Action: Strong operating cash generation could fund new projects
IRB has corrected 25% (vs Sensex return of -19%) YTD. We believe
concerns on rising competition in the road sector resulting in value
destructive bids and an adverse macro environment resulted in the
underperformance. We believe equity IRR in the road sector have come
down, but should stabilise at 15-17%, hence we believe that the
aggressive bids of the recent past need not be extrapolated to all future
projects. IRB is relatively better placed in the current environment, in our
view, as 1) almost 40% of the company’s net debt is secured at fixed
interest rates and b) the current projects can be executed through internal
accruals, hence there is little risk of dilution, in our view.
Valuation: Risk-reward attractive
IRB is currently trading at a P/BV of 2.2x vs. an average P/B of 3.2x over
the past three years. We believe that the current stock price is attributing
little value to potential project accretion in the future. Assuming that the
construction business is valued based only on the current order book (i.e.,
not attributing any future project accretion), the stock provides only ~8%
potential downside from current levels, as per our estimates. We believe
the risk-reward remains attractive as our TP provides potential upside of
25% from current levels.
Key catalysts
Increased visibility of revenues from newly commissioned projects,
Tumkur Chitradurg in Q2FY12 and Kolhapur in 2HFY12.
Reduction in bidding aggression in road projects.
One of the largest BOT players with a credible track record
IRB is one of the largest road developers in India , with18 road BOT projects of which 11
are operational. Its road portfolio consists of ~6700 lane Kms of which ~3400 Km are
operational. IRB was one of the earliest entrants in the BOT segment and owns some of
the very high density stretches in Western India. According to the company, it owns
concessions on ~11% of the Golden Quadrilateral, which has among the highest traffic
density in the country.
Since IRB was an early entrant in the BOT space, its initial projects were won when
competitive intensity was low. This has helped the company post high equity IRR on
these projects. We believe that IRB has been mostly prudent in project selection and
bidding. We list below the difference in IRB’s bid and the second lowest bidder in some
of its key projects. In our view, only the recent Ahmedabad-Vadodara bid is aggressive.
In the Ahmedabad-Vadodara project which IRB won in April 2011, the premium quoted
by IRB was 62% higher than the second highest bid. IRB offered to pay NHAI a premium
of INR3.1bn in the first year. This amount will increase by 5% y-y implying a total outgo
of INR147.8bn over the entire concession period. The next closest bidder (L2) had
offered to pay a premium of INR1.9bn in the first year, implying a total outgo of
INR91.2bn. We understand that other bidders had quoted INR1.0-1.5bn as premium,
implying that IRB's bid was100-200% higher than most other bidders. Management did
acknowledge rising competition and hence the aggressive bidding. Despite the
difference in bids, management expects to deliver 16-17% equity IRR which at this stage
appears optimistic, in our view. According to our estimates, the equity IRR for the project
is 9.3%, below the cost of equity of 13.5%. We therefore attribute a negative value of
INR 21/sh to this project in our valuation. In our view, the stock is already pricing in
negative value from the project, considering the price correction immediately after the
project win was announced.
Balance sheet strength
Net debt/equity ratio for IRB stands at 1.41 as of FY11, which is much lower than some
asset owners like GMR (2.47), Lanco Infra (2.21) and Adani Power (3.09). The company
expects to add US$1-2bn worth of projects every year. The projects can be absorbed
and funded only through internal accruals and additional debt, according to
management. Additional equity need not be raised for these projects as per company.
According to our estimates, we do not see the need for IRB to raise equity for the next
two years. In FY14, three of IRB’s projects which are currently under construction would
be commissioned, in our view. Beyond FY14, IRB could sell stake in these projects or
securitise future cash flows to raise capital to fund newer projects instead of raising
equity at the parent level, in our view.
Risk-reward attractive
We value the BOT projects at cost of equity of 13.5%. We value the construction arm at
7x FY13F earnings. Our end-FY12 value for IRB comes to INR 205/sh. Roll forward by
six months (methodology unchanged) gives us our price target of INR 212/sh. We
believe the risk-reward is attractive as our target price provides potential upside of 25%
from current levels.
IRB is currently trading at a P/BV of 2.2x vs. an average P/B of 3.2x over the past three
years. The stock has corrected 25% (vs Sensex return of -19%) YTD. We believe
concerns on rising competition in the road sector resulting in value destructive bids, and
the adverse macro environment resulted in the underperformance. We believe equity
IRR in the road sector has come down but should stabilise at 15-17%, hence we believe
that aggressive bids of the recent past need not be extrapolated to all future projects.
IRB is relatively better placed in the current environment, in our view, as 1) almost 40%
of the company’s net debt is at fixed interest rates and 2) the current projects can be
executed through internal accrual and hence there is little risk of dilution in our view.
We believe that the current stock price is attributing little value to potential project
accretion in the future. Assuming that the construction business is valued based only on
the current order book (i.e., not attributing any future project accretion), we estimate the
stock would provide just ~8% potential downside from current levels. We believe the riskreward
remains attractive as our target price provides potential upside of 25% from
current levels.
Key risks
The key risks to our target price and rating are: 1) lower-than-expected traffic in BOT
projects, 2) delay in construction of under-construction projects, 3) lower value attributed
to construction arm on lower-than-expected project wins and 4) increase in interest rates
and risk premium.
We present below the sensitivity of our target price to traffic growth as well as cost of
equity.
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