Monday, March 29, 2010


Preface: In 2007, we launched our landmark India NTD (Next Trillion Dollar) report. This report brought out a simple, yet profound, fact: it took India 60 years since independence to generate the first trillion dollar of GDP. Its next trillion dollar (NTD) would take only 5- 6 years, based on 12-15% nominal GDP growth.

This NTD era spells exponential growth for several businesses which, in turn, throws up several investment themes and opportunities. Since our first NTD report, we have captured such ideas in an "NTD Thematic" series. We already see the NTD opportunity playing out in Gas and in Consumer non-durables.

We now release a TRILOGY of reports - Cement, Construction and Engineering - all of which are offer a play on the India NTD theme.

We have lined up many more NTD Thematics in 2010. Stay tuned!

Indian Construction: Work-in-Progress

We believe India's Infrastructure is a 'work-in-progress', and offers significant opportunities for construction. We are bullish on the medium-term prospects of the Indian construction sector driven by: (i) improving order intake, (ii) stable margins, and (iii) value unlocking opportunities. Adjusted for BOT/Real Estate projects, sector P/E stands at an attractive 13x FY11E earnings. Our top picks are NCC and Simplex. We upgrade HCC to Buy and downgrade IVRCL to Neutral.

Improving order intake visibility to revive deteriorated book-to-bill ratio: The TTM book-to-bill (BTB) for our construction coverage universe has declined from 3.9x in FY05 to 2.6x currently. This moderation has impacted near-term revenue visibility and has been caused mainly by delays in order intake due to weak government finances and a challenging credit environment. We believe the macro environment is showing initial signs of improvement; orders from sectors such as roads, power and urban infrastructure are picking up. As L1 projects get converted into orders, we expect end-FY10 BTB of 3.2x against 2.6x currently. NCC and Simplex have diversified vertical, client and geographic mix and are better positioned.

Healthier BTB could boost FY12 execution: Our estimates suggest revenue growth of 19.8% in FY11 and 21.8% in FY12 compared with 9.2% in FY10. While growth rates are improving, they are still lower than the 37% CAGR over FY05-09. Revival in order intake and a healthier BTB could boost execution in FY12 and narrow the growth gap.

EBITDA margins to be stable: During FY10, most construction companies reported improved EBITDA margins despite poor execution, leading to low fixed cost absorption. Margin expansion is being driven by lower commodity prices, project mix change and other company-specific factors. During FY11 and FY12, we expect margins to be largely stable. Bunching up of order intake in the interim period could lead to higher mobilization expenses, resulting in possible near-term margin disappointment.

BOT/Real estate projects provide unlocking opportunities: Investments and advances in BOT/Real Estate (RE) projects for our construction universe have increased from Rs6.6b in FY06 to Rs28.2b in FY09, and are expected to be Rs37.3b in FY10. Of the Rs37.3b investments and advances, BOT projects account for Rs18.6b, RE for Rs15b and others for Rs3.3b.

To read the full report: CONSTRUCTION SECTOR