Valecha Engineering : Buy

Valecha Engineering's strong order book, improved balance sheet and plans for diversification augur well for its earnings growth. An investment can be considered in the stock with a 2-3 year perspective. At the current market price the stock trades at eight times its expected earnings for FY08 and is at a significant discount to peers.

Valecha is an engineering, procurement and construction (EPC) contractor for roads, piling works and airport runways. The company's order book of over Rs 800 crore is over four times its FY06 revenues. Road projects account for 70 per cent of the orders. While road projects are low-margin in nature, the company has managed to maintain its operating margins at 7-8 per cent on the back of better margins from piling projects. Until 2005, the company was unable to ramp up its order size as its diminutive net worth acted as a constraint in bidding for larger projects. In 2006, it managed to expand its net worth by 3.5 times. The company now appears well placed to bid for larger orders given its technical qualification and the improved capital adequacy. Increase in the size of orders may also pep-up operating margins. The company has executed airport runways in cities such as Mumbai and Chennai. With the airport privatisation activity gathering steam, the company appears well placed to bag similar orders from developers of airports.

While Valecha is less diversified than bigger players such as IVRCL Infrastructures, it now plans to diversify to BOT annuity, real estate and hydropower projects through special purpose vehicles. We expect real estate to play an active role in revenue contribution in the long term while the proportion of road projects may come down. The risks to the investment stem from the fact that Valecha is a small-cap stock with a market capitalisation of about Rs 140 crore and may be quite vulnerable to a corrective phase. The stock has declined by about 45 per cent since May in line with market trends and concerns about margin pressures on smaller construction companies. However, Valecha could contain such pressures through price escalation clauses built into its contracts. Moreover, the stock's decline has made valuations more attractive

Indiainfoline - Valecha Engineering

Valecha Engineering Ltd.

BUY

CMP: Rs209

VEL’s order book position at Rs8bn is a healthy 5.5x its FY06 sales. The company is awarded a significant part of its orders during the last nine months with order inflow rising to 4.6x FY06 sales. The company ramped up its networth through a preferential issue and GDR. Any announcement of an award of a BOT project on account of its increased financial muscle would lead to a positive surprise.

We expect an order intake in the region of Rs4bn during FY07, translating into an order intake of 1.8x its execution. Based on the present order book and the expected ones, we estimate VEL’s turnover to rise by 49.6% and 65.6% during FY07 and FY08 respectively.

VEL holds equity shares of Jyoti Structures, which translate into Rs76.9 per share of VEL diluted equity capital, which is 37.1% of the CMP. Besides, the stock is currently trading at its book value with a market capitalization of 0.9x its FY06 sales. This checks any significant downside to the stock from current levels.

The stock is trading at a P/E of 10.6x and a Price/CEPS of 8.3x its FY08E earnings and an EV/EBIDTA of 5.7x for the same period, which makes it a compelling buy. These estimates leave scope for upside from the company’s real estate foray. VEL, which generates 70% of its revenues from roads, offers good value, limited downside and high visibility for the next 2-3 years. The company has been consistent with dividend payments and 36% of the present equity is on account of bonus. We recommend a BUY with a one year price target of Rs294, based on a target enterprise value of 8x its FY08E EBIDTA and 50% discount to the two stocks held in its investment portfolio.