IL&FS Transportation Networks: Buy

Small players in the road development space are scrambling to fund projects won. That they placed expensive bids has also not helped. Thus, with the hitherto intense competition cooling off, large players have returned to the fore. They are also in a relatively better position to secure funding for their projects, have better operating margins and technical expertise.

IL&FS Transportation Networks (ITNL), among the largest listed road developers, has won about four large orders in the past three quarters. Over the next year and a half, as many as eleven projects are set to become operational, boosting cash flows. A mix of annuity and toll-based roads, strong parent backing and a good order book are other positives.

At Rs 194, the stock trades at 7.3 times trailing 12-month earnings and 6.5 times estimated earnings for FY-14. Valuations are at a discount to the smaller Ashoka Buildcon, while also being below historic valuations. Investors with a two-to-three year perspective can buy the stock.

Balanced portfolio

A mix of annuity and toll projects balances risks on ITNL’s road projects. About 40 per cent of ITNL’s road projects are on an annuity basis, where the company gets paid a fixed amount per year, regardless of traffic flow. Annuity projects are a better bet in stretches with uneven traffic. For instance, ITNL’s Chennani-Nashri tunnelway in Jammu & Kashmir, Jorbat-Shillong (both under execution), and a number of stretches in Jharkhand are on annuity basis.

More lucrative stretches which have heavy traffic volumes such as Vadodra-Halol, Jetpur-Rajkot and Pune-Sholapur (under execution) are on a toll model, where collections depend on traffic flow.

Toll collection in two projects in Gujarat alone, for instance, was up 22 per cent in the previous fiscal. But even in toll projects, the company has auctioned off toll receipts where it feels traffic may be prone to volatility. Such auctions are for a one-year period, which allows the company to take back toll collections if traffic flow improves.

For the six months ending September 2012, total toll revenues were up 16 per cent.

While the de-risked model may cap revenues, it may be a prudent strategy, given the uncertainties in predicting traffic volumes and the nascent nature of the toll model. Most peers have a far smaller share of annuity-based projects.

Healthy order book

While ITNL’s stronghold is in road Engineering Procurement and Construction (EPC), tolls and maintenance, it did attempt to diversify and reduce concentration risks.

To this end, it operates the Nagpur City Bus Service operations, is building a multi-level car park in Hyderabad and the Gurgaon metro rail.

Further diversification is in the form of its Spanish subsidiary Elsamex, an established player in operation and maintenance of roads, and in the 49 per cent stake ITNL picked up in an operational Chinese highway.

Elsamex affords it an international presence in Portugal, Spain and Latin America. Its expertise in road maintenance will serve it well in domestic markets, especially with older and other completed stretches of road coming up for maintenance contracts by the NHAI.

Order book currently stands at Rs 12,000 crore, at 2.1 times the revenues for FY-12, offering medium-term earnings visibility. Over half ITNL’s projects have been awarded by the NHAI, which will help it secure large-sized orders in future bidding.

Its parent (IL&FS) has strong relationships with State governments and brings expertise in financial structuring of projects.

Heavy debt

Strong order book and execution helped consolidated revenues grow at a compounded annual 66 per cent over the past three years to Rs 5,605 crore. Net profits grew multi-fold to Rs 496 crore.

Sub-contracting of construction leaves it with higher operating expenses compared to peers such as IRB Infrastructure. Operating margins for ITNL stood at 28 per cent for FY-12, lower than the earlier years on higher input costs.

But debt is on the high side, with the debt-equity ratio at 3.7 times at end-September 2012. Interest costs took a hefty 13 per cent out of revenues, which resulted in net margins dwindling down to 9 per cent.

For a developer the size of ITNL and the recent high-value bids it has won, the debt-equity ratio is unlikely to reduce significantly.

Comfort may be derived from the stable interest cover of 2.1 times. Eleven projects are likely to move into the operational stage over the next few quarters, boosting cash flows which could help manage the interest burden. Interest rates beginning to move downwards could also provide some relief.

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