Stock Review: Hindustan Construction Company (HCC)

THE June quarter results of Hindustan Construction Company (HCC) clearly indicate that challenges in terms of execution, higher working capital requirements, and thus, higher interest outgo, haven't eased. For the quarter, HCC reported a 90 per cent decline in net profit on a marginal 6.6 per cent growth in revenues, post which analysts have lowered their earnings estimates for the current and next financial years. On the back of these issues, coupled with worries over its Lavasa project, its stock has corrected almost 60 per cent in a year, wherein most of these issues are factored in. Patient investors with some appetite for risk (given that there is some downside) can look at this stock.

DRIVING VALUE

On the positive side, the company recently sold a 14.5 per cent stake in HCC Concessions for `240 crore. This business, which holds BOT (buildoperate-transfer) road projects, is valued at `1,650 crore or almost two times its book value. HCC's remaining stake of 85.5 per cent is thus worth about `14 per share (after adjusting for a 30 per cent holding company discount). These alysts' earlier estimate of about `7-8 per share and should boost HCC's overall valuations.

HCC's current market capitalisation is`1,832 crore, which along with net consolidated debt of `6,682 crore, translates into an enterprise value of `8,514 crore. This looks reasonable, considering the company's positioning in the infrastructure space – expertise in the high margin less competitive hydro power project segment. Additionally, its order book of `17,000 crore, (four times its FY11 construction business revenues) provides reasonable visibility.

WORRIES CONTINUE

The low valuations, however, teriorating fundamentals, which are likely to take some time to stabilise and improve. Here, the biggest issue relates to HCC's high debt of `7,382 crore, largely on account of working capital arising out of its business need. Going ahead, analysts believe that incremental sales may require the company to borrow more, which could put further pressure on profitability. The company's working capital, in terms of the number of days, has shot up to almost 280 days of sales in the June quarter as against 223 days in the yearago one.

This comes at a time when interest rates are on the rise and execution has been a key challenge. The company's borrowing cost has already gone up from 8.25 per cent to 10 per cent. On the positive side, the company has set up a team to recover large dues from various government agencies, which should lower some of the pressure.