Sadbhav Engineering

Shareholders of mid-sized infrastructure player, Sadbhav Engineering, can subscribe to the ongoing rights issue made by the company. At Rs 725, the offer is at a massive discount to Rs 1,500, at which the stock trades. Investors will also be allotted three convertible warrants of Rs 425 each, exercisable between three and 18 months, for every share issued on the rights basis.



The rights offer price values the company at 15 times the standalone trailing earnings on a post-issue equity and 11 times estimated earnings for FY-12. Valuations are at a discount to peers such as Nagarjuna Construction. A strong order book, transition into a developer from a contractor, reduced reliance on the road segment in favour of higher margin irrigation and mining segments and sustained margins augur well for the company's prospects. The company plans to raise about Rs 45 crore, excluding warrants, from this issue. Proceeds will fund acquisition of equipment and investments in road BOT projects. Successful warrant conversion will raise a further Rs 80 crore.

Segment presence

Sadbhav derives most of its revenues — 78 per cent for FY-10 — from the roads and highways segment. While this segment does offer growth potential, delays in project completion and payments indicate that excessive reliance on this segment can prove risky. Sadbhav's move to build its presence in other segments — irrigation and mining — will help spread risk, besides improving margins. Share of these two segments has gone up from 15 per cent in FY-08 to 21 per cent in FY-10.

Current order book stands at Rs 6768.6 crore, of which 77 per cent is in the roads and highways segment, 14 per cent in mining and 10 per cent in irrigation. A good part of mining contracts come from Coal India and its subsidiaries, thereby providing a fairly steady order inflow.

BOT projects

The company has nine build-own-operate projects in its kitty, of which eight are on toll basis and the remaining on annuity. Two of the BOT projects have been completed so far, turning operational in the latter half of FY-09 and FY-10. Its annuity project is likely to be operational this financial year.

The company's successful completion of BOT projects signals its execution capacity, besides expanding its bidding capacity, both of which will enable it secure bigger projects in the coming years. That the company has also, thus far, faced no hurdles in tying up project finances is a further confidence booster. Indeed, Rs 18 crore from the proposed rights issue will go towards funding the equity portion of two of its BOT projects. Projects have been secured in consortium with players such as SREI Infra and HCC.

Healthy growth

Revenues grew at a compounded three-year rate of 37 per cent, while net profits clocked a growth of 26 per cent during the same period. Operating margins held strong at 13 per cent for FY-10, improving from the 12 per cent of the year before. Margins have also held at that level for the June quarter.

Of the issue proceeds, Rs 16.45 crore will part-fund acquisition of equipment, which would help sustain higher margins. Such ownership will ensure timely availability of equipment besides reducing hiring charges. With increasing contribution of mining and irrigation contracts, operating margins are likely to improve.

Even so, higher interest outgo led to pre-tax profit margins slipping to 8 per cent. Interest costs are also unlikely to wane in the near-term on the back of the investments required in BOT projects. Some comfort may be derived from a reasonable interest cover of four times, and that as a percentage of sales, interest costs have been fairly steady. Debt-equity ratio is at 0.9 times. The issue closes on September 6, 2010. For every 20 shares held in Sadbhav, one share will be allotted


via BL