S. Vaidya Nathan

AN INVESTMENT in the equity offer of IVRCL Infrastructure may be considered at Rs 415, which is the upper end of the price band, for the following reasons:

A surging order book that is likely to drive robust revenue growth;

A widening geographic footprint in project implementation that would serve as a reference point for further accretion to the order-book;

An improvement in profitability levels as input price increases are built in into the pricing of orders clinched over the past nine months;

A higher share for building projects in the revenue stream with positive implications for profitability;

A good track record in implementing projects with dedicated funding from multilateral institutions, that is likely be positive when it bids for projects; and

The opportunity to scale up operations aided by the government's thrust on infrastructure.

The IVRCL stock trades at about Rs 500 and the possibility of price weakness once the offer closes cannot be ruled out. It may not be appropriate to take exposure just with the idea of taking gains upon listing of the new shares. Invest with a two/three-year perspective, as such a time period would be necessary to reap gains linked to fundamentals. The stock has moved up six-fold over the past two years and price increases are unlikely to be remotely of such a magnitude; returns are likely to be moderate. The equity base could expand by 17-22 per cent, depending on the pricing and the exercise of the green shoe option.

Stocks from the construction sector space have enjoyed the most spectacular re-rating in the ongoing bullish phase as a focus on infrastructure and enhanced institutional investor interest has lifted them out of the morass of low single-digit price earnings multiples. The pricing of this offer seeks to capitalise on this buoyancy and that enhances the risk element. IVRCL had placed 37 per cent of its equity with two FIIs at Rs 125 per share last April. At Rs 415, buyers would now have to buy into a growth story that is priced at stiff levels.

What provides a cushion is the healthy state of IVRCL's order-book. It has managed to report a steady accretion over the past nine months. As its financial strength improves with a larger shareholder fund base, it is likely to pre-qualify for a larger number of projects; even if its conversion-to-orders ratio does not improve from the existing 15 per cent, it could end up with a bulging order book. IVRCL's conversion ratio is likely to improve over the next few years. The enhanced focus of the government on drinking water, sanitation and irrigation projects is likely to propel growth as this is the key component of IVRCL's orders and revenues.

IVRCL derived a substantial part of its revenues from projects in Andhra and Tamil Nadu until a few years ago. Now, it is in the process of implementing projects in several states across the country, straddling areas such as waterworks, roads, buildings (residential, commercial and industrial), railways and pipelines. If its experience in the two southern states is an indication, these projects could prove a launching pad for bagging more orders in other geographies. Its plan to bid for projects in a few Asian countries could open a new stream of revenue.

As a third national level highways project is set commence and complement the ongoing Golden Quadrilateral and N-S-E-W corridor projects, growth opportunities in the roads sector are likely to expand. The enhanced size of dedicated fund for highways bankrolled by a higher cess on petrol and diesel is also likely to hasten the pace of implementation of such projects.

IVRCL has, on an average, derived about 20 per cent of its revenues in recent years from road projects and is now better placed to win more orders in this space.

Its order-book at about Rs 2,700 crore provides a cushion for at least two years of healthy growth in revenues. There has been a perceptible change in the order-book profile over the past nine months with a higher share for building projects where the profitability levels are higher than in water works. Its ability to pass on the service tax of 12 per cent as well as any further hikes in steel and cement prices would, however, be crucial.

Across various categories, about 25 per cent of its revenues are from fixed price contracts. This should ensure that cost increases are passed on to the clients on most of its orders and so, only a marginal dent to the margins. IVRCL's move to cut down on the use of sub-contractors, conversion of receivables into cash at a faster pace over the past few years and an imminent reduction in debt burden also augur well, as it is in a low-margin business.

The company plans to take up operation and maintenance contracts in water/sanitation projects. Given the sizeable number of projects that it has completed in the past and those pending implementation, this move could provide a steady source of revenue with marginal incremental costs. Its strategy of forging joint ventures to rope in expertise has also enabled it bid for more projects.

The possibility of further increases in steel/cement prices that are not passed on and a rise in the share of fixed-price contracts are the principal risks to earnings growth and our recommendation. The offer closes on March 23.

(This article was published in the Business Line print edition dated March 20, 2005)
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