The Hindu Business Line : Hindustan Construction: Hold

More low-margin road and pipeline projects have eroded Hindustan Construction's operating profit margins over the past three years. But things are changing as the order-book shows the company charging up in its key area — power projects. This coupled with steady growth in volumes are likely to sustain the margins.

Higher infrastructure spending has rapidly increased the number of players in the construction space. Technical qualification in diversified areas, the ability to forge joint ventures with foreign companies and provide integrated services as an engineering procurement and construction (EPC) contractor, have enabled HCC retain its position among the leading construction players in the country, despite the competition.

In this backdrop, investors can retain their exposure to the HCC stock with a two-year perspective. At the current market price, the stock trades at 28 times its expected FY-07 earnings. Return expectations, however, need to be tempered as the sector has already gone through a re-rating.

Changed order composition

HCC has traditionally been strong in nuclear and hydropower projects. To capitalise on business opportunities that came its way, the company had shifted focus to road and pipeline projects over the past few years. While this shift had led to a 23 per cent annualised growth in top line over the last three years, the OPM fell, from 13.2 per cent to 9.2 per cent.

But bagging four major power sector contracts the last fiscal has energised HCC. Power projects constitute 38 per cent of the order-book. Being a relatively high-margin business, this segment can be expected to protect the current OPM. Any near-term improvement in margins is unlikely, as power projects are typically of longer gestation.

The company's order-book jumped 80 per cent over the last year to Rs 9,672 crore. At about five times the revenues of 2005-06, the orders are likely to ensure the current growth.

Forging ties

HCC has employed the strategy of working in consortium with foreign companies to acquire superior skills and technology. It has jointly won an order in the hydropower space in Jammu and Kashmir with Norwegian and Turkish companies. With a share of Rs 2,000 crore, the project has helped the company take up EPC contracts in the hydropower segment.

HCC has also forayed into the lucrative gas pipeline project through joint venture with a Russian company.

These ventures are likely to act as reference points for future bids in the EPC power projects and also yield better returns on capital.

Last fiscal, HCC transferred its freehold land and stake in the real-estate business, Lavasa Corporation, to a 100 per cent subsidiary — Hincon Realty. The subsidiary plans to develop townships and, as a first step, has acquired the development rights for a portion of HCC's land in Vikhroli, Mumbai.

The transfer of the real-estate business to a subsidiary will enable HCC clearly have two focussed businesses.

While we have not factored-in the revenue flows from this business, given that it is yet in the preliminary stage, a listing of the real-estate company may well unlock value for shareholders, if shares are issued in proportion to their existing holdings.

Risks

HCC has been mopping up funds through global depository shares and convertible bonds. While aggressive ramping up of equity will aid the company bid for new projects, there exists a risk of earnings dilution if the profit growth fails to keep pace with the equity expansion.

Any delay in the execution of projects (the Bandra-Worli sea link project being a case in point) will inhibit earnings growth.

More Stories on : Stocks | Recommendation | Real Estate & Construction

Article E-Mail :: Comment :: Syndication :: Printer Friendly Page