On track to execution

Sadbhav Engineering has recently won a string of projects, propelling the project pipeline to over Rs 10,000 crore. The company, which undertakes projects in roads, irrigation, and mining, has a track record of finishing projects well ahead of time.

Delays in obtaining environment and forest clearance for two of its road projects held up execution, impacting revenues for the past two quarters.

With these approvals set to come in a few weeks, resumed execution will nudge a return to steady revenue growth. Moves to ease environmental clearances for road projects could further prevent prolonged delays in forthcoming projects.

At Rs 119, the stock trades at 16.9 times estimated earnings for FY-14. While valuations are above peers such as Ashoka Buildcon, Sadbhav scores on its diversified order book, more favourable debt and working-capital position, and strong fresh order flows. Valuations are also below the average of about 20 times of the past three years.

Investors with a two-to-three year perspective can buy the stock. But given its small-cap nature (market capitalisation at Rs 1,781 crore), investors are advised to limit exposure to the stock.

Robust order book

Order book for Sadbhav stood at Rs 8,747 crore at end-December last year. The order book is 4.3 times the trailing four-quarter revenues with an average execution period of 30 months, offering good scope for revenue growth over the next two-three years.

After strengthening the order book position, Sadbhav has won projects worth about Rs 2,535 crore over the past three months.

About 30 per cent of the order book is in irrigation and mining. These segments bring in higher margins than road projects. They also double as a route to diversify dependence away from the road sector, where progress has swung between being sluggish and aggressive over the past few years.

Sadbhav has also secured repeat orders in these two segments. In irrigation, for example, the Sardar Sarovar Narmada Nigam project provided a string of orders for the company. Repeat orders in mining come from the likes of Northern Coalfields and Bharat Coking Coal (Coal India subsidiaries), GMDC and GICPL.

Road strength

Sadbhav’s road portfolio consists of projects undertaken as a developer as well as those taken on a pure construction basis (EPC). A road developer takes on the financing, execution and maintenance of a road stretch and collects toll or annuity. Projects taken on an EPC basis — or Engineering Procurement Construction — involve just construction alone.

Such a diversification helps in the following ways. One, if awarding of fresh road projects slows as was the case last year, EPC orders for existing projects can be secured. Two, execution of development projects can be done in-house, lowering costs and improving margins.

Three, multiple road stretches are set to be awarded on EPC basis now, rather than on a development basis due to lack of financial viability in these stretches.

Sadbhav refrained from participating in the aggressive project bidding of the prior fiscal. Smaller road players entering the fray saw bids going through at high prices, even for lower-value projects.

With these players now pulling back owing to funding problems and a full order book, the field is more reasonable. Sadbhav has won six development projects in the current fiscal.

It has eight projects on which it is collecting toll, three of which turned operational in the current fiscal. One more is set to turn operational in a few months.

Further, it is beginning to add to its projects on annuity basis — two of the projects under implementation and one operational are on this model.

A mix between toll (where collection hinges on traffic flow) and the safer annuity (where fixed payment is received irrespective of traffic volume) models will help balance risks.

Sadbhav’s record of completing projects ahead of time — the Bijapur-Hungund 110 km stretch, for instance, was done a year before the slotted completion date — earns it steady performance bonuses.

For the nine months ending December ’12, bonus received totalled Rs 60.9 crore, about 6 per cent of revenues for the period.

Revenues hit

Environment clearance delayed for two projects hampered execution for the past two quarters. Revenues for Sadbhav thus took a hit and dropped 37 per cent for the nine months to December ’12 compared to the year-ago period. Operating margins fell three percentage points to 9 per cent.

Interest costs were a further drag, as was depreciation, which resulted in net profits dropping 77 per cent for the period. The lower operating profits also reduced interest cover from the comfortable 3 times at the start of this fiscal to 1.7 times now.

However, clearance for the two projects, which are together worth about Rs 2,000 crore should be received in the next few weeks.

The move to separate the forest clearance component of the environment clearance for road-widening projects will help mitigate such massive delays in forthcoming projects.

Sadbhav’s quick execution capabilities should bring revenues back on track in the next fiscal.

Revenues have grown at a compounded annual rate of 38 per cent over the past three years to Rs 2,866 crore in FY-12 while net profits grew 41 per cent to Rs 122 crore.

Consolidated debt-equity ratio as of March ’12 was at 2.9 times. Given its heavy order book, debt levels are unlikely to have gone down. Interest rates on some projects, though, such as the Rohtak-Panipat project are relatively lower at 10 per cent.

Some recently-secured projects such as Malavalli-Pavagada and Rajsamand-Bhilwara are on grant basis, reducing overall debt requirements.