Valecha Engineering's strong order book, improved balance sheet and plans for diversification augur well for its earnings growth. An investment can be considered in the stock with a 2-3 year perspective. At the current market price the stock trades at eight times its expected earnings for FY08 and is at a significant discount to peers.
Valecha is an engineering, procurement and construction (EPC) contractor for roads, piling works and airport runways. The company's order book of over Rs 800 crore is over four times its FY06 revenues. Road projects account for 70 per cent of the orders. While road projects are low-margin in nature, the company has managed to maintain its operating margins at 7-8 per cent on the back of better margins from piling projects. Until 2005, the company was unable to ramp up its order size as its diminutive net worth acted as a constraint in bidding for larger projects. In 2006, it managed to expand its net worth by 3.5 times. The company now appears well placed to bid for larger orders given its technical qualification and the improved capital adequacy. Increase in the size of orders may also pep-up operating margins. The company has executed airport runways in cities such as Mumbai and Chennai. With the airport privatisation activity gathering steam, the company appears well placed to bag similar orders from developers of airports.
While Valecha is less diversified than bigger players such as IVRCL Infrastructures, it now plans to diversify to BOT annuity, real estate and hydropower projects through special purpose vehicles. We expect real estate to play an active role in revenue contribution in the long term while the proportion of road projects may come down. The risks to the investment stem from the fact that Valecha is a small-cap stock with a market capitalisation of about Rs 140 crore and may be quite vulnerable to a corrective phase. The stock has declined by about 45 per cent since May in line with market trends and concerns about margin pressures on smaller construction companies. However, Valecha could contain such pressures through price escalation clauses built into its contracts. Moreover, the stock's decline has made valuations more attractive