Friday, May 22, 2009

>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.


To see full report: ENGINEERING & CONSTRUCTION

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