ARSS Infrastructure and Projects - book profits

Investors can consider booking profits in the stock of ARSS Infrastructure and Projects, a construction contractor in the infrastructure space. At Rs 1,177, the stock is valued at 20 times the trailing 12-month earnings. Peers such as Tantia Constructions trade at valuations of 8 times.



Valuations on estimated FY-11 earnings are at about 15 times. The stock has more than doubled from its market debut last March, when the issue was priced at Rs 450, about 9.5 times the estimated FY-11 earnings.

The company is primarily a construction contractor, operating in Railways, roadways and irrigation. It has no plans yet to move up to the status of an infrastructure developer that could afford it premium valuations. The listed space also offers similar construction contractors at lower valuations, and ARSS does not possess a unique edge.

Order book, while sizeable, is also fragmented, with a large number of small-sized orders.

The company has also seen the working-capital turnover ratio decline, as a result of inventory build-up. Interest costs also dent profit margins significantly.

Small-sized orders

The company's current order book position stands at Rs 3,472 crore, about 3.5 times the revenues for FY-10. With an average order execution period of 18 months, this provides for near-term earnings visibility.

However, the order book is spread over a large number of contracts numbering close to 134, bringing the average contract size to Rs 26 crore. The order-book comprises order values as low as Rs 8.6 crore. Fresh orders secured in the past few months also do not suggest scaling up to larger-sized orders.

ARSS does have orders of a higher value, such as an Rs 99.9 crore order from the Madhya Pradesh Road Development Corporation. Even so, in its key railways segment, it is still securing smaller-value contracts.

Diversification of order book from its tilt towards railways (currently about 43 per cent of order book) may be a welcome move to mitigate risks of sector concentration.

However, this segment offers higher margins, and as the company brings in a greater number of road and transport projects into its fold, the high operating margins it enjoys may be squeezed.

Financials

Sales recorded a three-year compounded growth of 96 per cent, while net profits grew 118 per cent. However, this scorching pace of growth is largely a result of a lower base, and such high growth rates are unlikely to persist in the coming years.

The working capital turnover fell steadily from 3.3 times in FY-07 to 1.9 times in FY-10. A build-up in inventory largely accounts for this decline; from FY-07 to FY-10, inventory growth has far out-paced growth in order book.

That aside, the company has also borne heavy interest costs. Operating margins for FY-10 stood at a good 18 per cent, a significant improvement from the 16 per cent in FY-08. Raw material costs and labour costs largely helped this improvement.

However, net profit margins were at 9 per cent for FY-10, only a slight improvement from the 8.7 per cent of FY-08. Interest costs, as a percentage of sales went up from 3 per cent in FY-08 to 5 per cent in FY-10.

Debt-equity is also on the high side at 1.4 times. The IPO offer document mentioned defaults on interest payments in FY-06, FY-04 and FY-03.