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Tuesday, June 27, 2006

Kotak - GHCL

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Infrastructure Reports - Edelweiss

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IVRCL Vs HCC: Constructing India!

The construction industry in India has received a fillip during the past 3 years, with the government showing increased focus towards developing a strong and sound infrastructure setup in the country. The industry is the second largest economic activity after agriculture, and is estimated to grow at an average rate of 9.5% during FY02 to FY06, against 8.6% average growth for the services sector during this period. In this article, we compare the two major players in the construction sector – IVRCL Infra and HCC – and see where they stand on a relative basis.

About IVRCL Infra
IVRCL Infrastructures & Projects Ltd., (formerly IVR Constructions Limited) was incorporated in 1987 and commenced its operations in 1990, thereby establishing itself as a premier EPCC (Engineering Procurement, Construction and Commissioning) & LSTK (Lump Sum Turnkey) Service Provider with front-end engineering capabilities. The company initially undertook small projects for building hospitals and roads in the interior regions of the country. Of late, it has emerged as a major player in water transmission, treatment and wastewater management. IVRCL is also known for its desalination drive, which was vindicated by it winning the Chennai Desalination Water Plant Project from the government. Beside this, the company is also into the business of constructing buildings and industrial structures.

About HCC
HCC is one of the largest private sector construction companies in India and the foremost in infrastructure building. The company has been involved in the construction of diverse projects ranging from power dams, highways and bridges to marine structures, water supply, factories and waste treatment plant. Apart from the domestic presence, HCC has executed several projects overseas in countries like Iraq, Nepal and Tanzania. Towards this, the company has entered into a number of technical collaborations as well as joint ventures with overseas players, bringing the latest technical know-how into the execution of its projects.

The comparison…
A look at the charts below makes it clear that HCC is a more diversified player than IVRCL. This is because the latter, though operating in four distinct segment, derives more than 60% of its revenues from the water segment, where it has presence into water desalinisation and supply kind of projects. In fact, the company is current executing the Rs 1,000 m Chennai Desalination Water Plant Project, which is supposed to be the largest of its kind in India. At the end of March 2006, IVRCL's order backlog stood at Rs 62.5 bn, almost 4 times its FY06 sales. Out of this backlog, the water segment contributes to 50% and the balance is distributed between roads (27%), building & structures (16%) and power (7%). Further, the management expects the order backlog to grow by 35%-45% in FY07. The company has especially stressed on its increasing focus in the power segment, whose contribution to the company's topline has increased from 3% in FY05 to 21% in FY06. In this segment, IVRCL has benefited from the government's thrust on improving the rural power situation through its Rajiv Gandhi Grameen Vidyutikaran Yojana.

Now, if one were to look at HCC's business mix (right hand pie chart), revenues are almost equally diversified into transport, water supply and hydel power segments, among others. In the transport segment, the company is especially focusing into BOT based projects, where margins tend to be relatively higher than the contract business.

On comparing these two companies on financial parameters, while IVRCL has grown revenues and net profits compounded rates of 39% and 32% during the period FY02 to FY06, the growth for HCC has been 37% and 38% respectively. However, if one were to compare the profitability, IVRCL scores over HCC in terms of sustaining margins at the operating level. As seen from the adjacent chart, while EBIDTA margins for IVRCL have moved in a narrow range of 8% to 10% during FY03 to FY06, the same for HCC have declined from 16% to just over 9% during this period. Focus on relatively low margin road construction sector seems to have been the main reason for the declining margins of HCC. On the other hand, water treatment contracts earn better margins due to more complex execution and this has benefited IVRCL in the past. However, one must note that considering the influx of a large number of players into the construction space, companies have sacrificed margins to gain on volumes. The same is likely to continue in the future as well and, to that extent, profitability is likely to be impacted, for HCC and IVRCL alike.

Financial comparison (FY06)
(Rs m) IVRCL Infra HCC
Net Sales 14,957 20,241
EBITDA 1,343 1,843
EBITDA margins (%) 9.0% 9.1%
Other Income 57 38.1
Depreciation 110 542
EBIT 1,290 1,339
EBIT margins (%) 8.6% 6.6%
Interest 253 413
PBT 1,037 926
Tax 108 172.353
PAT 929 754
Net profit margin(%) 6.2% 3.7%
Diluted EPS (Rs) 8.7 3
P/E 26.1 36.7

Comparative valuations
At their respective current prices of Rs 227 and Rs 108, IVRCL and HCC are trading at price to earnings multiples of 26 times and 36 times their FY06 earnings respectively. These stocks have been beaten down tremendously in the latest stock market correction and valuations have dropped to reasonable levels. Going forward, while we remain positive on the growth prospects of the construction sector in general and these companies in particular, investors need to look beyond order book accretions and study at what profitability are these companies accruing new orders.