Sadbhav Engineering - Buy

Last March, we gave Sadbhav Engineering a buy rating based on its strong order book, execution capabilities and diversified presence. But in the face of heavy debt requirements, an interest rate cycle that did not turn favourable as expected and the gloomy outlook for the infrastructure sector, the stock has dropped 30 per cent since the call.

Sadbhav still scores on its order book and execution strength. Equity-raising efforts undertaken recently can help balance out the high debt. Sadbhav’s exit from a large road project on which it had begun preliminary work, should ease its financial burden.

But the company still faces trouble on the debt front. Consolidated debt jumped 31 per cent to ₹4,564 crore in FY-13, and further to ₹4,950 crore now. Interest cost more than doubled. Also, slower economic growth has translated into lower traffic volumes for some road projects.

A turn in the interest rate cycle can be the trigger for the stock. Investors with a strong stomach for risk and a two-to-three-year horizon can buy the stock to average their costs.

At ₹85, the stock trades at around 18 times consolidated earnings for FY-15, below its five-year average of 23 times.

Sadbhav’s edge over peers lies in its diversity. Road projects make up 60-70 per cent of the order book. Within this segment, Sadbhav undertakes both development and pure construction (EPC) of projects developed by others. Many highway projects are now being bid through the EPC route.

The remaining order book is taken up by irrigation, where more projects are expected, and mining, where repeat orders are frequent. The two segments also have better profit margins.

The order book as of end-September stood at ₹9,241 crore. While the forthcoming elections could stymie order inflow, Sadbhav is well-placed to ride this out.

It has five road development projects in the execution stage, besides recently won orders from the irrigation and mining segments.

After a sluggish 2012-13, project execution gathered pace in the first half of the current fiscal, with a 24 per cent growth in revenues. Work on all projects, including those recently acquired, should be in full swing by the end of this fiscal. Revenues may therefore return to a healthy 20-plus per cent growth of the earlier years.

At the consolidated level, the company’s debt-equity ratio stood at 3.8 in March 2013, and is likely to have increased since. Interest cover has shrunk to just 1.6 times. But efforts undertaken recently can reduce the debt load slightly. In November, Sadbhav exited its ₹1,183-crore Solapur to Bijapur highway project, on which it had begun preliminary work, with no penalties or debarment from bidding for more projects.

With this, both equity and debt requirements have dropped. Tying up fresh debt has also become a tad easier, via securitisation of toll revenues of two operational road stretches. On the equity side, warrant issues will raise ₹92 crore, with a fourth of this already in. A delayed payment of ₹152 crore in one project has finally begun to come in.

Finally, with progress on the execution front, the working-capital cycle, which lengthened in 2012-13, can shorten. This, in turn, should lower short-term debt requirement. Even so, the debt risk for the company remains high.