The Hindu Business Line : Supreme Infrastructure India: Avoid

Investors can give the initial public offer of Supreme Infrastructure the go-by. Lack of a focussed strategy, a very small revenue base that could depress earnings even in a mild slowdown and presence in businesses such as quarrying that carry regulatory risks do not augur well for growth prospects. The company’s business also does not have high entry barriers.

The offer price (Rs 95-108) is at 8-10 times the company’s earnings for FY 2006-07 and on the current equity base. While the valuations are in line with similar companies, the risks associated with Supreme Infrastructure appear high relative to small-sized companies such as Tantia Constructions or PBA Infrastructure.

Within the infrastructure space, there are already superior listed plays which offer high earnings visibility backed by requisite technical qualification. Our recommendation for Supreme, however, does not factor in the possibility of gains on listing.

On the company and offer

Supreme Infrastructure is a construction company that builds roads and also executes projects involving widening and strengthening of roads and highways. The company also operates a ready mix concrete plant for internal consumption and for sale.

The Rs 33-38 crore raised through this offer will be utilised for purchase of plant and machinery for its construction activity, including specified machinery for real-estate construction and for long-term working capital requirements.

Post issue, the market capitalisation of the company would be Rs 132-150 crore.

Risky propositions

Supreme Infrastructure has been in the business of executing concreting orders in the roads and highway segments. The company has now been named a contractor for an upcoming IT park to be built by a group company recently incorporated by the promoter.

This company, with no previous experience in real estate development, will develop an IT park in Mumbai, on land for which development rights have been granted by the promoter for a consideration of Rs 44 crore. We foresee the following risks to this venture: For one, neither the group company nor Supreme have prior experience in developing and marketing real-estate. This is a project awarded by a start-up group company, which is likely to have limited financial and marketing resources.

There have been previous instances in other groups where transactions of realty companies with associates have posed problems of realisations.

Two, this order (for which the company is yet to enter into an agreement with the group company) of Rs 90 crore forms 30 per cent of Supreme’s total order backlog of Rs 300 crore, thus adding risks to earnings growth.

Three, about 20 per cent of the offer proceeds is to be utilised for procuring machinery for real-estate construction. As the company has not laid out any specific plans (in the offer document) on its venture into real-estate construction, there could be underutilisation of the equipment bought for this purpose, resulting in lower return from investment.
Attractive margins but….

Supreme Infrastructure has enjoyed double-digit operating profit margins despite being in the low-margin road business.

We attribute the relatively high margins to its owning a ready mix concrete (RMC) plant as well as a quarrying and stone crushing unit.

These activities of the company in Powai were stalled by the State Pollution Control Board and the High Court recently, although the RMC was later allowed to function.

The company will also have to get various approvals for another RMC to be installed in Karnataka and for quarrying activity near Mumbai.

With increasing environmental and public outcry with regard to such activities, the company may face regulatory risks to these businesses efficiently. Any such disruption may cause a reduction in profit margins from current levels.

While infrastructure growth does provide earnings visibility for a good number of construction companies, we are not sanguine about Supreme’s prospects, given that its small turnover base of Rs 82 crore (FY 2006-07) and narrow range of businesses provide little cushion from the above risks.

Governance issues relating to the structure of the real-estate construction business and high unsecured loans from group companies are concerns too. The offer is open during September 21-26. Karvy Investor Services is the lead manager.

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