Simplex Infrastructures

Simplex Infrastructures is among the few pure contracting companies in the infrastructure space that has managed to move up the value chain in terms of higher profitability while at the same time preserving the status of being contractors only.

The company has put up a strong show at a time when most other construction players have slowed down in growth and has also stood the test of surging commodity prices reasonably well.

Investors can consider buying the stock of Simplex Infrastructures (Simplex) with an investment perspective of two-three years. At the current market price of Rs 415 the stock trades at 10 times its expected per share earnings for FY10.

The stock has traditionally traded at a high premium to the industry average and the Sensex. While it continues this trend, its present price earnings multiple (on historical earnings) is near its three-year low valuations as of 2005. This presents an opportunity to enter the stock.
Expanding capabilities

Starting off as a piling contractor, Simplex quickly expanded its capabilities into executing projects in urban and marine infrastructure, industrial structures, roads, railways and power. While a good number of contractors would have charted a similar path, what differentiates Simplex is its well-diversified revenue mix.

For instance, revenues in the quarter ended June were a mix of industrial (25 per cent), marine (10 per cent), buildings (15 per cent), bridges and urban infrastructure (12 per cent each) segments, with some contribution from piling works, roads and railways. Diversification on this scale could be the key reason for the company’s ability to maintain robust order inflows, bucking the slowdown in the industry.

Simplex has also been conscious of changing opportunities in the industry and shifted focus to those sectors that hold better prospects.

For instance, its current order book shows a bias towards power projects, building contracts, railways and bridges and industrial structures. Clearly, the company has a higher proportion in sectors that hold potential for higher margins and provide scope for scaling up. For instance, in the power space, the company plans to transition from being a civil structure provider to a balance-of-plant executor.

We expect the power and urban infrastructure segments to be the key drivers for earnings and profitability while industrial and building projects could bring in higher volumes.

The company’s attempt to diversify geographically has also met with success. From a contribution of 9 per cent to revenues from overseas operations in 2006, the share doubled in FY 2008.

Overseas revenues, arising predominantly from construction work in the West Asian countries, contributed a whopping 27 per cent to the June quarter sales. Interestingly, the company has been able to naturally hedge the foreign currency revenues to a large extent as it has been utilising the revenues generated for capex and working capital requirements in the same geographies.

The above measures have ensured that the company’s order inflows remained robust. Simplex’s order book as of June 2008 stood at Rs 10,000 crore — a 56 per cent growth over a year ago.
Smart strategies

Simplex appears to be one of the few companies that has negotiated cost pass-through clauses that are in its favour. Close to 60 per cent of the company’s order book provides for a full pass-through of costs or requires the awarder of the contract to provide raw materials.

Of the remaining, 27 per cent orders are linked to indices where a large proportion of the cost hike is reimbursed. Orders with fixed price account for close to 15 per cent.

As the company has a practice of accepting short-term orders (with three-six months duration) such as piling works under fixed price contracts, this is unlikely to hit the overall margins. Among other companies only IVRCL has a similar favourable mix.

While the above could protect margins, the company may not see any significant improvement unless commodity prices remain stable.
Strong financials

Simplex’s revenue and earnings grew at a compounded annual rate of 41 per cent and 52 per cent, respectively, over the last three years. For the quarter ended June 2008, earnings, adjusted for extraordinary items, surged by 108 per cent. While operating profit margins witnessed an insignificant 50 basis point increase to 9.5 per cent, the company’s profit margins on domestic revenues took a dip, even as overseas margins remained high.

The management has stated that the dip is transitory in nature, owing to booking of mobilisation expenses on projects that are yet to contribute to revenues.

The cash position of the company also received a boost through qualified institutional placement in FY2008. Operating cash flows also turned positive on the back of an improvement in debtors’ turnover. Higher proportion of overseas revenue combined with increase in non-government clients could have led to the improvement. As a result of the above, Simplex managed to repay a part of its borrowings thus bringing the debt-equity ratio to comfortable levels and providing room for any fresh gearing.
New prospects

Simplex recently ventured into the onshore oil rig business. It leased out a recently acquired oil rig to Oil India for two years at a rental of $16,000 per day.

The company also hopes to let out three-four rigs by the end of this financial year. Such a business, although not fully related to its key business, would, nevertheless, provide a steady stream of income once the break-even is achieved in 2-2.5 years.

Similarly, in the real-estate space, the company’s gradual foray in the business without assuming responsibility for risk/cost of land (typically through joint ventures with a state Government) appears to hold potential. We, however, view this foray with caution at this juncture.