Punj LLoyd

At a time when a number of established infrastructure companies have reported sedate December quarter numbers, due to the macro economic slowdown, Punj Lloyd’s order flows and revenue growth have remained relatively healthy. But profits have been under pressure, with internal issues such as cost overruns and revocation of bank guarantee by its foreign subsidiary’s client weighing on the company’s consolidated profits.

For the quarter ended December 2008, the company posted consolidated losses of Rs 225 crore, on revenues of Rs 3,120 crore. This, together with delays in execution of some orders (delay being from the client’s end), may depress the near-term earnings picture for the company. Strong order flows, together with a shift in focus to segments that are less affected by the slowdown, however, continue to lend visibility to Punj Lloyd’s long-term growth story.

We, therefore, recommend a hold on the stock at this stage. Those with a three-year perspective can consider accumulating the stock on declines linked to broad markets. At the current market price of Rs 80, the share trades at six times its estimated consolidated earnings for FY10.
Dragged by subsidiary’s misfortunes

Over the past few quarters, Punj Lloyd has been disclosing details of cost over-runs that its UK-based subsidiary, Simon Carves (a subsidiary of Sembawang), has been facing on its legacy projects. While the company has been partly providing for this over the past few quarters, the issue appears to have escalated to a point where the concerned client SABIC has invoked a bank guarantee as well as performance guarantee, thus terminating the contract.

While Punj Lloyd’s management claims that the project had attained over 98 per cent execution and that Simon Carves has initiated court proceedings against SABIC, the former decided to provide for cost overruns of Rs 207 crore from the project in the December 2008 quarter.

Further, Rs 106 crore of expenses, on account of forex translation losses, had to be provided for Simon Carves’ loans as well as other loans. As a result, the company witnessed operating losses of Rs 73 crore (before interest depreciation and taxes) in the December quarter. But for these losses, operating profits would have grown by 28 per cent.

Aside of these issues, Punj Lloyd has demonstrated strong revenue growth of 48 per cent confirming that there have been no execution delays from its side on its on-going projects.

The management has stated that it has provided for cost over-runs on all existing projects, which could suggest that these losses may be one-off in nature. The company’s current debt equity ratio at less than one (although borrowing costs have gone up) also provides comfort on the financial front. If so, what other concerns are likely to mute the company’s earnings in the near term?
Current concerns

For one, the invocation of guarantee of Rs 200 crore has not been written off in the company’s books. If the final outcome of the Court proceedings, which may take anywhere between a year-and-a-half or two, is not in the company’s favour, another one-time expenditure can drag profits.

Two, Punj has also had cost-overruns in its offshore project with ONGC, as a result of engineering modifications made by ONGC, increase in inputs as a result of the changed specification and transportation costs. While Punj has been fairly conservative in providing for these over-runs, the company has prepared variation orders and claims to recover the same.

Even as there appears little reason to believe that the company cannot regain these additional costs incurred, it does cast a doubt on the company’s ability to build cost structures that cause less volatility to earnings. Having said this, it needs to be borne in mind that orders of a similar nature are not a regular feature.

Three, the company has stated that about 18 per cent (four orders) of its current order book of Rs 20,900 crore face the risk of delay in execution in the short term, either due to projects kept on hold by the client or delays in land acquisitions or financial closure on the client’s part.

While these delays could be as a result of funding constraints on the client’s side, near-term revenue flow from these projects may have to be discounted. Therefore, even after excluding these, the company’s revenue visibility over the next two years remains steady.

Assuming a revenue growth of about 20 per cent compounded annually between FY08-10, this increase, although it appears healthy, could well suggest a slowdown from the aggressive growth levels of 48 per cent CAGR witnessed over the four-year ended FY08.
Order picture

Punj Lloyd has been able to receive about Rs 2,300 crore of order inflows during the December quarter. Muted as it may seem, the company has further received over Rs 1,400 crore of orders in the last two months alone, suggesting that demand, though not enormous, has been fairly consistent.

The sedate growth could also be a result of the company becoming more choosy in obtaining a less risky business mix. Punj has been slowly shifting its focus to infrastructure/construction projects, which accounted for 75 per cent of order inflows in the third quarter and make for 33 per cent of the overall order book of Rs 20,900 crore.

The company’s business in overseas countries has also not come under serious threat so far, although the slowing of the West Asian economies could reduce capex activities. Such a slowdown could, however, be attributed to the fund crunch rather than a crude price correction.

Recent projects won in Libya, Indonesia and Singapore suggest that the company’s order inflows from overseas has remained strong. Further, according to the company, none of the national and international oil company projects are witnessing a slowdown in projects, although there could be fewer project awards in the petrochemical space.

From countries such as Qatar, which is high on gas exports, Punj expects incremental orders. Going forward, given the strength of its subsidiary, Sewbawang, in infrastructure projects, Punj is well-placed to comfortably diversify further into such projects in the event of orders drying up in the oil sector.