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Institutional Equities
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 Institutional Equities Research