Stress continues; results below expectation: In Q3FY2012 the net profit of the engineering, procurement and construction (EPC) companies (ex Punj Lloyd) fell by 45% year on year (YoY; below our estimate) despite a decent revenue growth. This was mainly on account of a lower EBITDA margin and a higher interest burden. The revenue growth was decent across our universe except for NCC, IVRCL and Ramky InfraStructure (Ramky), which pulled down the cumulative revenue growth to 7.2% YoY (which was still marginally above our expectation). However, most EPC companies except Unity Infraprojects (Unity), Gayatri Infrastructure (Gayatri) and Ramky experienced pressure on their margins which caused our universe's (ex Punj Lloyd) EBITDA to fall by 5% YoY (below our expectation) in Q3FY2012. Further, the 42% year-on-year (Y-o-Y) rise in the interest cost (in line with our expectation) caused the stress to continue at the earnings level.
In case of infrastructure developers, the aggregate revenue was up 44% YoY, in line with our expectation, on the back of the strong execution witnessed by IL&FS Transportation Networks (India) Ltd (ITNL). But on the margin front, while ITNL saw a contraction (as expected) due to a higher share of its revenue coming from its construction arms, IRB Infrastructure Developers (IRB) witnessed a stable margin (above our estimate), resulting in a cumulative 30% growth at the operating level. Despite a strong operating performance, the cumulative net profit was up by just 13% YoY on account of a high interest burden. However, it was better than estimated due to IRB's better than expected quarterly results.
IRB, Unity and Simplex outperform: In Q3FY2012 IRB, Unity and Simplex Infrastructures (Simplex) outperformed with regards to ours as well as the Street's expectations while IVRCL, NCC and Ramky were the laggards. IRB outperformed on the back of an expansion in its operating profit margin (OPM) along with a lower both depreciation charge and tax outgo. Even Unity outperformed on the back of margin expansion, a stable interest cost and a lower depreciation charge. Further, Simplex saw a pick-up in execution which resulted in a buoyant revenue growth; this supported by a stable interest cost led to its outperformance during the quarter. Even Pratibha Industries (Pratibha) saw a very robust revenue growth which led to its marginal outperformance at the earnings level.
On the other hand, IVRCL saw poor execution due to delays in obtaining approvals and acquiring land which resulted in poor revenue booking and lower OPM. Even Ramky saw a poor revenue growth due to slower execution on account of adverse weather conditions in some parts of India. This along with a high interest burden led to Ramky's underperformance. NCC recorded a multi-year low OPM which along with a high interest burden led the company to report a loss at the earnings level. Punj Lloyd seems to have gained some traction on the execution front which is well reflected in its revenue performance over the last two to three quarters. However, its OPM continues to be under pressure which along with a high interest burden continues to result in a poor show at the net profit level.
Outlook: For the EPC companies in our universe except IRB, we have marginally upgraded our estimates for FY2013 to factor in the better execution and higher margins as compared with our earlier estimates. However, we have revised our estimates downward for IRB to factor in the slower execution in a few of the company's projects and the substantial rise in the company's debt levels. The peaking of interest rates is a big relief for the sector and has led to a strong rally in the stock prices across the sector. The government is also slowly shedding its policy paralysis by taking a few initiatives. Now it remains to be seen when the government will speed up the decision making process in order to support the desired policy changes and will expedite the roll-out of the major projects as the same would boost investment in infrastructure. Quick policy actions will help the mid construction companies Like NCC, IVRCL to improve their execution and thus come out of the deep water. Till then we prefer being very selective and our top pick remains ITNL, Unity and Pratibha.
Q3FY2012 Cement earnings review
The Q3FY2012 earnings growth of the domestic cement players was impressive and ahead of the Street's estimates. The companies with a larger exposure to south India saw a significant improvement in their bottom line during the quarter, as their realisation surged due to a supply discipline followed by the manufacturers in the region. On the other hand, after a sluggish offtake during H1FY2012 the cement offtake witnessed signs of a revival in Q3FY2012. Hence, the impact of the cost pressure during Q3FY2012 was largely offset by the healthy realisation for most of the companies. Consequently, we have upgraded our earnings estimates for most of the cement companies under our coverage to factor in the better than expected cement realisation and the improvement in the cement offtake. Going ahead, with the price hike undertaken in January this year, we believe cement companies are expected to post better profitability and earnings in the coming quarter. Our top pick in the sector is Grasim Industries (Grasim) in the large-cap space on account of its strong balance sheet, better profitability in the viscose staple fibre (VSF) business and attractive valuation. In the mid-cap space we prefer Orient Paper & Industries (Orient Paper) due to its diversified business model, improving market mix in favour of the non-southern regions and attractive valuation.
Key points
Cumulative revenue grew by 20.8%: In the quarter under review, the cumulative revenues of the cement companies under Sharekhan's universe grew by 20.8% year on year (YoY) to Rs17,606.7 crore. The revenue growth was supported by the realisation growth of 18.2% YoY and the volume growth of 10.2% YoY. Among the Sharekhan cement universe, Shree Cement, Orient Paper and Madras Cement posted a revenue growth of above 25% YoY. On the other hand, the revenue of the other companies grew by 18-20%. Large players like Ambuja Cement posted an impressive revenue growth of 30.2% whereas the revenues of ACC grew by 27.8% during the same quarter.
Mixed volume growth of cement universe, Orient Paper takes the lead: The cement companies under our coverage posted a mixed volume growth during the quarter. Orient Paper reported a volume growth of 25% due to the stabilisation of its new capacity and the revival in the demand for cement. On the other hand, JP Associates Ltd (JAL) and Madras Cement also posted an impressive volume growth in the range of 16-18%. Companies like UltraTech Cement (UltraTech), Shree Cement and India Cements, however, posted a volume growth of 7-9%. The pan-India large players like ACC and Ambuja Cement reported a volume growth in the range of 6-7%.
Cumulative realisation increased by 18.2%, supported by supply discipline: The cumulative realisation of the cement makers under our coverage increased by 18.2% YoY in the quarter. The cumulative growth in the realisation was supported by the supply discipline followed by the cement players. The average realisation of Shree Cement and Orient Paper increased by 33% and 20.7% respectively whereas the average realisation of the other players increased by 10-15%. Further, the cement prices increased by Rs10-12 per bag during January this year which will be reflected in the coming quarters.
Cost pressure offset by surge in realisation, margin expanded: On the operating profit margin (OPM) front, the cumulative OPM of these cement companies expanded by 48 basis points to 22% during the quarter under review. Shree Cement, India Cements and Madras Cement reported a healthy improvement in their OPM whereas the margin improvement was comparatively lower in case of UltraTech and Grasim. The margin expanded on the back of a surge in the realisation which offset the cost pressure in terms of an increase in the power & fuel cost (due to a rise in the coal price YoY) and a higher freight cost (due to an increase in the lead distance). On the other hand, players like JAL and Orient Paper reported contraction of 150-400 basis points in their margin. However, in the coming quarters we believe the margins would improve sequentially due to the recent increase in the cement prices.
Earnings improved by 46.1% due to revenue growth and margin expansion: The revenue growth (supported by the realisation and volume growth) coupled with the margin expansion resulted in a better than expected earnings growth during the quarter. Further, the impressive performance of the non-cement division of JAL also supported the overall earnings growth. On a cumulative basis, the Sharekhan cement universe registered a 46.1% growth at the net profit level.
