The Hindu Business Line : Sadbhav Engineering: Invest at cut-off

INVESTORS with a long-term investment horizon can consider subscribing to the initial public offer of Sadbhav Engineering. At the price band of Rs 165-185, the price-earnings ratio works out to 9-10 times the expected FY-07 earnings on a post issue basis. A strong order-book, healthy operating margins and experience in the road segment lend optimism to the company's earnings growth.

Sadbhav Engineering is a small player compared to frontline companies such as Hindustan Construction or Nagarjuna Construction. Hence, risks associated with the stock would be relatively higher. Sadbhav Engineering is a Gujarat-based infrastructure company that focusses on roads, highways, irrigation projects and mining operations. A majority of the proceeds are to be deployed as investment in the Mumbai-Nasik Highway special purpose vehicle for the execution of Vadape-Gonde build-operate-transfer (BOT) project. Sadbhav Engineering has been awarded this project in consortium with Gammon India and B.E. Billimorea and Co. The company's share of the project subcontracted from Gammon is Rs 486 crore. .

Healthy order-book

Sadhav Engineering's order-book of Rs1081 crore is more than five times its FY-05 turnover. The order books are stronger than those of similar players such as Era Constructions and Valecha Engineering. The orders are likely to be converted into revenues over the next two years and offer earnings visibility. Roads and highways account for about 75 per cent of the order books and about 20 per cent pertain to irrigation projects. . Over the years, the company has reduced its focus on mining operation due to delayed receipts from clients. However, given the company's qualification in mining in the state of Gujarat and Gujarat Mineral Development Corporation's plans to set up new power projects, the company's prospects of orders in lignite excavation and mining operations may be imminent.

The public issue would help Sadbhav Engineering ramp up its net worth to qualify for BOT projects in the highways sector independently. This space is, however, highly competitive and may warrant joint ventures, in which case the margins may be subdued. Gammon India holds a 14 per cent stake in the company. This may be viewed as a positive for the company since the possibilities of further sub contract projects from Gammon — a frontline player in road projects — may materialise.

Financial performance

The annualised sales and profits for the last three years have been flat. Sadbhav Engineering's sales for the half-year ended September 2005 stood at Rs 124 crore. Operating profit margin (OPMs) at 12 per cent is superior to relatively large players such as IVRCL Infrastructure & Projects or Hindustan Construction.

The company is likely to sustain the present OPMs as a result of increased volumes. The company's debt-to-equity ratio stands at 1.3 on a post-equity issue basis. A majority of this is due to working-capital requirements typical to the construction industry.

Risks

The company has so far had a good track record for executing projects. However, any slowdown in the conversion of current orders into revenues may affect the earnings. The Vadape-Gonde BOT order is a toll-based project. The revenue flow over the years would depend on toll-collection, which adds an element of uncertainty to the long-term annuity flow.

Offer details: The book-built offer is open from February 3-8.