Stock Review: Hindustan Construction Company(HCC)

Hindustan Construction Company's (HCC's) revenues (excluding from joint ventures) grew a moderate 13.3 per cent to `885 crore in the September quarter due to long gestation hydro power and transport projects. Good monsoon and higher share of slow-moving government projects (73 per cent of backlog) also hit the performance.

The operating profit margin rose 161 basis points to 12.9 per cent due to cost control and high-margin hydro projects. However, interest costs as a percentage to sales surged 117 basis points to 7.6 per cent – the highest in the construction sector and in the last 10 quarters – due to introduction of base rates, rising interest rates and a `3,300 crore increase in the net working capital. Stable depreciation and taxation costs, coupled with doubling of other income to `6.1 crore, helped net profit margin rise 67 basis points to 1.4 per cent.

Going ahead, revenue growth is expected to be robust on the back of a pick-up in execution of new large projects, including road build-operate-transfer (BOT) ones. Projects under various subsidiaries, such as HCC Infrastructure and HCC Real Estate (construction work on 247 Park Phase-II to start by March 2011, approvals for slum rehabilitation and 2,000-crore primary offering by Lavasa) are also progressing well.

However, the impact of high interest costs on profitability is the biggest risk, given a leveraged balance sheet (net debt-to-equity of 1.9 times), due to its presence in capital-guzzling segments like BOT, real estate and hydro power. The falling share of hydro power and water solutions in the total order book over the past several quarters, compensated partly by the transportation sector, is also aworry. Further, concerns about the company's exposure to Andhra Pradesh (19 per cent of the total order book) persist, though the share is declining (25 per cent in 2009-10). At `66.05, the stock looks expensive at 25 times 2011-12 estimated earnings.

Though the outlook is bright, high interest costs may prove to be an overhang on the stock