Thursday, May 3, 2012

>PUNJ LLOYD: Positive developments on ONGC-Heera contract

Ahead estimates – EBITDA margin at 8.4%, APAT at Rs90 mn
Punj Lloyd posted its highest operating profit in past 11 quarters on back of healthy revenue growth as well as operating margins (1) Led by a healthy order backlog and execution, revenues grew 31% yoy to Rs30.4 bn (2) Post dip in Q3FY12, EBITDA margins returned to +8% levels to 8.4% (-50 bps yoy) – ahead estimates. (3) Consequently, EBITDA growth was ahead estimates at 22% yoy to Rs2.6 bn (4) However, interest costs continued to trend up (+89% yoy to Rs1.9 bn), negating operational gains – attributed to higher borrowing costs and debt (5) Consequently, net profit declined by 49% yoy to Rs90 mn – though ahead estimates.

Key highlight – Operating performance stabilizing… addressing a primary investor concern
For the past 5 quarters, Punj has posted +20% revenue growth – on back of healthy order backlog and order book execution, in turn outperforming its peers. Further, barring for Q3FY12, operating margins have remained in the 8-9% range. Lower EBITDA margins in Q3FY12 (5.6%) were attributed to sharp rise in contractor charges with fixed expenses remaining stable. Importantly, no instances of extraordinary or one-off expenses and provisions have marred the performance – addressing a primary investor concern.

But balance sheet remains weak with net DER at 1.4X – stalling re-rating
Despite visible stabilization of operating performance, Punj’s profitability and balance sheet health remains weak. Punj’s working capital remains stretched at 113 days – cascading into deterioration of net DER (up from 1.1X in Mar’11 to 1.4X in Mar’12) and low RoE (sub-2% for FY12P) – increasing risk of equity dilution. Improvement in balance sheet health and return ratios alongside stable operating performance sans cost over-runs and provisions is imperative to address investor concerns and trigger stock re-rating.

Order book robust at 2.7X revenues
Punj Lloyd secured orders worth Rs10.0 bn in Q4FY12 and Rs138.2 bn in FY12 – thereby achieving its FY12 target order inflows. Order book also grew 20% yoy to Rs272.8 bn with cover at 2.7X revenues – lending revenue visibility for next 2 years and amongst the best in peer group. Infrastructure (44%) dominates the order book composition followed by Process & Power (36%), Pipelines (13%) and Tankages (6%). Geography-wise South-Asia comprises bulk of the order backlog at 48% followed by Middle East (21%), Africa (16%) and Asia Pacific (15%).

Key takeaways from conference call – Profitability improvement at the core
■ On reducing borrowing cost – With 80% of debt denominated in high-cost domestic currency, Punj has planned to reduce its debt financing cost by swapping INR denominated debt with low-cost foreign currency loan. Average borrowing cost for FY12P stood at 11.4%

 Improving working capital cycle and debt ratio – Punj indicated improvement in working capital cycle and corresponding reduction in debt as its core business strategy. It expects to achieve the above through debtor realization and active measures to de-leverage the balance-sheet.

■ Positive developments on ONGC-Heera contract – Punj Indicated that $85 mn were released by ONGC. Further, Punj the case was suspended under arbitration and is being referred to an external settlement agency for faster resolution.

■ Cut FY13E earnings by 33% - Factor higher debt
We have cut our FY13E earnings estimates by 33% to Rs1.7 per share to factor steady rise in debt (net DER up from 1.1X in Mar’11 to 1.4X in Mar’12) and related interest expense. Reduction in borrowing costs or debt will lead to earnings upsides. We also introduce FY14E earnings at Rs2.1 per share.

■ Reiterate Accumulate rating – Upsides from operational & financial leverage
We reiterate receding investor concerns on the back of (1) stable and consistent operating
performance for the past 5 quarters (2) reducing auditor qualification and release of
retained funds (3) strong revenue visibility – on back of robust order backlog alongside
strong order-bid pipeline. Further, upsides to earnings estimates from high operational and
financial leverage exist – increased probability to play out with management plan to reduce
financing costs, the same are not factored in EMKAY earnings estimates. We retain our
Accumulate rating on the stock with a price target of Rs74. Though, concerns on operating
& free cash flow, low ROE and high DER remain and need to be continuously monitored.