Thursday, December 22, 2011

>CONSTRUCTION SECTOR: Implementation of the Lokpal mechanism across states could make things even worse for the sector

Of all the current challenges faced by the construction sector, the  policy paralysis at the Centre seems to us to be the biggest concern.  We met the managements of some companies to seek any signs of  change, but come away largely disappointed. Implementation of the  Lokpal mechanism across states could make things even worse for the  sector as the fear psychosis may extend to state department officials.  The role of interest rate reversal as a catalyst may be muted in the  context of a sharper slowdown – any significant improvement in  fortunes may be at least 2 quarters away.

■ Government approvals slow; turnaround at least 2 quarters away
Our interactions with the managements of some construction companies in  Hyderabad indicate that there is no discernable pick up in the pace of  government approvals. Delays in documentation have impacted last‐mile  approval of several projects. Collections from irrigation projects executed in the  state of Andhra Pradesh have normalized, though companies continue to be  cautious and are going slow on execution. Receivables from central authorities  in some projects have been delayed due to setting in of extreme fear psychosis 

amongst government officials. We see a large risk that implementation of the  Lokpal mechanism across states may extend the paralysis to state machinery as  well and adversely impact the construction industry, which has large exposure  to orders from state government departments.

■ Bidding for NHAI projects is less intense, but IRRs still uneconomic
Managements have echoed the common view that bidding for NHAI projects have become less intense than the situation six months ago. However,  companies that have won projects recently have lowered their threshold IRR  expectations to 16% and below. We believe actual IRR may end up being lower,  if traffic disappoints. Companies that win projects are, thus, accruing negative  NPV projects; the poor relative stock performance of such companies reflects  the market’s concerns. Although bids aggregating to c950km were opened in  Nov11, it does not necessarily indicate a pick‐up in award activity since bid  awards are being bunched up by the NHAI – the next bunch of bids being  invited in Jan12. Large companies have shown interest in bidding for small ticket  OMT projects to get a sense of traffic patterns. The discord between the  NHAI and the Planning Commission seems to have increased, resulting in  resignation of several top officials of the NHAI. This is likely to further hamper  the organization’s working.

■ Interest rate reversal may not be enough of a catalyst
Interest rate reversal is a much‐anticipated catalyst for the sector. However, its  impact may not be significant in the context of overall slowdown in the sector.  The sector is not facing an acute funding crunch—as in 2008—hence, we  believe the competitive intensity continues to be high at the current stage. NCC  (NJCC IN, Buy) is our preferred sector pick as a potential stake sale in  development assets may drive a large re‐rating from current levels.

To read the full report: CONSTRUCTION SECTOR

>HINDALCO INDUSTRIES: Novelis holds the key; India’s leading aluminium & copper producer

Novelis to continue surprise positively with stable EBITDA
Post its turnaround, Novelis has been surprising positively with its strong operational performance. During H1FY12, its adjusted EBITDA stood at US$607 mn, in line with the FY12E guidance of US$1.1-1-15 bn. Adj. EBITDA/ tonne touched a high of US$418 during Q2FY12. We believe Novelis would continue to deliver strong performance as it is largely immune to the LME volatility, being cost efficient and having pricing power.

Low cost operations, an asset; enhanced capacity, future trigger
Hindalco’s aluminium cost of production (~US$1,650/ tonne) remains in the first quartile of the global cost curve due to captive power and alumina backed by own coal and bauxite mines respectively. Efficient technology, part sourcing of concentrate from captive mines and significant by-product contributions make its copper business cost competitive. Hindalco plans a threefold increase in its aluminium and alumina capacities to 1.64 mtpa and 4.5 mtpa respectively in a phased manner by FY16, through both greenfield and brownfield expansions. The cumulative capex for these projects is pegged at ~Rs500 bn. Though, there have been some delays in all the projects due to various externalities, we believe FY13 would see some comfort as far as the commissioning of Mahan smelter and Utkal refineries is concerned.

Focus on value added products to help mitigate volatility
Value added products constitute about half of Hindalco’s aluminium operations in India. In alumina, the focus remains on special grade (contributed 60% of the total alumina sales during Q1FY12). In copper segment too, the company has value added products meeting international standards. We believe this will continue to help the company offset volatility in LME to a large extent. Long term engagement at higher copper TcRc (Treatment and Refining charges) during early FY12 serves as a safeguard against the recent global pressure on TcRc contracts.

Project execution concerns priced in; valuations comfortable
At CMP of Rs 126, the stock trades at 7.8x and 5.4x FY13 EPS and EV/EBITDA respectively. We believe delay in domestic projects is already priced in. However, Novelis is likely to continue delivering excellent performance. Factoring these along with volatility in aluminium prices and copper TcRc, we have valued Hindalco on SOTP basis and arrived at a fair value of Rs 154/ share, providing an upside of 22%. We initiate our coverage on Hindalco with a ACCUMULATE recommendation.

India’s leading aluminium producer
Hindalco is a leading producer of aluminium in India with an existing capacity of 506 ktpa of primary aluminium. Its aluminium operations are largely integrated with bauxite mining, alumina refining, primary aluminium, value added products (rolled products, extrusions, foils and specialty alumina) and power generation. The acquisition of Novelis has provided the company a presence in the global high technology rolled product market. Hindalco, along with Novelis, is the largest aluminium producer in rolled products category in Europe and South America, while it ranks second in North America and Asia. Through Novelis, Hindalco is also the largest producer of rolled beverage cans and aluminium automotive sheets in the world.

It is also a leading copper producer
Hindalco’s copper operation comprises of producing copper through smelting, converting to copper cathode and continuous copper rods. The copper smelting facilities with a combined capacity of 500 ktpa located at Dahej, is one of the largest single location smelting facilities in the world. Hindalco’s copper smelting is also equipped to produce gold, silver, phosphatic fertilizers and sulphuric acids as by- products. The domestic copper operation is also supported by assured supply of concentrates (~20% of the total requirement) from its two Australian copper mines viz. Nifty and Mount Gordon.

To read the full report: HINDALCO INDSUTRIES

>ASHOKA BUILDCON LIMITED: Traditionally a state player, has transformed into a national player

Ashoka Buildcon (ABL), traditionally a state player, has transformed into a national player by winning four NHAI projects totaling to a TPC of ~`5,156cr. However, this transition has come at a cost, as it entails premium commitments to NHAI (~`220cr per year, albeit covered by toll collections during the construction period) and huge equity contributions from ABL’s side, which we believe would stretch its leverage (consolidated net D/E is expected to rise from 1.4x in FY2011 to 3.0x by FY2013E). We have valued ABL on an SOTP basis – by assigning 5.0x EV/EBITDA to its standalone business (`87/share) and valued its BOT projects on NPV basis (`158/share). We initiate coverage with a Buy rating on the stock and a SOTP target price of `245/share and key catalyst being raising equity from capital markets.

Integrated business model: ABL boasts of an integrated business model in place with strong in-house execution capabilities, which helps it to have control over time and cost – the two key essentials of road development business. In the past, many industry players have witnessed severe strain on the financials and profitability of their projects because of their inability to control these important factors. Even in current times, there are developers who do not have an integrated business model and are dependent on contractors for construction activities, making them vulnerable. Hence, we believe players (read ABL) having an integrated business model are better placed.

Road sector; opportunities galore: NHAI has set itself an aggressive target of awarding ~9,371km of road projects in FY2012 against ~5,000km in FY2011. NHAI has done a commendable job by handing out ~4,000km so far in FY2012. Going ahead, NHAI, state and rural projects are expected to garner investments of `6.1trillion over FY2012-16E, which augurs well for road developers. Prefer IRB over ABL in the Road BOT space: We initiate coverage on ABL with a Buy rating and a SOTP target price of `245. Our analysis indicates that ABL would need to infuse equity up to ~`990cr (FY2012-14E) in various SPVs; this would be substantially funded by the PE route, as per management. However, we have not factored the same in our estimates, given the gloomy market conditions; instead, we have penciled in the increase in debt levels. In recent times, markets have been harsh on companies with loose financial discipline and, hence, we are conservative in assigning trading multiples to ABL. Therefore, we prefer IRB over ABL, considering ABL’s comparatively smaller size, dependency on capital markets for equity and projects at nascent stage.

To read the full report: ABL