Saturday, February 25, 2012

>CONSTRUCTION QUARTER 3 REVIEW: Macro headwinds changing, impact to be limited

■ Order inflows scenario improved: Engineering & Construction (E&C) companies which had seen a gradual downward shift in the order inflows since the last two quarters, have seen a healthy revival this quarter. Mining, Water and Road orders contributed majorly to the revival. Total orders announced in Q3FY12E for PL Universe are close to Rs309bn (Overall: Rs400bn) which was up by 39% QoQ and 19% YoY. However, if one excludes NCC’s internal power order of Rs52bn then the growth would be 15% QoQ and flat YoY. Orders from the Gulf countries in the petrochemical segment have cooled off in Q3FY12 to Rs15-16bn from close to Rs67bn in Q2FY12. The total order inflow till now has been close to Rs115bn in Q4FY12.

 Earnings in Q3, though, have not shown improvement: Sales growth stood at 17% YoY and higher by 20% QoQ (as Q2 is seasonally weak). However the ‘C’ segment was down by 9.1% YoY, where IVRCL’s sales were down by 15.3% YoY, whereas the ‘E’ segment stole the show by a 24% growth YoY and 20.9% QoQ. Sales growth for ‘C’ segment was mainly arrested by working capital constraints faced by mid-sized players. EBITDA grew by 2.8% YoY and flat QoQ, where barring L&T & EIL, all the players were in the negative territory. EBITDA margins (down by 120bps YoY) were down for all the companies which clearly shows the competitiveness and lower execution/higher fixed overheads is taking toll on the margins. Interest continues to haunt the companies growing by 30-40% YoY and 5-10% QoQ. Interest as a % to sales (excl. L&T & EIL) stood marginally lower QoQ at 5.2%. Overall, PAT grew by 8.1% YoY, mainly arrested by losses in Punj Llyod, NCC and HCC.

 Risk reward ratio still not predictable: Markets have risen since the last quarter, particularly the Infrastructure sector, where the jump has been substantial, mainly in the last 30 days. However, the balance sheet profile, ROEs and moreover corporate governance issues still continue to haunt the prospects, which don’t make our view any positive on the fundamental side. With the run up to the 2014 elections and fresh orders from the 12th Plan, we expect a sharp revival in order inflows. Investment opportunities pegged at 9-10% of the GDP could bring out new projects worth US$1trn over 2012-2017, doubling the 11th plan estimates. However, we think that the onus will again fall on the private sector and with stretched balance sheets and liquidity crunch, only few players will be able to cash in on the opportunities. Only a potential dilution at the parent level and SPVs will bring some hope to ease the debt trap and working capital deadlock. However, due to overall improvement in the macro economic environment, there has been a re-rating in the sector. Our sector stance remains ‘Neutral’.


>ABB INDIA: Growth in base orders remains healthy but revival in project capex, particularly in the Industrial segment, may take some time

UW: Recovery remains elusive; valuation premium unjustified

  • Q4 earnings miss but orders surprise positively; beat driven largely by the booking of old HVDC order 
  • Margin recovery remains elusive; negative surprises likely to continue as restructuring benefits appear backend loaded
  • With further downside risk to earnings, valuation premium unjustified; reiterate UW with a TP of INR510
Earnings miss but orders surprise positively: ABB reported another set of weak results missing our Q4 EPS estimate by c8% but consensus by c50%. Sales growth of c6% came in line with our expectations and was driven primarily by the Power business, which grew c13%. Industry growth disappointed, as large automation projects failed to materialise. While the total order intake of INR22bn surprised positively, the beat was largely driven by the booking of the 9-month old HVDC order worth INR5.6bn. Management noted that growth in base orders remains healthy but revival in project capex, particularly in the Industrial segment, may take some time. The order backlog was largely in line with our expectations and stood at INR91bn, on the back of which management expects strong (double-digit) sales growth in the next couple of quarters.

Visibility on margin recovery remains low: While margins improved somewhat q-o-q, they once again fell short of expectations. Management attributed weak profitability to lower volumes, high input costs, project delays and poor project mix. We note that ABB India’s margins have remained depressed for two years now, more so than any of its competitors, and this may indicate poor project selection. In addition, restructuring benefits seem to be more backend-loaded as they have hardly provided the necessary impetus to the margins in last two years. Hence, while on a long term basis, ABB India may appear to be well placed to benefit from India’s growth story, in the near term the outlook certainly remains weak, particularly as expectations of recovery remain too high in spite of estimate downgrades in the last 8 quarters. We currently forecast EBITDA margins to improve to c7.7% in CY12 and c9.1% in CY13; however, if the project mix remains suboptimal, future results may warrant further downgrades.

We trim our CY12/13e EPS by c3%/5%; maintain UW with TP of INR510: As Q4 results came only c8% below our forecasts and the order intake was ahead of our estimates, we are only marginally reducing our CY12/13e earnings. Consequently, we keep our TP of INR510 unchanged and reiterate UW on the stock as we believe ABB will most likely continue to miss expectations in the near term. In addition, the stock remains priced for perfection, trading at c51x CY12e (Dec YE) PE and c35x CY13e PE, factoring in a solid beat to our numbers, which appears unlikely. Hence, we would take profits at current levels. Our target price is derived from our preferred EVA valuation methodology and implies a 12 month forward target PE multiple of c21x on 24 month forward estimated EPS of INR24.5.