HG Infra Engineering: Primary Offer - Execution on fast track

The road infrastructure (mainly highway construction) segment has seen a slew of companies make initial public offerings over the last couple of years. Since the sector depends largely on government awards, and as profitability and risks vary depending on the models under which contracts are given, it is important to be discerning while choosing exposure to mid-tier players in the space.

Investors with a reasonable risk appetite and at least a two to three-year horizon can subscribe to the IPO of HG Infra Engineering, a mid-sized player focused on the construction of roads, highways, flyovers and bridges. The company has presence in six States, though Maharashtra and Rajasthan dominate in revenue share.

A business focused on executing projects under the low-risk EPC (engineering procurement and construction) model, a strong order-book and a pipeline of lucrative ongoing constructions are key positives for the company.

A majority of its revenues comes from government contracts, though private sector clients too contribute significantly.

At the upper end of the price band (₹263-270), the stock would trade at 33 times its FY17 per share earnings (on a fully diluted basis) and 30 times its annualised earnings for the first half of FY18. The offer is not cheap, but at these levels, HG Infra’s multiples would be lower than those of the likes of KNR Constructions and PNC Infratech that trade at 37-38 times the trailing earnings.

However, given that the valuation is not cheap, investors would be better off playing the longer game instead of betting on listing gains.

Between FY14 and FY17, HG Infra’s revenues grew at a compounded annual rate of 30.8 per cent, while net profits increased at 69.8 per cent. In the first half of FY18, the company’s revenue was ₹569.5 crore, while net profit was ₹29.3 crore. Its net margin, of more than 5 per cent, is comparable with the best players in the industry. On parameters such as debt/EBITDA and interest cover, HG Infra scores better than many peers. The total debt on the balance-sheet is about ₹222 crore, of which about ₹115 crore would be paid off from the proceeds of the issue.

EPC model lowers risk

The company bids for EPC projects alone currently. These include those from the NHAI, the Ministry of Road Transport and Highways and state public works departments. It also works with private clients on select projects.

The advantage of working with an EPC model of highway construction is that there is no revenue risk for the bidders of the highway contracts.

Essentially a fixed-rate contract, the EPC model has been a sought after mode of bidding for large and mid-sized players alike, given that there are no toll, traffic or annuity risks for the companies executing these projects. Costs are known upfront and bidding is done accordingly – usually aggressively.

While margins could get squeezed in the EPC route, HG Infra has managed to maintain or improve EBITDA margins over the years (11-12 per cent earlier and at 14 per cent for the first half of this fiscal), indicating efficient execution capabilities.

HG Infra restricts itself only to EPC projects. Industry analysts (From India Ratings) believe that EPC contracts would still account for more than half the total value for the awards made for the construction of highways for the future.

According to a Crisil report, of the ₹4.3 lakh crore likely to be invested in the road sector up to fiscal 2022, only about ₹1.4 lakh crore would be through the HAM (hybrid annuity model) mode.

So, there appears no major risk in revenue visibility for the company.

Robust order book

The company is executing several projects involving four-laning and six-laning of highways in large States such as Maharashtra and Rajasthan. Contract values range from ₹300-640 crore. In these projects, the company plays the role of a contractor or a sub-contractor.

The company is pre-qualified to bid for projects from the NHAI and MoRTH with a contract value of up to ₹806 crore.

As of November 2017, HG Infra’s order book size was around ₹3,708 crore, more than three times its FY17 revenues. More than two-thirds of the pie came from public sector entities and about 32 per cent from private sector clients.

The key risk to the issue would be the competitive intensity as a number of mid and large players dot the space.

Of the ₹462 crore being raised totally, ₹162 crore is an offer for sale from the promoters.