The Hindu Business Line : Punj Lloyd: Invest at cut-off

INVESTORS with an investment horizon of two-three years can consider subscribing to the book-built initial public offer of Punj Lloyd. At a price band of Rs 600-700, the stock commands a price-earnings multiple of 20-23 times its expected FY-06 consolidated earnings on a fully diluted basis.

Growth opportunities in the oil and gas infrastructure sector, expected improvement in the bottomline arising from debt reduction, and a foothold in major oil-producing regions underline a long-term growth story for Punj Lloyd. However, at the current offer price, the stock trades at a significant premium to its peers such as Larsen & Toubro and Hindustan Construction. Hence, the stock may not be suitable for investors looking for near-term gains.

Facts from the offer

Punj Lloyd is a large player in the engineering and construction sector. The company specialises in laying pipelines, building oil and gas storage tanks, terminals and process facilities. It also provides facility maintenance services and builds civil infrastructure such as highways and bridges. In FY-05, the company's derived 78 per cent of its income from the energy sector.

The proceeds from the offer are to be used for purchase of capital equipment, prepayment of debt and investment in infrastructure projects and subsidiaries. For 2004-05, the company's consolidated revenues stood at Rs 1,790 crore and the post-tax earnings at Rs 101 crore.

Though the company's stand-alone operating profit margin (OPM) has fluctuated, the consolidated OPM in the last two years has been in the 19 per cent range. This is superior to the construction industry average of 7-10 per cent.

Oil and gas infrastructure yields better margins than other civil infrastructure works. As the company derives much of its earnings from this segment, the margins are likely to be higher than that of most of its peers, deriving bulk of their income from civil works.

In addition, Punj Lloyd owns and manages its own equipments unlike some construction companies that lease them. This will help the company sustain its higher operating margins vis-à-vis its peers. The company's plan to prepay about 37 per cent of its current debt out of the proceeds of the issue will bolster the bottomline. The net profit margin is now 5-6 per cent.

Strong foothold in oil and gas

Punj Lloyd, and its 100 per cent subsidiaries, have an extensive geographical presence. The company has forayed into West Asia, Asia-Pacific and the Caspian region of Kazakhstan, Georgia and Turkey. In India, BHEL, ONGC, GAIL, Reliance Industries and IOC are some of its clients.

The increased production and exploration activity in West Asia and the relatively abundant natural gas flows from Asia-Pacific are likely to increase the demand for pipeline and transportation facilities. In the domestic market, the company is well-placed to capitalise on the proposed national pipeline grid of GAIL, the east-west pipeline by Reliance and other capex plans by major refiners.

The company is likely to bag a good proportion of business in the local market through sub-contracting, irrespective of the outcome of the Gas Pipeline Bill pending in Parliament. Punj Lloyd's edge lies in its vast experience as a complete solutions provider in the oil and gas segment.

This pre-qualification would help the company bag orders; its order backlog of Rs 3,700 crore is about twice its FY-05 earnings.

The company has also bagged orders in the road sector from the National Highways and the annuity income from this segment will support earnings growth. Its plan to diversify into thermal and hydel projects may, however, not contribute immediately to its revenue streams, as it does not have qualification in this space.

Risks

The risks that pose a threat to Punj Lloyd's earnings are:

About 41 per cent of the company's orders are fixed-price contracts and limits the possibility of protecting its margins from steep price hikes; this can dent the company's margins.

The geographical diversification has boosted the financial performance, but it leaves the company exposed to the risk of foreign exchange fluctuations.

Though the company is now a major player in the oil and gas infrastructure space, increased opportunities are likely to see other players entering the field. Competition is likely to intensify in the coming years.

The offer is open from December 13 to December 16. ICICI Securities, Citigroup, DSP Merrill Lynch and Kotak Mahindra Capital are the lead managers.