KNR Constructions IPO Review

Investors with a two-year perspective can consider applying to the initial public offer of infrastructure company KNR Constructions. A strong order book, reasonable track record in the industry and ability to forge joint ventures to foray into larger projects are the key positives that provide earnings visibility over the medium term.

At the offer price band of Rs 170-180, the company is valued at 8-9 times its expected per share earnings for FY 2009 on the expanded equity base. The stock’s market capitalisation at the issue price would be about Rs 500 crore. The small market-cap could expose the stock to steep declines if there are any broad market corrections. Investors should, therefore, be willing to hold the stock over a longer time horizon.
Offer details

KNR Constructions is a Hyderabad-based infrastructure company with operations predominantly in the road and highways sector. The company is also present in irrigation and urban water infrastructure segments. It plans to raise Rs 142 crore through this offer. The proceeds will be utilised to invest in capital equipment and finance build-operate-transfer (BOT) projects secured through joint ventures.
Strong order book

The unexecuted portion of the orders in hand is Rs 1,734 crore. This is about 5.4 times the company’s sales for FY 2007.

That a good number of these orders are slotted for completion by FY 2009 provides strong earnings visibility for the next two years.

KNR is also geographically well diversified with state/NHAI projects in Andhra Pradesh, Uttar Pradesh, New Delhi, Assam and Gujarat. While the South accounts for 70 per cent of the order book (as a result of the large size of BOT orders bagged in the region), the rest of the orders are from the East, North-East and the Northern regions.

With the National Highway Development Programme moving to the next phases (Phase IIIA and later IIIB) of road development, KNR’s qualification in projects across the country lends confidence as to its ability to bag bigger orders in the new phases.

While roads remain KNR’s area of focus, it has diversified into irrigation as well as urban water solutions. Although business prospects for these segments remain bright, the company may have to compete with larger/established regional players.
Deriving strength through joint ventures

KNR has steadily moved to implementing larger-sized orders, thus improving its operating profit margins. Its OPMs have grown from 8.3 per cent in 2006 to 15.5 per cent for the half-year ended September 2007. The company’s ability to forge successful joint ventures may have been the key to ramp up the size of orders.

Notable among them is KNR’s association with Patel Engineering for the past seven years. Joint ventures and special purpose vehicle (SPV) projects with Patel Engineering have enabled KNR to not only diversify to other locations but also move to big-ticket orders. Its recent venture into BOT projects in the road space is through SPVs of Patel-KNR. These SPVs, in turn, secure KNR the Engineering Procurement and Construction (EPC) contract for such projects.

Interestingly, in order to forge a cautious entry into this new segment, the company has decided to go in for annuity-based BOT projects, which provide assured payments from the Government. The company plans to bid for toll-based projects too in future. Its well-timed move into the BOT space and the prospects arising from Phase IIIA (which awards only BOT projects) augur well for future orders in this segment.

KNR being a mid-sized company, its cautious approach to new segments through joint ventures with reputed players and annuity-based models minimises the risks typically associated with small companies aiming to qualify for bigger/high-end projects.

KNR’s net profit grew at a compounded annual rate of 42 per cent over the three years ended FY 2007. The company witnessed some slowdown in orders in 2005 before they picked up pace. While the prospects for the next two years, based on orders in hand, appear bright, investors with a longer perspective may have to look out for the company’s ability to scale up the order book beyond this time frame.

Although KNR has comfortably managed its debt obligations, its debt-equity ratio has been high. Post offer, however, the ratio would come to 1.6. An adverse interest rate scenario, though not an immediate risk, could affect the bottom line. At the operating profit level though, the increasing contribution from irrigation and urban water infrastructure projects may bolster earnings.

The offer is open during January 24-29. Axis Bank is the book running lead manager.