>CONSTRUCTION SECTOR (GOLDMAN SACHS)

What's changed: Over the last few weeks, the government has announced and proposed for discussion a number of policy initiatives that are aimed at making road projects more attractive for contractors (Ex 1). Our analysis of these proposals suggests that the biggest impact of these initiatives would be in increasing the pace of land acquisition for new projects, and for clearing ownership and exit clauses for the developers, both of which have been major constraints to the execution of road projects in India. In tandem with these policy actions, there has also been an increase in the pace of execution of the National Highway projects, with the avg. per day Km addition even over the traditionally slower monsoon period June–Aug 2009 increasing to 8Kms from the 5Km per day seen over 2008.

Implications: IRB and IVRCL are our preferred picks for exposure to the Road Infrastructure segment. On the back of the above policy actions, we expect a significant increase in both the number of projects put up for bidding (NHAI targeting $20bn in the next 12 months) and also an increase in participation by both Indian and foreign contractors.

Policy reforms in place, strong orders likely next 3m; Buy IRB, IVRCL

Despite the increase in competition, we expect IRB to maintain its market share (about 8%) – driven by its strong execution track record and strong cash flow generation from existing assets. On Oct 14 2009, NHAI announced the award of the Jaipur-Deoli road project (146.3km, $300 mn) to the company, strengthening our view of continued awards for IRB.

We estimate that IRB’s free cash flow generation over the next two years positions it to add about $1bn of new projects (70:30 debt: equity) without any equity dilution. We expect an EPS CAGR of 64% over FY09-11E and value the stock at Rs289, implying 16% upside from the current level.

Valuation: IRB and IVRCL currently trade at FY11E PE of 17.4X and 13.5X vs historical median 12–mo fwd PE of 13.8X (since listing in Feb 08) and 14.8X (5-yr) respectively. We consider these multiples reasonable, given our outlook of strong growth and expanding returns over the next 12-18 months.

Risks: 1) Lower traffic growth; 2) Volatile interest rates and raw material costs.

To see the full report: CONSTRUCTION SECTOR