Q4FY2013 Construction earnings review Decline in revenues and margin contraction; interest cost weighs down earnings
EPC companies continued to witness stress on top line and bottom line; margin declines: For Q4FY2013, the net profit of the engineering, procurement and construction (EPC) companies (excluding Punj Lloyd [Punj], Ramky Infra [Ramky] and C&C Construction [C&C]) declined by 43% year on year (YoY) on account of a de-growth in the revenue EBITDA coupled with higher interest expenses. Our construction universe (excluding Punj, Ramky and C&C) witnessed a cumulative decline in the revenues to 8% YoY barring Gayatri Projects (Gayatri; which registered a 15% year-on-year [Y-o-Y] growth). At the operating level, all the companies witnessed a margin contraction (except Simplex Infrastructure, which showed a 104-basis-point improvement YoY) due to higher raw material prices. Gayatri and Ramky were the worst hit as their margins declined by 736 basis points and 336 basis points respectively. On the other hand, Punj and Unity Infraprojects (Unity) registered a decline of 239 basis points YoY and 192 basis points YoY respectively in their operating profit margins (OPMs). Overall, due to the deteriorating margin performance, the EBITDA for our universe (excluding Punj, Ramky and C&C) declined by 22% YoY in Q4FY2013. Further, the 15% Y-o-Y rise in the interest cost led to a decline at the earnings level.
Asset developers fare relatively better: On the other hand, the infrastructure developers performed relatively better in comparison with the EPC players. The aggregate revenues for IL&FS Transportation Networks Ltd (ITNL) and IRB Infrastructure Developers (IRB) combined were up by 1% YoY, lower than our expectation, on account of the lower execution. On the margin front, though IRB saw a contraction (53 basis points) due to margin contraction in the build-operate-transfer (BOT) segment, ITNL witnessed an expansion of 145 basis points in the margin on account of the higher share of its revenues coming from its construction arm, resulting in a cumulative 6% growth at the operating level. However, the interest and depreciation expenses on an aggregate increased by 20% YoY and 8% YoY respectively. However, ITNL reported a reversal of the deferred tax liability and IRB reported an effective tax rate of 18%, which led to a cumulative net profit growth of 11% YoY.
Outlook: For the last eight quarters, the infrastructure sector has been continuously underperforming with its net profit growth being in the negative territory. Poor execution due to want of clearances, approvals and land along with a continuous rise in the interest rates has been leading to the poor performance. The situation is further aggravated by the order intake continuing to be weak across segments. Thus, the three key things that are monitorable going ahead include: (1) faster clearances/approvals and land acquisition; (2) a pick-up in order inflow across sectors; and (3) a reduction in interest rates. Till then, we prefer being very selective and our top pick remains ITNL among the larger players and Unity among the smaller players.
Q4FY2013 Capital Goods & Engineering earnings review Margin pressure across the board; remain selective
Sluggish sales growth; in line with our expectation: During Q4FY2013, our coverage universe of capital goods and engineering companies showed a sluggish sales growth of 5% year on year (YoY). The sales of Bharat Heavy Electricals Ltd (BHEL) and Thermax declined while PTC India (PTC), V-Guard Industries (V-Guard) and Larsen and Toubro (L&T) showed a very healthy sales growth of 52% YoY, 34% YoY and 10% YoY respectively during Q4FY2013. Sequentially, our universe grew by 47% due to seasonal nature of the business, where majority of the sales are booked in the last quarter of the financial year. All the companies under our coverage universe have performed largely in line with our estimate at the sales level.
Margin pressure continues; growth at the cost of margin trend could emerge: During Q4FY2013, most of our coverage companies observed a margin pressure, except PTC and Thermax, which showed a flattish to marginal expansion. We believe in the current macro-economic environment, the companies are experiencing rising competition to win projects or retain market share, which could lead to compromised margin. Moreover, in the current situation, the management of several companies shared that winning projects would be more important than having higher margin. Thermax managed to expand its margin by 40 basis points YoY at 11.5% with the help of cost control and value engineering, despite a decline in sales YoY. PTC's operating profit margin (OPM) remained positively biased with increasing share of power volume from tolling arrangement in the overall power trading volume.
Weak working capital, higher interest cost and lower other income dented the overall profitability: The interest cost for the universe doubled YoY and grew by 10% quarter on quarter (QoQ) during Q4FY2013 mainly due to an increase in the interest cost of heavyweights like L&T and BHEL. Adding to this, the other income of our universe (down 3% YoY) dented profitability (down 6% YoY). The net working capital days of all our coverage companies went up except in the case of PTC. PTC witnessed a decline in its sticky receivables as it received payment from the state electricity boards (SEBs) of Tamil Nadu and Uttar Pradesh. Effectively, the net profit of our coverage universe declined by 6% YoY in Q4FY2013. The profit after tax (PAT) of Crompton Greaves Ltd (CGL) and V-Guard declined sharply while PTC was the only company that recorded a positive earnings growth. Thermax and BHEL showed a decline of 4-5% in the net profit. On a sequential basis, due to seasonality of the business, the PAT of our universe doubled in Q4FY2013.
Order inflow improved in Q4, but backlog yet to impress; book-to-bill ratio is historically low: The overall order inflow quantum of our coverage universe improved in Q4FY2013 both on YoY and QoQ bases, largely driven by the better record of the two heavy weights, BHEL and L&T. The order inflow for Q4FY2013 grew by 67% YoY and 112% QoQ to Rs53,024 crore. This is supported by a significant order inflow of BHEL to the tune of Rs20,957 crore as against Rs7,000 crore in Q4FY2012 and around Rs2,000 crore in Q3FY2013. However, the cumulative order backlog of our universe is yet to indicate any significant growth trajectory. At the end of the FY2013, the order backlog of all our coverage companies, except BHEL (which declined by 15%), grew in the range of 5-15%. The book-to-bill ratio stood at 2.3x, which is a five-year low in our coverage universe.
Positive triggers for the sector: The order awarding activity could pick up triggered by: (1) a cut in the interest rates; and (2) an uptick in the demand environment followed by the positive policy actions.
Negative triggers for the sector: The capital goods and engineering stocks continued to face risk from the continuous competitive pricing pressure, leading to a margin contraction amid a slow demand environment due to policy inaction, the deadlock in the power sector and the continuing sluggishness in the execution of the infrastructure projects. Moreover, the environment is yet to be considered conducive to kick-back the investment cycle in the economy.
Q4FY2013 earnings review Given the improving macro scenario, supportive policies and general uptick in economic activity, FY2014 earnings growth is likely to be much higher than 6% reported in FY2013
Earnings growth exceeds low expectations; stress visible across sectors: On an aggregate basis, the earnings of the Sensex companies grew by 6.6% year on year (YoY; by 7% ex oil companies) in Q4FY2013. The growth was higher than our estimate largely due to our conservative estimate (derived on the basis of the weak macro-economic numbers) and positive surprise in select sectors, like automobiles (auto; due to the yen's depreciation and a better product mix) and metals (due to a pick-up in export volumes). Notably, these were the sectors (especially auto) which had disappointed in Q3FY2013 leading to the lower expectations. However, sectors like telecommunications (telecom) and banking (State Bank of India [SBI]) disappointed on the earnings front.
Top performers and losers: The breadth of the earnings growth has not improved for the past few quarters and in Q4FY2013 also 11 out of the 30 companies in the Sensex showed a year-on-year (Y-o-Y) decline in their profit. The major disappointments came from Bharti Airtel, Cipla, Tata Power, GAIL and SBI. On the other hand, companies like Maruti Suzuki (Maruti), Tata Motors, Mahindra and Mahindra (M&M), Tata Steel and Dr Reddy's Laboratories Ltd (DRL) delivered a positive surprise.
Revenue growth slowdown getting broad-based: The aggregate revenues of the Sensex companies grew by 6.5% YoY (ex oil companies), largely in line with our estimate. The growth in the sales has been declining for the past five quarters and many sectors are in the grip of the slowdown. The slowdown in the economy and consumption has moderated the revenue growth for the corporates. During Q4FY2013, the growth in the revenues was led by pharmaceutical (pharma), fast moving consumer goods (FMCG) and information technology (IT) sectors. Sectors like capital goods, metals and banking (public sector banks) have shown a low single-digit growth in the top line.
Margin largely stable YoY: During Q4FY2013, the EBITDA margin of the Sensex companies (ex banks) stood at 19% (up 80 basis points YoY), in line with our estimate. The margin uptick on a Y-o-Y basis was seen mainly in Reliance Industries Ltd (RIL), followed by the metal and pharma companies. However, IT, telecom and capital goods companies reported a decline in their EBITDA margin on a Y-o-Y basis. Of late, the margin pressures have percolated to the FMCG and pharma sectors.
Earnings growth outlook subdued in near term: During FY2013 the earnings of the Sensex companies grew at about 6%, which was far lower than the initial consensus expectation. However, the recent improvement in the macro variables, supportive monetary policy and easing of commodity prices coupled with the expected cyclic uptick in the economy should result in a better earnings growth in FY2014. The downgrade/upgrade ratio has not undergone any major change but given the uncertainties around, the upgrades are still some time away. The Sensex is trading close to the mean valuation and therefore sluggishness in the earnings could cap the market's upside in the near term.