BackSmaller infra companies reward investors as larger rivals struggle
Analysis of share performance shows that smaller EPC firms have lived up to investor expectations
Premium
At a time when India’s storied infrastructure firms, executing large projects, struggle with project delays and crushing debt, a number of relatively smaller engineering, procurement and construction (EPC) firms are coasting along, helped by strong balance sheets, tight cost controls and conservative bidding strategies.
An analysis of share performance across infrastructure companies shows asset-light companies such as KNR Constructions Ltd, PNC Infratech Ltd, ITD Cementation India Ltd and J. Kumar Infraprojects Ltd are rewarding investors with high returns.
Stocks of asset-heavy infrastructure firms such as IL&FS Transportation Networks Ltd (ITNL), GVK Power and Infrastructure Ltd, GMR Infrastructure Ltd, IVRCL Ltd, Gammon Infrastructure Projects Ltd and Hindustan Construction Co. (HCC) Ltd, with a collective debt of over ₹ 100,000 crore as on 30 September, have fallen between 13-56% in the past year.
In the same 12 months, stocks of relatively small EPC firms have gained, with KNR Constructions rising 98.28%, ITD Cementation 123% and J. Kumar Infraprojects 74.29%. PNC Infratech, which went public in May, has seen its stock rise about 48.1%, helped by cost controls and a regional bidding strategy.
According to sector analysts, smaller EPC firms may continue to deliver strong performance for the next few years, while weak growth, falling profits and highly leveraged balance sheets hurt large and asset-heavy entities.
Increasing preference for the engineering, procurement and construction (EPC) model— where the government pays the contractor a sum to build a project awarded through competitive bidding—over the build-operate-transfer (BOT) model—where a private operator completes a project from its own funds, operates it for a period and then transfers it to the government—is aiding the growth.
The National Highways Authority of India (NHAI) plans to award 20,000 km of projects over the next two years, involving an investment of ₹ 2.3 trillion. As much as 70% of these projects are likely to be awarded on an EPC basis, as road developers go slow on bidding for BOT projects.
KNR Constructions, PNC Infratech and J. Kumar also reported strong September quarter results, raising investor confidence.
“Improved order book, ramp-up in recently won projects, strong earnings growth potential, and comfortable balance sheet strengthen our view that KNR will continue to trade at rich valuations," wrote Angel Broking analyst Yellapu Santosh in his 16 November report. He said KNR Constructions, a Hyderabad-based firm, enjoys a strong execution track record, a better cost structure in comparison to its peers, low leverage and superior return on equity (RoE).
According to IDFC Securities, PNC Infratech, which bids for projects in Uttar Pradesh and neighbouring states, too, may do well. “A strong execution track record, healthy margin profile and low leverage are PNC’s key strengths. Its BOT (build-operate-transfer) portfolio is fully funded and offers high predictability owing to its largely operating assets. We expect a compound annual growth rate (CAGR) of 19.5% in revenue and 22.5% in profit after tax over FY15-18 on a consolidated basis," wrote IDFC Securities in a 6 November note.
PNC is also expected to benefit from NHAI’s awards in the states of Uttar Pradesh and Bihar over the next six months.
According to Phillip Capital, Mumbai-based J. Kumar will continue to benefit from upcoming urban infrastructure projects such as the metro railway.
“We expect the surge of order awards in urban infrastructure (roads, flyovers and mass rapid transit system) to catapult JKIL (J. Kumar) into being one of the leading EPC players in the next three years. Its strong balance sheet and superior margin profile should translate into robust earnings growth and superior returns to its investors," analysts Vibhor Singhal and Deepak Agarwal said in a 2 November report.
Singhal and Agarwal said the EPC sector is undergoing a radical transformation in the listed space. “Old stalwarts such as Gammon, HCC, and IVRCL are being discarded in favour of new ‘kids’ on the block such as JKIL, KNR and PNC. Asset owners (GMR, GVK and Lanco) are being ignored due to keen interest in asset-light EPC companies such as NCC, ITD and JKIL. The underlying reason is simple: this time around, the market does not intend to reward leverage," they said.
ITD Cementation has managed to get large orders in sectors such as urban transport, ports, roads and railways and is expected to benefit from an expected increase in the number of awards across these sectors.
Similarly, Ahmedabad-based Sadbhav Engineering and Nashik-based Ashoka Buildcon, with strong EPC portfolios and well-funded road projects, are performing better than many of larger rivals such as Larsen & Toubro Ltd and ITNL. Sadbhav Engineering’s shares have risen 38.85% in the past 12 months while those of Ashoka Buildcon have risen about 33.6%.
According to an analysis by Equirus Capital, the asset-light construction sector has outperformed all other sectors in infrastructure since the Narendra Modi-led government came to power.
The lower the percentage of assets deployed towards asset-heavy businesses, the lower is the debt burden on the company, the analysis shows.
The last two years have seen regional road contractors gaining market share at the cost of larger peers, said Devam Modi, analyst at Equirus Capital.
“This can be seen from the growth in market share of companies like KNR, G R Infraprojects Ltd, Dilip Buildcon Ltd, PNC Infratech and others who have managed a 41% combined market share in the last two years," he said.
Unlock a world of Benefits! From insightful newsletters to real-time stock tracking, breaking news and a personalized newsfeed – it's all here, just a click away! Login Now!
