>ENGINEERING & CONSTRUCTION (MERRILL LYNCH)

Stable Govt. to drive re-rating

■ Good governance in AP & Delhi voted; Buy Infra Builders
A stable Govt. in UPA alliance & voting back of Andhra (AP) & Delhi Govt. is great news for pick-up in Infra spends. Budget deficit will encourage divestment of PSUs such as NTPC, NHPC, Power Grid and more PPP projects, that should necessitate progressive policies in sectors such as power & roads. These coupled with Infra deficits creates a macro framework for robust sustainable growth & that has potential to drive E&C cos re-rating as they move into a higher orbit, in our view. We raise PO to factor-in re-rating across BAS-ML universe with top picks – E&C - BHEL (Rs2000 v/s 1700) & IVRC (255 v/s 215); Reliance Infra, JPA (developers).

■ Vote for incumbent Govt. in AP/Delhi = vote for governance
We attribute the voting back of incumbent Congress Govt. (see table 2) in the state of Andhra Pradesh (AP) led by land mark US$10bn Irrigation spends and Delhi – fixed water, power and transportation (metro rail + roads) problems. While this will not only encourage in-coming Govt. to accelerate Infra spends, but it will also act as role model other Govt. Loss of election by Mr. Balu, ex-transport minister despite win by his party in TN, may be a vote v/s ineffective governance.

■ Buy builders - stocks to re-rate before EPS become visible
Likely improving visibility of Infra capex, potential falling-in place of Industrial capex on return of business confidence coupled with the global liquidity makes for a potent combination to re-rate the sector till the order inflows / earnings becomes visible in the next few quarters. We think that once the earnings catch-up, rich multiples will start to look reasonable.

■ Top Picks: BHEL, R. Infra, IVRC, L&T & JPA

1. BHEL: We raise PO to Rs2000 (1700) as it will be the main beneficiary for the liquidity driven sector re-rating given its visibility of 23% CAGR in earnings, potential for PE expansion to 17.5x (15x) FY11E at 20% premium to Sensex and thrust on power capex incl. the ‘bulk’ ordering by its customers’ – NTPC/DVC.

2. Reliance Infra with surplus equity (~US$1.5bn) may benefit from likely auction of three more UMPP by Govt. in FY10E leading to higher E&C value and value of R. Power investment. Stock is inexpensive at 1.1x consolidated FY09A P/BV.

3. IVRC: We see IVRC to benefit from return of pro-Irrigation capex (70% of its backlog) Govt. in AP. Potential pick-up in roads / real estate capex is +ve.

4. L&T: PO Rs1235 (1110) on benefit from thermal & Nuke power capex, potential pick-up in roads & industrial capex from improving business confidence.

5. JPA: Markets does associate JPA being close to BSP and hence, it runs the risk of not participating fully in the ensuing rally. However, we think that eventually a 40% discount to NAV and strengthening new project pipeline will drive stock.

■ Minister is key catalyst to watch
We think that personalities do matter in polity. We look for change in Industry, and transport ministry, while hope better performing Aviation & Power minister (Jairam Ramesh) to return. Return of aviation minister should secure ADF funding deals.


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