Stock Review: Patel Engineering

 

 

Given Patel Engg's foray into the realty and power generation biz, investors with moderate risk appetite can take exposure in this stock

 

 

Patel Engineering (PEL) is one of the largest firms engaged in building hydropower generation plants in the country. With a good project execution history, strong order book and dominance in hydropower plants that carry a higher margin among various infrastructure businesses, the firm provides reasonable earnings visibility in the near term. Given its foray into realty and power generation businesses, investors with moderate risk appetite can take exposure in this stock with an investment horizon of 2-3 years.

BUSINESS:

PEL is the leading civil engineering and construction company for hydropower units besides irrigation, water supply and transportation projects. Since its inception in 1949 the company has executed 30 hydro projects, 250 km tunneling projects and 75 dams in India. PEL through its subsidiary in the US has also acquired a construction technologies company that brought it innovative technologies like roller compacted concrete (RCC), besides micro tunneling that allows digging up roads to lay pipes replacing conventional methods. PEL has diversified from pure construction firm to a developer of infrastructure and real estate projects through its wholly-owned arms Patel Energy and Patel Realty (India). PEL has an order book of 8,000 crore as on June 30, 2010, which is 2.54 times its revenue for the 12 months ended June 2010. Further, under irrigation, close to half of the orders comprise projects in Andhra Pardesh, which increases the risk of over dependence of revenue from one state.

GROWTH DRIVERS:

PEL's future strategy is to focus on its core business of construction of hydropower projects besides executing plans to set up thermal power plant of 1,050 mw capacity in Nagapatnam in Tamil Nadu, for which land has been acquired and coal linkages are also in place. The financial closure will be done by December and construction is expected to complete by September 2011. The company has accumulated land bank in Mumbai, Noida and Bangalore.

FINANCIALS:

The company's consolidated net sales rose at a CAGR of 40% over the past four years. Operating profit grew a tad faster at 45% but net profit growth was a relatively modest 22% annually during this period. While revenue growth was due to timely execution of projects, net profit growth was comparatively subdued due to high increase in interest cost. But the company had a debt-equity ratio of 1.35:1 as of March 2010, lower than the industry average of 1.86:1. For the JUne 2010 quarter, PEL's revenue grew at a slower pace of 9% over the year-ago period to 702 crore due to project execution getting impacted by political turbulence in Andhra Pradesh. In comparison, net profit grew 15% to 44 crore due to lower increase in non-operational cost.

VALUATIONS:

At the current market price of 379, the scrip is trading 12.6 times its consolidated profit for the 12 months ended
June 30. This looks reasonable compared to industry average price earning multiple of 22. Assuming 15-20% annual growth in revenues for the current fiscal and for the year ending March 2012, we expect the company to close with consolidated net profit of 250 crore in FY12. This means PEL scrip is trading around 10.3 times the estimated two-year forward earnings, which means reasonable upside in the stock. With additional revenue visibility from its other segments, such as real estate and power, the company is likely to post good numbers in the next couple of years. So, investor with long-term horizon of at least two year should take exposure in the stock.

CONCERNS:

PEL relies more on hydropower projects that are awarded by state governments so any delay in projects allocation can result in lower income going forward. Another big chunk of revenues is derived from Andhra Pradesh an irrigation project that also brings geographic risk. Further, any delays in real estate projects can impact earnings owing to its high leverage.