanks and terminal capacity and has executed 11 refinery modernisation and quality improvement projects. In FY 2005, it sold its equity in an annuity-based NHAI project and also earned bonus for early completion of the project. The current order book (November 2005) stands at Rs 7000 crore with an unexecuted order backlog of Rs 3700 crore (of which 47% is from NHAI).

The net proceeds from the issue of new equity shares will be utilised for investment in capital equipment (Rs 150 crore), prepayment of debt (Rs 300 crore) and investment in infrastructure projects (Rs 50 crore) besides for general corporate purpose.

Strengths:

1. Punj Lloyd is one of the few Indian construction players to own a large fleet of sophisticated construction equipment.
2. Projects under the higher-margin driven energy segment (40% of the order book), its area of specialisation, have relatively shorter completion period of 8-15 months as compared to two-three years of road projects (60% of the order book), where the margin is lower. In FY 2005, about 80% of the total revenue came from the energy sector
3. More than 180 projects executed in over 12 countries. In FY 2005, approximately 58% of consolidated sales and contract revenue generated from projects executed outside India. This is the highest in the Indian construction industry.
4. Worked on projects for leaders in the energy industry in India and abroad and has got repeat orders despite increased competition with 58% of the order book (FY 2005) comprising export orders. Moreover, has presence in all areas of oil and gas project management. Thus, the geographical spread has no concentration in a single region or country and non-dependence on single project is a major positive.
5. Successful execution of projects in different parts of the world adds to knowledge of working in different terrain and cultures. Additionally, its experience in the segment gives it a better chance at the pre-qualification stage. It is one of the few companies to have laid pipelines, including those with a 48-inch diameter, in shallow water and swampy or marshy terrain.
6. The recent discovery of large oil and gas reserves in the world (including India) is expected to increase the demand for pipelines, storage tanks, terminals and process facilities in the oil and gas industry. The national pipeline grid by Gail, the east-west pipeline by Reliance Industries and the increasing capital investment by major players in the energy industry in India are expected to further fuel this growth. Moreover, the increased thrust by the Indian government on increased and better infrastructure involving speedy procedures and new public-private partnership models augur well.

Weaknesses:

1. Punj Lloyd has performed substantial projects on a lump sum or fixed price. In FY 2005 and six months ended September 2005, approximately 41.61% and 35.48% of the consolidated revenue was derived from fixed price/ lump sum contracts. The actual expense for executing a lump sum or a fixed-price contract (mainly in the infrastructure projects) may increase substantially on account of unanticipated increases in input cost and delays in execution of projects. In FY 2005, the operating profit margin (OPM) slipped sharply due to the lower margin in annuity-based NHAI projects due to increased steel and cement costs.
2. Since 58% of the consolidated sales comes from projects outside India (FY 2005), there is risk arising from foreign exchange fluctuation as well as normal legal and political risks associated with operating in foreign countries.

Valuation:

With a price band of Rs 600- Rs 700, Punj Lloyd has an abnormally high PE of 113 to 131.8 times FY 2005 earning of Rs 5.3 (excluding extraordinary items) on a post-issue equity of Rs 52.22 crore. The fixed-price NHAI project has hit OPM severely in FY 2005 due to increased steel and cement prices. Moreover, the order inflow got delayed due to elections in India and Indonesia. Thus, the operating profit in FY 2005 had almost halved. However, it is expected that OPM will bounce back and growth in sales will accelerate in FY 2006. Thus, EPS in FY 2006 can cross Rs 20.4 achieved in FY 2004. This will bring down PE to around 25 to 35.

Larsen & Toubro (L&T), which is India’s largest engineering and construction company and more than 6.5 times the size of Punj Lloyd, trades at PE of 27.5 times expected FY 2006 EPS. L&T’s market cap to sales ratio is 1.57 compared to Punj Lloyd's 1.79-2.10 (at the upper and lower price band). The order backlog to sales ratio of L&T's Engineering & Construction division on September'05 stands at 1.7 against Punj Lloyd's 2.1 on November 2005. Overall the issue is costly (from short-to-medium term angle) even at Rs 600 and only long-term investors should consider the offer.