Simplex Infrastructure

Simplex Infrastructure

Jaiprakash Associates, IVRCL, Simplex Infrastructure, Shree Renuka Sugar

Jaiprakash Associates, IVRCL, Simplex Infrastructure, Shree Renuka Sugar

Simplex Infrastructures

Simplex Infrastructures

Reliance Communications,Piramal Healthcare, Pantaloon Retail, Simplex Infrastructure, Deccan Chronicle

Reliance Communications,Piramal Healthcare, Pantaloon Retail, Simplex Infrastructure, Deccan Chronicle

IOC, HPCL, Reliance Communications, Tulip Telecom, IVRCL, Simplex Infrastructure

IOC, HPCL, Reliance Communications, Tulip Telecom, IVRCL, Simplex Infrastructure

Simplex Infrastructures

Simplex Infrastructures

Simplex Infrastructure, Tata Steel, Polyplex Corporation

Simplex Infrastructure, Tata Steel, Polyplex Corporation

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.

Simplex Infrastructures

Simplex Infrastructures

Simplex Infrastructures

Simplex Infrastructures

Simplex Infrastructures

Simplex Infrastructures

Simplex Infrastructures

Simplex Infrastructures

Simplex Infrastructures

Simplex Infrastructures

Simplex Infrastructures

Simplex Infrastructures

Simplex Infrastructures

We reiterate a buy on the stock of Simplex Infrastructures (Simplex) for investors with a two-three year perspective. The company’s strong business and financial fundamentals — arising from its diversified business, presence in the relatively low risk business of contracting and superior return on equity — support its prospects in the construction space.

Simplex is unlikely to grow at the scorching pace (62 per cent compounded annual growth in earnings over the last five years) seen in the past; in other words, it may no longer witness the ‘mid-cap rate of growth’ witnessed from early 2000.

However, the company’s order-book and strong execution skills are likely to offer a more sustainable earnings model. Further, there remains substantial potential for higher spending in infrastructure and housing in the Indian context.

Contractors such as Simplex, with superior execution skills are likely to benefit from the long-term spending in these sectors.
Why the correction?

At the current market price of Rs 137, the stock trades at six times its trailing 12-month earnings. For the half year ended September alone, the company’s adjusted net profit grew by 82 per cent.

We believe that the steep correction witnessed by the stock over the past few months, is the result of an en masse de-rating of the infrastructure space.

While some among the infrastructure-developer players do face concerns in terms of slower order flows and shrinking IRRs, a steep hike in raw material costs and stretched working capital were the predominant risks seen in the contracting space.

However, with the liquidity situation easing, fears on the second score may be overdone.

Further, while September numbers did show some contracting companies give in to cost pressures, Simplex’s financials suggest that it handled these pressures better than the rest.

With the recent trend of declining cost of borrowing, improving liquidity and sharp reversal in commodity prices, the risks to earnings faced by the contracting companies may also partially abate.
Diversification helps

Simplex’s order-book, at Rs 10,700 crore, witnessed a growth of 50 per cent in the first half of FY09; impressive, at a time when orders especially from the private sector have been on the decline. Interestingly, building and housing accounts for as much as 28 per cent of the order book.

However, a good part of this comes from overseas projects, especially in West Asia, where the building activity was hectic until recently.

With the global economic recession beginning to be felt in West Asia as well, a slowdown in the construction activity in this region appears imminent.

The company appears to have anticipated this as it has diversified its presence into other segments as well. Urban infrastructure, power and other transport projects together account for a chunk of the order book.

The company has also shifted focus back to its core business in these tough times. Piling and ground engineering works, the key strength for Simplex, has once again gained ground, with the segment contributing 16 per cent to H1FY09 sales as against 10 per cent in FY08.

Overall, infrastructure projects would be the biggest revenue driver followed by industrial and building segments.

To this extent, the company’s exposure to sectors that have slowed down appears limited. In the long-term however, we expect Simplex to benefit from a gradual revival in the domestic housing construction.

Simplex has protected close to 90 per cent of its future revenues through price escalation clauses.

Nevertheless, the steep commodity price hikes, together with booking of mobilisation expenses for projects for which revenues are yet to be booked, led to about 120 basis points dip in operating profit margins to 8.7 per cent in the September quarter.

We expect OPMs to improve over the next few quarters for the following reasons: One, the benefit of a decline in commodity prices may be reflected in the financials with a lag of a quarter or two.

Two, the effect of a higher share of overseas orders (26 per cent of total order book) is likely to provide superior margins, once these translate into revenues.

On the bottomline, however, net profit margin may remain muted for sometime as higher depreciation (as a result of new assets) and interest costs may act as a drag.

On the latter, while the cost of borrowing could well decline, the quantum of borrowing, especially for working capital purposes, may remain high for sometime.

This premise is based on the likelihood of private sector clients (who account for about 60 per cent of expected revenues) needing longer periods to pay their dues or, in other words, higher debtor days as a result of the less robust industrial growth.

Simplex Infrastructures

Simplex Infrastructures is among the few pure contracting companies in the infrastructure space that has managed to move up the value chain in terms of higher profitability while at the same time preserving the status of being contractors only.

The company has put up a strong show at a time when most other construction players have slowed down in growth and has also stood the test of surging commodity prices reasonably well.

Investors can consider buying the stock of Simplex Infrastructures (Simplex) with an investment perspective of two-three years. At the current market price of Rs 415 the stock trades at 10 times its expected per share earnings for FY10.

The stock has traditionally traded at a high premium to the industry average and the Sensex. While it continues this trend, its present price earnings multiple (on historical earnings) is near its three-year low valuations as of 2005. This presents an opportunity to enter the stock.
Expanding capabilities

Starting off as a piling contractor, Simplex quickly expanded its capabilities into executing projects in urban and marine infrastructure, industrial structures, roads, railways and power. While a good number of contractors would have charted a similar path, what differentiates Simplex is its well-diversified revenue mix.

For instance, revenues in the quarter ended June were a mix of industrial (25 per cent), marine (10 per cent), buildings (15 per cent), bridges and urban infrastructure (12 per cent each) segments, with some contribution from piling works, roads and railways. Diversification on this scale could be the key reason for the company’s ability to maintain robust order inflows, bucking the slowdown in the industry.

Simplex has also been conscious of changing opportunities in the industry and shifted focus to those sectors that hold better prospects.

For instance, its current order book shows a bias towards power projects, building contracts, railways and bridges and industrial structures. Clearly, the company has a higher proportion in sectors that hold potential for higher margins and provide scope for scaling up. For instance, in the power space, the company plans to transition from being a civil structure provider to a balance-of-plant executor.

We expect the power and urban infrastructure segments to be the key drivers for earnings and profitability while industrial and building projects could bring in higher volumes.

The company’s attempt to diversify geographically has also met with success. From a contribution of 9 per cent to revenues from overseas operations in 2006, the share doubled in FY 2008.

Overseas revenues, arising predominantly from construction work in the West Asian countries, contributed a whopping 27 per cent to the June quarter sales. Interestingly, the company has been able to naturally hedge the foreign currency revenues to a large extent as it has been utilising the revenues generated for capex and working capital requirements in the same geographies.

The above measures have ensured that the company’s order inflows remained robust. Simplex’s order book as of June 2008 stood at Rs 10,000 crore — a 56 per cent growth over a year ago.
Smart strategies

Simplex appears to be one of the few companies that has negotiated cost pass-through clauses that are in its favour. Close to 60 per cent of the company’s order book provides for a full pass-through of costs or requires the awarder of the contract to provide raw materials.

Of the remaining, 27 per cent orders are linked to indices where a large proportion of the cost hike is reimbursed. Orders with fixed price account for close to 15 per cent.

As the company has a practice of accepting short-term orders (with three-six months duration) such as piling works under fixed price contracts, this is unlikely to hit the overall margins. Among other companies only IVRCL has a similar favourable mix.

While the above could protect margins, the company may not see any significant improvement unless commodity prices remain stable.
Strong financials

Simplex’s revenue and earnings grew at a compounded annual rate of 41 per cent and 52 per cent, respectively, over the last three years. For the quarter ended June 2008, earnings, adjusted for extraordinary items, surged by 108 per cent. While operating profit margins witnessed an insignificant 50 basis point increase to 9.5 per cent, the company’s profit margins on domestic revenues took a dip, even as overseas margins remained high.

The management has stated that the dip is transitory in nature, owing to booking of mobilisation expenses on projects that are yet to contribute to revenues.

The cash position of the company also received a boost through qualified institutional placement in FY2008. Operating cash flows also turned positive on the back of an improvement in debtors’ turnover. Higher proportion of overseas revenue combined with increase in non-government clients could have led to the improvement. As a result of the above, Simplex managed to repay a part of its borrowings thus bringing the debt-equity ratio to comfortable levels and providing room for any fresh gearing.
New prospects

Simplex recently ventured into the onshore oil rig business. It leased out a recently acquired oil rig to Oil India for two years at a rental of $16,000 per day.

The company also hopes to let out three-four rigs by the end of this financial year. Such a business, although not fully related to its key business, would, nevertheless, provide a steady stream of income once the break-even is achieved in 2-2.5 years.

Similarly, in the real-estate space, the company’s gradual foray in the business without assuming responsibility for risk/cost of land (typically through joint ventures with a state Government) appears to hold potential. We, however, view this foray with caution at this juncture.

Simplex Infrastructures

Simplex Infrastructures

Unitech, Simplex Infrastructures, India Cements,TVS Motor

Unitech, Simplex Infrastructures, India Cements, TVS Motors

Simplex Infrastructures

Simplex Infrastructures