Simplex Infrastructures

Investors with a high appetite for risk and a two-three year perspective may buy the stock of Simplex Infrastructures, a diversified construction contractor. Our previous buys on this stock were at Rs 137 in January 2009 and at Rs 415 in September 2008. A pick up in order inflow, diversified presence in terms of segments and geography and a graduation to build-operate-transfer projects bode well for the company.



Trading at Rs 492, the stock is at 20 times trailing twelve-month earnings and about 15 times the estimated FY-11 earnings. A very sharp spike in borrowing costs poses a risk, as the company has low net profit margins and interest cover.

Diversified order book

Simplex has a presence across segments such as infrastructure real-estate, , industrial and building contracts, power projects, urban infrastructure, roads and marine projects, besides an overseas presence.

The order book also has a mix of government and private contracts thus tapping opportunities in both besides reducing risks of sector concentration.

Within the buildings segment (22 per cent of order book), projects lean towards the safer residential sector than the slightly riskier commercial real estate. The company also stands to boost order inflow from Government spending on urban infrastructure. Projects undertaken so far include sewerage and water supply, besides metro projects for cities such as Bangalore, Mumbai and so on. The segment constitutes 15 per cent of order book. The power segment constitutes 27 per cent of orders, with the rest from bridges, roads, piling and so on.

Hitherto, Simplex was a pure-play construction contractor. In FY-10, it bagged a road expansion project in consortium with SREI and Galfar on a build-own-operate basis. Slated to be completed in a little over two years, this order marks Simplex taking advantage of its expertise to move into bigger projects. The ability to partner with other established players is an another plus.

The order book at the close of FY-10 stood at a substantial Rs 11,000 crore, 2.5 times the revenues for FY-10. A cautious stance adopted by the company in booking new orders, besides a decline in overseas orders meant that order inflow was rather muted.

Pick up in flows from the March quarter, which saw a 94 per cent increase in order inflow, resulting in a 6 per cent growth in order book. An execution period of two to two-and-a-half years provides medium-term earnings visibility.

Overseas orders

About 25 per cent of revenues and order book stem from overseas contracts. Projects were concentrated in the Middle Eastern markets, which resulted in a slowing of order inflow as execution faltered. This also muted revenue and profit growth in FY-10.

Revenues from overseas orders fell by 21 per cent in FY-10; in the three years prior, revenues had grown over 80 per cent. The company has since moved away from West Asia, diversifying into other regions such as South-East Asia and North Africa.

Financials

Revenues in FY-10 fell 5 per cent. However, due to lower interest and direct costs, net profit decline was contained at two per cent. In a three-year period, sales have clocked a 37 per cent compounded annual growth, while net profits recorded a 34 per cent growth in the same period.

Operating margins have been maintained at about 9 per cent for the past five years. Price escalation clauses built into most contracts, domestic or overseas, will help protect operating margins. Working capital cycle has also been maintained at about 90 to 100 days.

However, interest and depreciation costs have been quite a drag, with net margins hovering at about 3 per cent. In FY-10, even with a 21 per cent drop in interest costs on backs of lower interest rates and replacing high-cost debt, net margins were still at 2.8 per cent (2.6 in FY-09) due to a 30 per cent increase in depreciation.

The company’s debt-equity stands at 1.3 times. Should the company secure fresh BOT contracts, it would indicate a higher capital requirement. With an interest rate uptrend in the offing, and an interest cover of about two times, besides high depreciation costs, margins are still likely to come under pressure.

via BL