<strong>Institutional</strong> <strong>Equities</strong> This page has been intentionally left blank
Sector Jan-09 Mar-09 May-09 Jul-09 Sep-09 Nov-09 Jan-10 Mar-10 May-10 Jul-10 Sep-10 Nov-10 Jan-11 Mar-11 May-11 Jul-11 Sep-11 <strong>Institutional</strong> <strong>Equities</strong> Infrastructure Sector 26 September 2011 Light At The End Of The Tunnel The infrastructure sector has witnessed many pitfalls in the last two years which have hurt investor sentiment. We believe the valuation of the sector is close to the bottom as the stocks of infrastructure companies have corrected between 60%-75% in the period July 2010 to August 2011. Post correction, they are trading 33%-47% below their five-year historical average price-to-earnings of 20x-44x. We believe slower order inflow, rising interest rates, regulatory issues and earnings downgrade have been largely discounted by the market. Although we believe the earnings will not improve significantly, concerns over rising interest rates, regulatory issues and execution risks are likely to subside in the short term, thereby leading to outperformance by infrastructure stocks. Fundamentals versus valuation: We believe the infrastructure sector is currently moving from a moderation phase to a slowdown phase, and the slowdown has started hurting profitability (as seen from a sharp decline in earnings in 1QFY12 by 97% YoY) which will continue in the short term. However, as the slowdown has already been factored in (stock prices have declined by around 60%- 75% between July 2010 & August 2011), we believe the sector is set for a re-rating as FY13 net profit for our universe of companies is set to grow by 44%. Stability in interest rate cycle to aid performance: To curb rising inflation, the Reserve Bank of India (RBI) raised its repo rate by 25bps in September 2011 (175 bps since January 2011), the 12th hike in the past two years, to 8.25%, which is 75bps below the peak witnessed in October 2008. As per consensus estimate, the repo rate may be hiked further by 25bps and then it may stabilise at that level (not correct sharply as in the previous FY09 cycle). Historically, whenever interest rates peak, the infrastructure stocks outperform. Further earnings downgrade due to rising interest rates unlikely: Between January 2010-September 2011, revenue estimates of our universe of companies (Bloomberg consensus) have been downgraded by 11% for FY12 and 5% for FY13 and PAT estimates cut by 33% and 31% for FY12 and FY13, respectively. As per our analysis, we believe the market has already discounted higher interest rates and further earnings downgrade is unlikely. Uncertainty in order execution in near term, but FY13 to witness strong growth: Despite a strong order book, revenue growth was muted during the past one year due to order execution-related issues. The market believes these issues will continue to impact the growth of the sector. However, we believe the order execution will improve because these issues are more technical (short-term in nature) rather than structural. Coverage universe: We initiate coverage on five companies with a Buy rating on IRB Infrastructure, Reliance Infrastructure, GMR Infrastructure and IVRCL, as we believe they are best placed in terms of execution track record, Balance Sheet strength and valuation parameters. Despite attractive valuation, we assign a Hold rating to HCC as we believe that higher leverage and the Lavasa issue will cap any upside. View: Positive Amit Srivastava amit.srivastava@nirmalbang.com +91-22-3926 8116 Nitin Arora nitin.arora@nirmalbang.com +91-22-3926 8169 One Year Indexed Performance 230 210 190 170 150 130 110 90 70 50 Source: Bloomberg Nifty Infra index Market cap CMP Target Up/ EPS (Rs) P/E (x) RoE (%) Company Rating Rsbn US$ bn (Rs) price Down (%) FY11 FY12E FY13E FY11 FY12E FY13E FY11 FY12E FY13E IRB Infra Buy 54.1 1.1 163 235 44 13.6 14.0 18.0 12.0 11.7 9.1 18.6 16 17.1 Reliance Infra Buy 116 2.3 434 724 67 58.0 60.6 72.6 7.4 7.1 5.9 6.6 6.5 7.3 GMR Infra Buy 110.4 2.2 28 39 39 (0.3) 0.2 1.2 NA 134.4 22.8 NA 1.0 5.8 HCC Hold 17.4 0.38 29 33 14 1.2 0.8 1.5 23.9 33.1 18.7 4.7 3.3 5.7 IVRCL Buy 10 0.20 38 59 55 5.9 5.1 6.7 6.3 7.3 5.6 8.2 6.6 8.1 Source: Company, Nirmal Bang <strong>Institutional</strong> <strong>Equities</strong> Research