Punj Lloyd

A repeat instance of cost overruns by Punj Lloyd’s subsidiaries, albeit with a different client, has sprung a surprise on investors. This comes after the management’s comments in the June quarter that the company has made adequate provisioning for other projects where it anticipated cost overruns. Slow-moving contracts in Libya and Jurong Island also cast doubts on timely execution of projects.

Volatility and unpredictability on the cost front and uncertainty in revenue growth as a result of delayed projects reduces comfort from an investment perspective, even as Punj Lloyd continues to be well placed to bag more orders in the oil and gas and infrastructure space.

Investors can consider exiting the stock of Punj Lloyd on the back of recent developments. The company’s performance over the next two quarters, coupled with the outcome of the troubled contracts, would determine the company’s growth prospects over the medium-term.

At the current market price of Rs 212, the stock trades at 20 times its likely per share earnings for FY-10. The recent happenings pose a challenge for earnings to keep up with this valuation.
Slipping up

Punj Lloyd’s consolidated sales for the September quarter fell 2 per cent while net profits dropped 63 per cent to Rs 52 crore, over its year-ago numbers. The company has stated that orders from Libya, which account for 37 per cent of its current order book, yielded neither revenues nor profit margins in the September quarter. The revenue booking is expected to begin in the third quarter. Given the large-size of these orders (Rs 9,850 crore), any further delays in the execution of projects in Libya would dent revenue growth.

Punj Lloyd’s profits plunged as a result of a fresh case of cost overrun, this time for an Engineering Procurement and Construction (EPC) contract for a bio-ethanol plant for its client, Ensus. The company was forced to book cost overruns of Rs 104 crore, claimed to be a result of low productivity and delays attributable to sub-contractors. Neither the agreement with the contractors nor the local laws provide scope for claiming the same from them.

There are two discomfiting factors to this event: One, the earlier project in which cost overrun was incurred was a legacy order of the overseas subsidiary, Simon Carves. That is, the order was bagged before Punj Lloyd acquired the company. This bio-ethanol plant project is, however, stated to have been bagged post acquisition — which suggests that the project may have been verified for its feasibility by Punj Lloyd as well. Two, a less significant Rs 30 crore was booked as losses from the current project in the June quarter itself; this did not however find any separate mention in that quarter. These two factors cause some uneasiness from a standpoint of greater transparency.

Punj Lloyd’s woes came to light in December 2008, when its auditors qualified non-provision of certain costs. This issue later ballooned into Rs 430 crore of losses by FY-09. The company meanwhile had to provide for Rs 360 crore of additional costs incurred in ONGC’s Heera project in March ’09. There appears more hope for recovering this, as changes in specifications and resulting excess costs are common in such projects.

The company is once again facing trouble on a project awarded by Ensus. Another £16 million (Rs 125 crore) might be demanded by the client as liquidated damages. Punj Lloyd’s management hopes to enter into a production-sharing agreement with this client as the plant is being built with a 15 per cent additional capacity than was planned originally. Even if such a favorable pact is entered into, the cost recovery may be over two years. The litigation with the earlier client, SABIC, and the negotiation with the present one, may affect the earnings growth of Punj Lloyd over the next few quarters.
Strength in order book

The biggest strength for Punj Lloyd currently is its healthy order book of Rs 26,808 crore (2.2 times FY-09 consolidated sales), originating largely from infrastructure and hydrocarbon segments. The order inflows though, have declined sharply compared with a year ago. We believe that oil and gas projects would, however, provide traction to the company’s order intake. Such orders, typically pipelines and storage tanks, may provide lucrative margins than infrastructure projects. Operating profit margins for the September quarter fell 3 percentage points to 7.2 per cent.

Another concern on the financial front is the mounting interest cost, despite raising funds through qualified institutional placement and non convertible debentures. Clearly, working-capital requirements appear stretched.