Road construction companies namely IRB Infrastructure, Sadbhav Engineering, Ashoka Buildcon, KNR Constructions and PNC Infratech have been the favourites within the mid-cap space, mainly due to the brisk pace of order awarding by National Highways of India (NHAI) in the past quarters. The Street, too, was hopeful that these companies would lead the earnings growth among mid-caps in December 2015 quarter (Q3FY16). But despite Q3FY16 results throwing up mixed trends, the street's bullishness on these companies remains unchanged, primarily due to optimistic order flow guidance in Q4FY16 and the longer-term growth prospects for the sector. Companies such as Sadbhav Engineering and KNR Constructions witnessed insignificant order flows during the December quarter. However, some like PNC Infratech, Ashoka Buildcon and Sadbhav Engineering guide for order flows of Rs 1,500-2,400 crore between March 2016 and June 2016. Also, with Q4 of any fiscal usually seeing higher order inflows, the Street expects road infrastructure companies to post 15-20 per cent revenue growth in March 2016 quarter. The Union Budget too is expected to announce higher allocation to infrastructure sector, including the roads segment.
As for the December 2015 quarter, while IRB Infra, Ashoka Buildcon and PNC Infratech kept up with expectations posting revenue growth of 32-38 per cent, results from KNR Constructions and Sadbhav Engineering were a let down. While Sadbhav Engineering's consolidated top-line grew by just four per cent due to lower mining revenues (though a small revenue contributor at about 15 per cent), that of KNR Constructions dipped by about 4.5 per cent year-on-year. But, the positive takeaway is upward trend in toll collection for the fifth consecutive quarter. "Traffic growth rate continued to maintain momentum for the 5th consecutive quarters, with 6% volume growth clocked by IRB Infrastructure, Sadbhav Engineering witnessed six per cent plus volume growth. Ashoka Buildcon reported six per cent plus traffic growth," notes a recent Emkay Global report. With the momentum expected to stay in March'16 and thereafter, analysts remain upbeat on toll operators such as IRB Infra, Sadbhav Engineering and Ashoka Buildcon. What needs to be seen is whether the companies see any meaningful tariff hike in the coming months as wholesale price index (a key component in determining tariff increases) which is on a declining trajectory may limit the possibility of substantial toll fee hike.
Tariff hike in Q3FY16 was about two to three per cent year-on-year and consequently year-on-year toll revenue growth of IRB Infra and Sabhav Engineering was nine and 11 per cent respectively. Ashoka Buildcon however was an exception posting 22 per cent year-on-year increase in toll revenues. With further expansion in Sambhalpur project where operation will commence by March 2016 with 30 per cent tariff hike, analysts feel that Ashoka Buildcon may outperform the rest in terms of toll revenues growth in the near-term. Concerns, however, emerge in PNC Infratech's toll operations as its key Bareilly-Almora and Ghaziabad-Aligarh projects continue to operate at below than estimated collection levels.
Most road infra companies also earn revenues from road building operations (also called EPC). The quarter gone by saw an increase in revenue from engineering-procurement-construction (EPC) business. This consequently hurt the operating margins of IRB Infra dragging it from 61 per cent in Q3FY15 to 54 per cent in Q3FY16. Sadbhav Engineering too saw flat margins at 10 per cent, while the rest managed to increase their margins by 300 to 800 basis point year-on-year due to correction in raw material prices -- namely diesel and bitumen. Going ahead, margins are expect to remain healthy, led by traffic growth and as order book and execution picks up.
While interest cost continues to stay high for the industry, Teena Virmani of Kotak Securities says what is positive is the cooling-off of interest rates (25 to 30 basis points reduction in short term borrowings) and what needs to be watched is whether the average cost of borrowing reduces hereon.
That said, a decent top-line growth is shielding the interest cost escalation for now. But additional capital expenditure undertaken at competitive and challenging pricing scenario may curtail profit growth going forward.
Going by price target set by analysts polled on Bloomberg, the road infrastructure stocks offer 12-months price upside of 30 to 50 per cent. But if the expected order inflow targets are not met within the next two quarters, there is a risk of price targets seeing downward revision.
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