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.