building blocks

 

If infrastructure and capital goods are the best investment theme for the next few years, infrastructure ancillary industries too will do well

 

The most common advice from investment advisors and analysts is that you must own infrastructure in your portfolio. This is also reflected in the increasing number of domestic infrastructure mutual funds and their corpus.

 

There is a huge deficit in domestic infrastructure, and attempts are being made to fill the burgeoning demand for power, ports, roads etc. Obviously, infrastructure companies will be the direct beneficiaries. But there is a host of industries that will also gain from this spend.

 

"Infrastructure is the biggest opportunity today in India backed by the monetary allocation of about $500 billion in current Five Year Plan. This opportunity will cascade down to every player operating in infrastructure space, which will further require a lot of ancillary activities to support the main infrastructure activity," says, Sanjay Sinha, CIO, SBI Mutual Fund.

 

Srividhya Rajesh, fund manager, Sundaram BNP Paribas Mutual Fund, "We like infrastructure ancillaries. These companies are having order book of about two-three times their sales providing strong earning visibility. We also like them, as these companies realise their money relatively faster or before the competition of the project." 
 

FUTURE PERFECT

Company

Order book

Sales FY07

Order book/Sales

BL Kashyap

1600

808

1.98

Punj Lloyd

15000

5126

3

Gammon

8000

1864.7

4.29

HCC

9381

2357.6

3.98

IVRCL

9500

2305.9

4.12

Jaiprakash

7300

3463.9

2.11

L&T

39630

20347.9

1.95

Nagarjuna cons

7771

2871.1

2.71

Patel Engineering

5000

1102.4

4.54

Order book in Rs crore as of June 2007

 

Digging more into infrastructure segment here are some of these ancillary companies, which are a part of the overall value chain of Indian infrastructure sector.

 

Handle with care
Services of material handling and construction equipment companies are extensively used in various applications in construction and infrastructure projects. Whether it is a dumper, road-roller or a crane, these equipment are in huge demand and play a critical role in executing complex and large projects with speed.

 

Among the listed players, companies like TRF, McNally Bharat, Action Construction Equipment and Gremach Infrastructure Equipments are the major players having adequate products and capabilities.

 

Action Construction Equipment
Action Construction Equipment is one of the fastest growing construction equipment companies in India. Its equipment is used in many industrial sectors like infrastructure, construction, roads, engineering industry, coal mines, power stations, ports etc.

 

The company enjoys a market share of around 50 per cent in the hydraulic cranes segment. It is also foraying into the forklift and backhoe loaders segment and plans to introduce higher capacity cranes, piling rigs and trailer mounted concrete pumps.

 

Having a strong distribution network across the country, the company caters to over 5,000 customers. "Since the company is a dominant player in the construction equipment sector, it is expected to benefit from huge investments planned in the construction, industrial and infrastructure sectors. Also, the Introduction of new products will contribute to the future growth and help it tap other segments of construction," says Arpit Agrawal, head research, Arihant Capital Markets.

 

Considering the huge opportunity, the company is well placed to take advantage of the ongoing investments in the infrastructure sector. Its net sales and net profit are expected to grow at 70 per cent and 80 per cent a year respectively for the next two years. At current market price of Rs 541, the stock is trading 26 times estimated FY08 earnings and 19 times FY09 earnings.

 

TRF
Besides construction equipment, there is a huge opportunity for companies in the material handling equipment space. TRF is one such player, operating into the business of design, manufacture, installation and commissioning of engineering equipment and systems.

 

Its clients include power plants, mining and metals industries. The company has an order book of over Rs 500 crore which is almost 1.4 times its FY07 revenue of Rs 347 crore.

 

The company has been growing consistently--its sales have grown at 27 per cent a year for the past four years, while net profit has gone up to Rs 20.17 crore in FY07 against a loss of Rs 42 lakh in FY03.

 

Factoring the improved margins on the back of higher ongoing investment, the company is expected to maintain an earnings growth of about 50 per cent and a top line growth of 30-35 per cent. At the current market price of Rs 1760, the stock is discounting estimated FY08 earnings 29 times and FY09 earnings about 18 times.

 

McNally Bharat
Within the material handling space, McNally Bharat Engineering Company is considered to be a leading company providing turnkey solutions for industries such as power, steel, alumina, ash handling and disposal, port cranes, civic and industrial water supply.

 

In the first half of FY07, its operating margin improved by 200 basis points to 8 per cent but its sales growth was muted due to low billing in the project division and delay in receipt of some orders. McNally's order book of over Rs 1,400 crore (almost 2.7 times its FY07 revenues) will provide sustainable revenue growth in future.

 

The company is also expanding its capacity. Like TRF, McNally too has a locational advantage of being located in eastern India, close to the mining and metal belt.

 

Its margins, which are quite low, could improve, which will be another boost to its earnings growth. At current market price of Rs 300, the stock is trading 31 times its FY08 earnings and 17 times FY09 estimated earnings.

 

Sanghvi Movers
The demand for cranes is so huge that there actually is a global shortage. So for Sanghvi Movers, there is no dearth of opportunities. According to industry estimates about 1.5-2 per cent of the total cost of the project is spent over cranes.

 

Sanghvi Movers is one of the largest crane-hiring companies in Asia. It has a fleet of 260 cranes of capacities ranging from 20 tonne to 800 tonne. The company has added cranes worth Rs189 crore in FY07. It is planning to invest another Rs 200 crore in FY08 and FY09 each, which will lead to sustained earning growth between FY07 and FY09.

 

"The capacity expansion exercise undertaken by India Inc and the thrust on infrastructure spending has led to a strong demand for cranes. We believe with a market share of 45 per cent, Sanghvi Movers is poised to benefit from the ongoing investment in the infrastructure space. We expect its revenue and profits to post a compounded growth of 32.5 per cent and 30 per cent respectively," says Sandeep Nanda, head-research, Sharekhan. 
 

A LONG WAY TO GO

India

China

$ billion

% of GDP

$ billion

% of GDP

Transport

10.9

1.4

95.7

4.3

Roads

5.8

0.7

67.1

3

Airport

0.4

0.1

3.7

0.2

Electricity

8.4

1.1

80.1

3.6

Urban Infra

1

0.1

6.4

0.3

Others

4.7

0.6

24.9

1.1

Total

25

3.2

207

9.3

 

Drilling gains
Moving down in the infrastructure value chain, a lot of investment will go into the compressors and drilling equipment. This will further augur well for companies such as Atlas Copco, Elgi Equipment, Ingersoll Rand, Kirloskar Pneumatics and Revathi Equipment.

 

Atlas Copco
Atlas Copco's products and services range from compressed air and gas equipment, generators, construction and mining equipment and industrial tools etc. The company considers India as one of the biggest market and has embarked investment for its growth through organic and inorganic move.

 

The massive investment in oil and gas, mining and construction are the major driver for the future growth of Atlas Copco. At the current market price of Rs 1370, the stock is trading 25 times its FY08 earnings and 19 times FY09 estimated earnings.

 

Revathi Equipment
Revathi Equipment is a manufacturer of drilling equipment and accessories for mining, construction and water wells. The company has been highly dependent on Coal India for its business so far. However, it is now taking initiatives to diversify its products as well as reducing its dependence from the single client.

 

It has forayed into the concrete equipment business, which contributed about Rs 2 crore in FY07 of the total Rs 87 crore sales. The company has started manufacturing equipment such as concrete batching plant, transit mixers and concrete pumps. The management expects this division to start contributing significantly going forward.

 

Also, its annuity income from the power generation and treasury are additional benefits to the shareholder. However, the stock price has shot up in the recent past and the valuations appear stretched at present. At Rs 1340, the stock trades at 28 times estimated FY08 and 23 times estimated FY09 earnings. 
 

CONSTRUCTING INDIA

(in $ bn)

Construction
share (%)

X Plan

XI Plan

CAGR
(%)

Power

36

34.6

103.7

25

Railways

42

19.5

79.5

32

Roads

100

10.3

62.7

44

Irrigation

60

34.6

43

4

Urban Infra

60

4.8

14.8

25

Ports

50

2.4

12.3

39

Airports

42

2.5

9.9

32

Total

109

326

25

Source: Planning Commission document and industry estimates
*
The Planning Commission has revised the capex target from earlier $320 billion to $490 billion or 9% of GDP
*
The revised target will have higher allocation for various infrastructure sectors and thus higher growth than those mentioned here

 

Strong foundation
As a part of construction activity, a lot of construction work such as roads, bridges and structures require investment in steel bars, wires, roads or long products. Within these segments, though there are lot of players, Usha Martin and Kamdhenu Ispat should stand to gain for their various products applicable in the construction and other infrastructure related activities.

 

Usha Martin
Usha Martin, the world's second largest wire rope manufacturer, is expanding its capacities and embarking on backward integration. The company produces steel wire rod and bars, which find application in mining, drilling, elevators, cranes, aerial haulage and track installations etc. It also manufactures structural ropes used in public and commercial Infrastructure, high-rise buildings.

 

The company is investing Rs 500 crore, which will more than double its capacities by the end of FY10. The company will also spend Rs 120 crore for acquisitions and backward integration over the next couple of years.

 

Usha Martin will be the key beneficiary of investment in steel products required in different applications across the infrastructure sector. At the current market price of Rs 119, the stock is trading at 20 times its FY08 earnings and 12 times FY09 estimated earnings.

 

Well connected
Welding and cutting equipments are an integral part of any kind of fabrication required in engineering and construction work. These products have wide application from industrial to the infrastructure sector. Ador Welding and Esab India are the two leading companies in this segment.

 

The companies will benefit from the ongoing investments in the industries such as steel, oil and gas pipelines and ship building industries. Also, the strong capex in power and construction sectors, airports, ports and other infrastructure projects will provide the boost in revenue.

 

Esab India
Esab India has expanded its product profile and production capacities recently. Analysts expects robust product demand to continue for the company owing to planned investment in core infrastructure sectors such as roads, ports, airports and construction in the country. At current market price of Rs 461, the stock is trading at 14 times its trailing EPS of Rs 32.6.

 

Ador Welding
Within the welding segment, Ador Welding is another stock commanding a market share of 35 per cent of India's organised welding sector. The stock is currently trading at Rs 240, discounting its estimated FY08 earnings 9 times and FY09 earnings 8.5 times. 
  

THE ENABLERS

Rs crore
Standalone numbers

Net Profits

Net Sales

NPM (%)
2007

OPM %
2007

EPS (Rs)

PE (x)

2007

%
chg

2007

%
chg

FY08E

FY09E

FY08E

FY09E

Action Construction

19.93

57.05

245.27

48.04

8.13

12.3

20.8

28.5

26

19

TRF

20.17

184.89

342.86

59.77

5.88

10.4

60

95

29.3

18.5

McNally

17.5

233.33

503.41

52

3.48

7.61

9.5

17.3

31.6

17.3

Atlas Copco

72.04

42.48

738.44

29.07

9.76

18.7

55

71

24.9

19.3

Usha Martin

101.48

56.2

1394.71

17.28

7.28

20.94

6

9.6

19.8

12.4

Ador Welding

32.62

-18.86

273.92

3

11.91

17.7

24.6

27.5

9.8

8.7

Esab India

42.67

7.45

287.93

21.21

14.82

24.3

5.7

7.5

39

30

Revathi Equipment

16.4

-25

87.7

-4

12.57

22.35

47.9

58.3

28

23

Sanghvi Movers

47.18

46.61

178.63

19.85

26.41

73.85

14

17

21.6

17.8

IDFC

462.87

23.22

1500.55

49.94

30.85

96.2

5.74

7.47

39

30

SREI

79.25

63.67

398.74

75.78

19.88

83.69

9.7

11.4

19.8

16.8

 

Funding for growth
If all this infrastructure is to be created, it's going to need a lot of money. For the growing infrastructure need, the funding or the viable financing is the most critical. In the Indian context the nature of funding or financing is still evolving where lot of instruments and options of public and private partnership have been explored to finance projects.

 

Unlike in the past, financial institutions such as IDFC and SREI Infrastructure will have a major role to play in providing instruments, raising funds, consultancy, project viability and for exploring various options of public and private partnership.

 

IDFC
Infrastructure Development Finance Company (IDFC) has made a lot of progress in the last five years when the economic boom started. Its core business of lending for infrastructure projects like roads, highways, ports, airports, energy, telecom, and transport has helped the financial institution to grow rapidly.

 

Its assets and net profit has grown at a compounded 42 per cent and 20 per cent respectively. Revenues and profits are expected to gain at a similar rate as infrastructure spending keeps growing. However, at the current price of Rs 224, the stock is not cheap, as it trades at 39 times its FY08 earnings and 30 times FY09 earnings.

 

SREI Infrastructure
SREI Infrastructure is the largest infrastructure equipment finance company with a market share of 30 per cent. The total market size is around Rs 14,000 crore, which is growing at 50 per cent annually. In May 2007, the company transferred its equipment financing business to a 50:50 JV with BNP Paribas.

 

Thus post de-merger, SREI will be left with infrastructure project financing, leasing, advisory and venture capital businesses. The stock has more than doubled in the last six months. At the current market price of Rs 192 the stock is quoting above its sum of parts valuation of Rs 160, which reflects high growth and better industry outlook.