Sunday, January 24, 2016

KNR Construction: On the right path

The road sector is expected to see better times in the next two years, with the National Highways Authority of India set to award 20,000 km of road projects, worth an estimated Rs.2.3 trillion.

Over two-third of this will be through engineering procurement and construction (EPC) contract orders — a shift from the build, operate and transfer (BOT) model awards. The changes are likely to revive the fortunes of EPC service provider companies.

Investors looking to make long-term bets on this segment can consider buying shares of KNR Construction (KNR). The company has executed road contracts in 12 states, besides three toll projects. Its order book growth is strong and stands at over four times the 2014-15 revenue. KNR has a good execution track record and has received early completion bonus for delivering roads ahead of schedule.

The company has been able to maintain healthy operating margin even during the downturn, thanks to it cutting costs substantially by executing orders in-house rather than relying on sub-contracting. Its balance sheet is strong with comfortable leverage levels.

These strengths have not gone unnoticed and the stock has surged since February 2014. But it is still attractively valued, given its high growth potential.

The current price discounts the company’s trailing 12-month earnings (adjusted for one-time gains) by about 19 times. The stock’s valuation is cheaper than that of peers, such as NCC, Sadbhav Engineering and Gayatri Projects, which are either loss-making or are trading at much higher multiples.

Strong revenue growth

KNR’s order book, which provides visibility into future revenue, is growing at a fast pace. Its order book contracted between 2012 and 2015 by 27 per cent as the company went slow on bidding, in order to maintain margins.

This has changed, thanks to favourable policies and more projects in the road sector. KNR bagged new orders worth Rs.2,600 crore in the first half of 2015-16 and the total outstanding orders were Rs.3,665 crore as of September-end. While over 90 per cent of the orders are from the Central government, the company contracts work for other road developers, including Sadbhav Engineering, Ashoka Buildcon and L&T. It also has orders from Bangaladesh.

KNR is targeting additional order wins of over Rs.500 crore in the second half of 2015-16.

Revenue fell 4 per cent in the first half of 2015-16 due to low order levels in the earlier years. It may not pick up in the next three-four quarters until execution reaches the revenue recognition stage. But the long-term revenue growth should be robust on the back of existing and expected new order wins.

The company also earns revenue from its completed BOT projects (toll and annuity). Its BOT project in Kerala became operational in October 2015, ahead of schedule. Its Muzaffarpur Barauni tollway project has been facing delays, but about 90 per cent of the work has been completed as of September 2015. Project completion could add to revenue in the near term.

Stable margin

KNR has maintained its operating margin at around 15 per cent, even during the downturn, helped by on-time completions. In the first half of 2015-16, operating margin improved 120 basis points year-on-year to 16.2 per cent, as costs were managed well. Operating margins could remain at 15-16 per cent levels in the next few years.

Pre-tax income increased 35 per cent Y-o-Y in the first half of 2015-16, helped by lower interest expense due to debt reduction and lower depreciation expenses.

The company changed its tax policy in 2012-13 and started claiming benefits under Section 80I for lower tax rates.

The changes have helped net margins to rise to 8 per cent from 6 per cent levels earlier. In the September 2015 quarter, KNR received the Section 80I tax settlement of Rs.31 crore for prior taxes paid, boosting net profit.

KNR’s consolidated debt as of March 2015 was about Rs.760 crore and its debt-to-equity ratio is 0.8 times.

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