Sunday, December 18, 2011

>ENGINEERS INDIA LIMITED (EIL): Providing design, engineering, procurement, construction and integrated project management services mainly to the petrochemical and oil and gas refining sectors.

The real Indian engineers
Amongst its Engineering & Construction (E&C) peers, EIL has an unmatched cash flow profile and RoEs (37%-40%). Specific, yet scalable, hydrocarbon engineering and project management skills, a large talent pool and Government ownership drive its competitiveness. Rising investments in the hydrocarbons sector by Government related companies (XIIth 5-year plan suggests 2x XIth plan investments) will fuel EIL’s growth. Whilst there can be near-term growth deceleration, the present valuations (12x FY13 core eps) do not reflect the firm’s competitiveness and its cash flow generating capability.

■ Competitive positioning: STRONG Change to this position: POSITIVE
The E&C sector’s overhang has led to EIL’s stock price declining 37% over the past year despite revenue growth remaining strong (up 40% YoY in 1HFY12) and the firm’s business capabilities being robust. In an industry where companies are shedding strength with rising debt, we recommend EIL due to: Government sponsored enterprises to invest twice in the XIIth plan v/s the XIth plan: The cyclical nature of refinery and petchem investments can lead to a lack of orders for a brief period. But Government sponsored plans to increase their refinery capacity [by 60% (74mmtpa) by investing US$18bn in greenfield capacities and US$13bn in upgradations] will provide EIL with growth visibility over FY12-FY17. Further, greenfield petchem capex is expected to be closer to US$8bn. Slippage risks are low owing to Government support for energy PSUs and fewer procedural problems in expansions.

 Superlative capabilities with flexibility: EIL’s scalable hydrocarbon engineering/project management skills, extensive experience and Government ownership make its offerings flexible — not only E&C services across the contracts spectrum (design to EPC) but also critical path projects, tweaking the usual EPC models (offering open book estimates, OBE) and entering into longterm relationships (MoUs, nominations) with energy PSUs. The cost-sensitive nature of large projects keeps the threat from the high-cost global majors low.

■ Unrivalled CFOs and RoEs: Over FY08-FY11 EIL leveraged its rising investments by capturing a bigger share of hydrocarbon spend by taking up low EBITDA margin (10%-12%) high volume lumpsum turnkey (LSTK) jobs (144% CAGR) instead of high EBITDA margin (40%) low volume consulting jobs (22% revenue CAGR). Hence, op cashflows (CFO) rose and RoEs moved to 37%-40% from mid-teens earlier, overriding the declining EBITDA concerns.

■ Valuations projecting near-term concerns into long-term? Despite a radically better CFO/RoE profile, EIL’s stock trades in line with peers. Paltry orders in FY12 and a growth deceleration beyond FY13 have led to a gradual derating. We do expect lower revenue growth over FY13-FY15, but believe EIL’s multiple should retrace lost ground as the refinery opportunity gets supplemented with fertilizer capex, thus addressing growth concerns. A higher investible float than many peers addresses low free float concerns.

To read the full report: EIL