The Hindu Business Line : Patel Engineering: Invest at cut-off

Riding on its experience in constructing tunnels and pumphouses for hydropower projects, Patel has also strengthened its position in the irrigation sector.

MR PRAVIN PATEL, Chairman, Patel Engineering Ltd, with Ms Sonal Patel, COO, and Mr Rupen Patel, Managing Director. — Paul Noronha

A strong presence in high-margin hydropower construction projects showcases Patel Engineering (Patel) as an infrastructure player with a slightly different business profile. With a burgeoning order book and access to leading-edge technology, Patel appears well placed to capitalise on the current infrastructure spending in the country. Its presence in the US through subsidiaries has added impetus to its earnings growth.

Investors can subscribe to the company's public offer with a medium-term perspective. The price band of Rs 400-440 is at a discount of 15-20 per cent to the current market price. At the offer price, the stock trades at 25-27 times its expected consolidated per-share earnings for FY07 and is at a discount to players such as Gammon India and Nagarjuna Construction, which operate on relatively lower margins.

The proceeds of the offer are to be used for investing in capital equipment, new infrastructure projects, subsidiaries and joint ventures. The company also proposes to use a part of the funds to repay debt amounting to Rs 80 crore.

Diversifying order book

Patel's order book of Rs 4,339 crore is 5.6 times its consolidated revenues of 2005. This is likely to be converted to revenues over the next three years lending steady growth to the top line. Of the total orders on hand, hydropower and irrigation projects account for 40 per cent each. Patel's core competence is construction of dams and powerhouses. The company's strength in terms of technology and experience is likely to ensure that it has an edge over competitors in this space.

Riding on its experience in constructing tunnels and pumphouses for hydropower projects, Patel has also strengthened its position in the irrigation sector. It has now bagged orders for lift irrigation projects in Andhra Pradesh as an EPC (Engineering, Procurement and Construction) contractor. Entry into EPC has enabled it to move up the value chain and is likely to fetch better operating margins. Patel has also capitalised on order flows from the government in the road segment. Road projects now form 23 per cent of the order book against 3 per cent in 2005.

Spread over south, east and north-east, the order book reflects diversification across States and into various businesses. This is likely to ensure that revenues and margins are well-cushioned against sluggishness in any segment.

Technology edge

Through its subsidiaries in the US, Patel has access to technology that gives it an advantage to bid for new projects. Roller Compacted Concrete (RCC) technology for building dams reduces project execution time and cost by replacing cement with fly ash. RCC is internationally accepted and has already been used by the company in Maharashtra. The company has also pioneered the use of micro-tunnelling and horizontal directional drilling technologies that enable mechanised tunnelling for water and drainage pipelines and underground cabling without surface digging such as for roads or rail tracks. Although such expertise is yet to gain popularity in India, the emphasis of the Government on development of infrastructure is likely to drive business for the technology given its time and cost advantages and technical superiority.

Patel has grown the inorganic route and acquired the above technologies. It plans to acquire more companies that will equip it with unique pre-qualification skills. If this strategy works well, Patel will not only get a foothold in new territories but also make a head-start in applying new skills to domestic projects.

Stable margins

Patel's main business of hydropower construction and irrigation projects has yielded superior operating profit margins (OPM) over the years. The current OPM at 13 per cent is superior to peers such as Gammon India , given that the latter have core competency in less lucrative businesses such as road projects. With the company's continuing focus on its core competency, OPMs are likely to remain stable.

As of March 2005, only 30 per cent of the hydropower capacity as envisaged by the Tenth Plan has been completed. This leaves immense scope for players such as Patel Engineering and is likely to ensure steady earnings growth.

Risks

Patel's debt levels are slightly higher than peers, thus posing a risk. The profits, however, adequately cover the interest costs. The current fund raising and repayment are likely to ease the situation. The debt-equity ratio, excluding current liabilities, appears comfortable at less than 2.

Patel's revenues are completely dependent on government projects. Any change in policies or a slowdown in spending is likely to affect earnings. While the company remains a frontline player in the hydropower space, competition in the irrigation segment from players such as IVRCL Infrastructures and Nagarjuna Construction is likely to remain a threat.

Offer details: The offer closes on May 9. ICICI Securities and Enam Financial Consultants are lead managers to the issue.

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