Saturday, February 4, 2012


Exceptional Items drag PAT below expectation
HCC reported in-line revenue and operating profits for Q3FY12. However, exceptional items below EBITDA pushed PAT to a massive loss of Rs1.6bn v/s Rs270mn loss expected. We are not bullish on EPC due to its Hydro power exposure and high leverage eating away operating margins. Exceptional items are a further drag on the earnings capability of the EPC arm. We downgrade HCC to Sell from Hold due to its recent rally of 20% after our upgrade to Hold on 10th Jan’12. However, we maintain our target price of Rs19 (14% downside). We advise investors to look at Road Developers like ITNL and Sadbhav Engg for better risk-reward.

■ Operational numbers in-line: Revenue and EBITDA have been in-line with our expectation, though much below that of the street. We believe the company will face execution challenges due to its high exposure to Hydro power EPC and slow moving AP irrigation projects. Its road project in West Bengal provides a breather to its overall EPC revenue, though not to the level of superior growth. Order-Intake during the quarter was Rs8.5bn and orderbook at Rs162bn.

 Exceptional Items were beyond our understanding: HCC reported a list of exceptional items like 1) Rs648.7mn on account of additional cost on account of substantial delays in approval of claims 2) Rs520mn provision made for expected future losses in respect of 2 new projects 3) Rs160mn provision arising from revision of cost to completion for expected future loss on sale of asset 4) Rs270mn provision made on account of performance bank guarantee wrongfully encashed by a client 5) Rs66.9mn against dues from a subcontractor. Standalone business earnings already had low visibility. These items will further drag confidence on profitability and prove our assumption on the company incurring losses till FY14.

■ Other construction stock to provide better risk-reward , but recent rally makes asset owners like ITNL & Sadbhav better bets: The company faced multiple headwinds like 1) execution challenges in Hydro power & irrigation order backlog 2) High leverage in stand-alone balance sheet that is eating away operating profit and 3) Uncertainty on Lavasa project’s future. The only value driver for the stock is its robust road portfolio which saw a PE equity valuation of Rs17bn. Due to risks in EPC, we do not value the EPC arm, ascribing a nominal value of Rs3/share to Lavasa, Rs11 to the roads arm and Rs5 to other assets, and derive a SOTP value of Rs19 (14% downside from the CMP Rs23). We advice investors to stay away from HCC and consider ITNL and Sadbhav).