The Hindu Business Line : Hindustan Construction: Hold

SHAREHOLDERS can remain invested in the Hindustan Construction stock despite the company's sharp run-up in price and the declining operating profit margin. At the current market price, the share trades at about 17 times its expected FY-06 earnings. This multiple is attractive vis-à-vis its peers and provides scope for further appreciation.

Hindustan Construction's operating margins has declined over the last two years. From 17 per cent in 2003, it fell to 10.5 per cent in 2005.

This can be attributed to the steep rise in raw material costs, the increasing number of players in the sector and the revenues being shared through joint ventures. We, however, remain bullish on the stock for the following reasons:

Despite the increased competition, a few players such as Larsen and Toubro are capable of executing large projects that require sophisticated technology and execution capability. Hindustan Construction, with its track record of executing large projects, is better placed to qualify for them than its peers.

In March 2005, the company made preferential allotment of equity shares and increased its net worth by 115 per cent. This reduced the debt-to-equity ratio from 2.6 in FY-04 to 1.2 in FY-05. The potential risk of high gearing has now been alleviated to some extent.

To reduce the cement content in concrete, the company is working on using the environmental-friendly fly ash. By this, it expects to minimise costs and also earn credits for carbon emission reduction in future. This may add cushion to operating margins.

Volume-driven growth

A surge in Hindustan Construction's order-book has turned out to be a big positive and can accelerate growth in the company's revenues for the next couple of years. The company's order-book this fiscal has surpassed its revenues of Rs 1487 crores for FY-05.

The expanding order-book appears to indicate a volume-driven strategy, which may also help compensate the margin pressures by bolstering the bottomline. In FY-06, the first quarter revenues and post-tax earnings rose 32 per cent and 66 per cent respectively on a year-on-year basis. The sharp growth in post-tax earnings is largely on account of tax provisions and may not be sustainable for the full year.

Sector outlook

The road sector has assumed importance on account of the massive outlay for the Golden Quadrilateral and the North-South-East-West corridor projects, apart from construction of dams and roads in states.

The recent orders bagged by Hindustan Construction for the Lucknow-Muzaffarpur national highway project and East-West corridor project appear to demonstrate that it has been able to bid successfully amidst intense competition and also move in consonance with its volume-driven plan.

In areas where the company's pre-qualification is not sound, the company has tied-up with other big players to bag contracts.

The joint venture with Nagarjuna Construction for the Godavari lift irrigation scheme is a case in point. Such ventures may qualify Hindustan Construction for other projects independently.

The company also has experience in power and hydel projects, where revenues will be value-driven.

In FY-05, Hindustan Construction broke into the global market with a Saudi Arabian order. It plans to expand operations in West Asia as well.

If this succeeds, the contracts will help the company pre-qualify for other projects in the region.

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