The Hindu Business Line : Valecha Engineering: Buy

VALECHA Engineering (Rs 333) is one of the prime beneficiaries of the infrastructure boom in the country. A good track record of executing infrastructure projects, healthy order-book and imminent order flows from the Central and State governments in the road segment lend visibility to this small-cap stock.

Exposure to the stock can be considered with an investment perspective of two years since foray into new segments and markets are likely to convert into earnings after FY-07.

The stock trades at 14 times its expected FY-07 earnings, without factoring in revenues from impending entry into new segments.

Valecha Engineering is an infrastructure company focussed mainly on road and highway development work and foundation projects. The current order-book of Rs 800 crore is about 5.5 times FY-05 turnover.

These orders are likely to convert into earnings over the next 24-30 months. The company has over the years moved up the value chain and has qualified itself in high-end engineering projects such as irrigation, dams, power projects, tunnels, railways, and so on.

Focussing on highways

The order flows from Central and State Governments for road and highway works have continued unabated. Valecha Engineering has bagged orders the National Highways Authority and other state agencies.

Recent orders bagged in 2006, amounting to about Rs 300 crore, are sizeable in relation to the company's revenues (Rs 145 crore in 2004-05) provides an indication that the company has begun to capitalise on the infrastructure boom.

With funding options in place and a special purpose vehicle for financing infrastructure projects now added by the Government, the flow of orders in the road sector is likely to continue at the current pace.

Valecha Engineering derives a majority of revenue from the road segment, which is a low-margin business. The company's foundation works business has however, compensated for the low-margins from roads.

The company is among the few players to own a large number of hydraulic piling rigs used to lay pile foundations for heavy structures. Ownership of equipment and relatively low competition in this segment provides lucrative margins for the company.

Imminent opportunities

Valecha Engineering, unlike bigger players such as Nagarjuna Construction and IVRCL Infrastructure and Projects, is yet to enter the build-operate-transfer (BOT) space. The company, although technically qualified, lacks the equity base to enter such projects. It, therefore, plans to expand its equity through preferential allotment and foreign depository receipts or foreign currency borrowings.

Such an expansion may dilute earnings over a short term, but is likely to provide payoffs once the company starts executing BOT projects.

Expansion of equity base has become a pre-requisite for most construction companies entering the BOT space and has provided adequate returns and even ramped up the margins.

If Valecha Engineering, given its pre-qualification, is able to win a bid in this segment, it may see an increase in bottomline. The company is also in final stages of talks for a joint venture in West Asia. This may see the company foraying into overseas markets in the foundation engineering space.

Valecha Engineering has also executed airports runways in places such as Bombay and Chennai International Airport. Privatisation in this area may see the company bagging orders as an engineering-procurement-construction (EPC) contractor for airport developers, although it does not qualify as a developer.

Financial performance: The company's revenue has grown at 33 per cent annualised over the past three years. The operating profit margin hovers at about 7-8 per cent and is comparable to similar sized players such as Era Constructions.

Risks

Valecha Engineering's revenue is concentrated on the road segment. Any slowdown in the order flows due to policy changes may have an impact on the revenues. The revenue growth may stagnate if the company is unable to expand its equity base to qualify for new projects.

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