The Hindu Business Line : Era Constructions: Buy

Execution of contracts with better margins, entry into new segments and a rise in order-book position bring earnings visibility to the Era Constructions stock (Rs 278).

The Budget, through its fund allocation, has further reiterated the Government's thrust on infrastructure spending.

The company is at a stage of moving up the value chain through high-value projects and widening business segments. This will involve an expansion in its equity base. The benefits of these measures are, however, likely to translate into numbers over the next couple of years.

Investors can add the stock to their portfolio with a two-year perspective. Any decline linked to the broad markets will serve as an attractive entry point.

At the current price, the stock trades at 13 times its expected FY-07 per-share earnings.

Era Constructions is engaged in diversified construction activities such as industrial complexes, residential buildings, power and airport projects. It has now forayed into road and railway contracts.

The current order-book of Rs 807 crore is five times the FY-05 revenues. If the company is successful in its current bids, the order-book for the year may well close at Rs 1,200 crore.

The high order-book, once converted to revenues, is likely to largely neutralise any dilution in earnings that could result from a scaling up of equity capital.

Broad client base

Era Constructions has clients across private and state enterprises unlike several infrastructure companies, which depend on government orders.

Further, the profitability margins from industrial projects in private sectors such as textiles, pharmaceuticals and hospitals are higher than that from core infrastructure projects such as roads or railways.

Of the company's orders on hand, about 42 per cent constitute contracts other than infrastructure. This is likely to offset the less attractive margins from infrastructure work.

Diversifying revenue

Era Constructions is aiming at backward integration by setting up a plant for making pre-engineered building (PEB) material. This will be initiated through a separate entity so as to retain the tax benefits available for construction companies.

The new entity will also enjoy excise and sales tax incentives given by Uttaranchal. The PEB industry is at a nascent stage in India but, increasingly, being used in non-residential structures such as power plants, railway stations and airports.

The company also plans to enter the real-estate development business through a special purpose vehicle (SPV). Construction work for the real-estate projects would be awarded to Era Constructions. This is likely to supplement company's revenues.

Era's bottomline has grown at an annualised rate of 32 per cent over the past three years. The operating profit margins for the past nine months at 13 per cent, is superior to bigger players such as Nagarjuna Construction. This margin may see a reduction of 100-200 basis points, if the company forays into BOT projects.

It is, however, likely to remain above the industry average. Any decline in profitability due to the effect of BOT projects is, however, likely to more than adequately compensated by enhanced revenues and the foray into newer segments.

In this backdrop, the impact of lower margins on earnings may be marginal. We expect the company to post robust growth in earnings and this could provide support to the higher valuation levels that the stock now commands.

Risks

The principal risk to our recommendation will be delays in converting order-book to revenues. If the company maintains its track recent in recent years, it may not act as a dampener on valuation.

Era Constructions has doubled its equity share capital over the past year. This has enabled it bid for higher value contracts. With further expansion through issue of depository receipts, the company is likely to qualify to bid for Build-Operate Transfer (BOT) projects.

If the proceeds are not systematically deployed in projects, the earnings may see a dilution. Even with ramp-up of capital, the company will face competition from bigger players such as Gammon India and Hindustan Construction in the infrastructure space. Inability to win bigger orders may slow down revenue growth.

Although the company is not taking a direct route to venture into real estate, the stake in the SPV may expose it to risks associated with real estate-development.

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