The Hindu Business Line : Sadbhav Engineering: Buy

Investors looking to diversify their exposure in the infrastructure sector can consider the Sadbhav Engineering stock. The company's ability to diversify its portfolio and forge ties through the joint venture route were key uncertainties when we recommended the IPO (initial public offering) a year ago. The company has made significant progress in both these respects. It has also managed robust financials and renewed bidding strength as a result of a ramp-up in net worth after the IPO. At the current market price, Sadbhav trades at 12 times its expected earnings for FY-08. Investments can be considered with a two-year perspective. Any weakness in the broad market can be used to buy the stock.

Diversification

While Sadbhav continues to remain focussed on road projects, it has managed to increase its order book in mining operations. A 10-year mining operations contract from Gujarat Heavy Chemicals (GHCL) has taken the company's orders-in-hand from mining operations to Rs 265 crore or 11 per cent of the order book. This will see the company deriving an increased contribution from the sector. In FY-06 and FY-07 the segment accounted for barely 2-3 per cent of the total revenue. Further, the payment for mining contracts with GHCL are based on the total excavation work made and not just on the mineral extracted.

The company plans to concentrate only on similar projects. This segment holds potential on the back of plans of Gujarat Mineral Development Corporation (GMDC) to set up new projects to aid power generation. While we do not expect the mining operations to be the key growth driver, this segment can help maintain operating margins, as returns are relatively lucrative compared with the road segment.

Forging ties

Sadbhav ramped up its net worth from Rs 60 crore in FY-05 to about Rs 125 crore, post-IPO. While this has strengthened its qualification to bid for projects, BOT (build-operate-transfer) schemes, which are typically large in size, often require a higher net worth that can be achieved through tie-ups with bigger players. Sadbhav has managed to forge ties with players such as Patel Infrastructure and Gammon India. Such joint ventures lend optimism to the company's prospects in bidding for big projects.

Comfortable order book

Sadbhav's order book as on March 2007 stood at Rs 2393 crore. This is close to five times the FY-07 turnover. The company has stated that about 80 per cent of the orders on hand are likely to be completed in 30 months. This lends considerable visibility to the earnings growth provided the company is able to complete the projects on time. Roads account for 72 per cent of the current works on hand. A majority of these are BOT based with a mix of annuity- and toll-based models. While the latter is considered slightly risky, the company has two of the three toll-based projects with a grant component, which lends more viability to the model.

Sadbhav's turnover grew 68 per cent in FY-07 and net profits more than doubled. The Operating Profit Margin, which is in the 11-12 per cent range, is superior to a number of industry peers. If the company focuses on BOT projects in the road space instead of pure contracts, the OPM is likely to stay at this level.

Any jump in the price of raw materials such as steel and cement is a major risk. The company depends on a few clients for orders in irrigation and mining sector though there is enough scope to broad-base operations in the irrigation space. Any miscalculation in the toll potential in its toll-based projects would leave limited returns on the table from such projects.

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