HINDUSTAN CONSTRUCTION

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1 India Midcaps RESULT UPDATE HINDUSTAN CONSTRUCTION Robust margin, forex gains stem loss India Equity Research Construction Hindustan Construction (HCC) reported lower than expected loss in Q2FY13 at INR179mn (our expectation INR628mn loss) due to sharp expansion in EBITDA margin and forex gains. However, execution and order intake continued to remain soft. Also, working capital cycle remains high, which is likely to dilute any potential benefit of interest rate softening. Maintain HOLD with SOTP based TP of INR25/share. Surge in operating profitability HCC s revenue booking continued to remain sluggish; revenue, at INR8.6bn, grew 4% YoY. EBITDA margin, which had plummeted in the past two quarters due to cost overruns, bounced back sharply to 12.9% during the quarter, improving 100bps YoY. Also, higher than expected other income coupled with forex gains of INR59mn stemmed the loss. Further, there was an exceptional income of INR22mn due to reversal of interest costs of INR181mn consequent to debt restructuring programme and related expenses of INR159mn. As a result, INR179mn loss was lower than our expectation of INR628mn loss. Order intake a concern The company s order book at Q2FY13 end stood at INR151bn (INR147bn at FY12 end); it is L1 in INR19bn worth of projects. Book to bill remained at 3.8x, as previous quarter, providing limited revenue visibility to HCC, which has a long execution cycle. The company has excluded INR6.6bn of projects from its order book where the client has not received environment clearance. Outlook and valuations: High leverage a worry; maintain HOLD Slow order intake and weak execution have led us to tone down our revenue estimates; however, we have revised our operating profitability assumptions on uptick in EBITDA margins. This, coupled with higher than expected other income has led us to lower our loss estimates for HCC. We remain concerned about the high leverage (3.7x at Q2FY13 end) and the elevated working capital cycle. We maintain our SOTP based target price of INR25/share (INR19/share from BOT projects and balance from Lavasa). Execution concerns, a stretched balance sheet and Lavasa issues mean that the stock is expected to be range bound in the near future. Hence, we maintain HOLD recommendation on the stock. EDELWEISS RATINGS Absolute Rating Investment Characteristics HOLD None MARKET DATA (R: HCNS.BO, B: HCC IN) CMP : INR 18 Target Price : INR week range (INR) : 33 / 15 Share in issue (mn) : M cap (INR bn/usd mn) : 11 / 199 Avg. Daily Vol. BSE/NSE ( 000) : 4,352.5 SHARE HOLDING PATTERN (%) Current Q1FY13 Q4FY12 Promoters % MF's, FI's & BKs FII's others * Promoters pledged shares (% of share in issue) PRICE PERFORMANCE (%) BSE Midcap Index Stock : NIL Stock over Index 1 month 1.6 (4.3) (5.9) 3 months (6.1) 12 months 6.8 (36.1) (42.9) Financials (Standalone) Year to March Q2FY13 Q2FY12 % change Q1FY13 % change FY12 FY13E FY14E Revenues (INR mn) 8,656 8, ,694 (10.7) 39,882 39,944 40,552 EBITDA (INR mn) 1, ,303 3,990 4,253 Net profit (INR mn) (179) (405) NA (310) NA (2,223) (1,707) (1,645) Diluted EPS (INR) (0.3) (0.7) NA (0.5) NA (3.7) (2.8) (2.7) Diluted P/E (x) NA NA NA EV/EBITDA (x) ROAE (%) NA NA NA Edelweiss Research is also available on Bloomberg EDEL <GO>, Thomson First Call, Reuters and Factset. Parvez Akhtar Qazi parvez.qazi@edelcap.com October 26, 2012 Edelweiss Securities Limited

2 Construction Chart 1: Order book Segmental break up Others 14% Hydro 32% Water 21% Transport 33% Chart 2: Order book Geographical break up Jammu & Kashmir 22% Others 38% Andhra Pradesh 17% Gujarat 8% West Bengal 15% Chart 3: Order book Client wise break up In house BOT 18% Private 3% Government 79% Source: Company, Edelweiss research 2 Edelweiss Securities Limited

3 Hindustan Construction Financial snapshot Standalone (INR mn) Year to March Q2FY13 Q2FY12 % change Q1FY13 % change FY12 FY13E FY14E Revenue 8,656 8, ,694 (10.7) 39,882 39,944 40,552 Direct cost 6,348 5, ,840 (19.0) 29,657 30,023 30,276 Staff cost 953 1,155 (17.5) ,392 4,399 4,466 Other expenses (21.4) ,530 1,533 1,556 Total expenditure 7,535 7, ,004 (16.3) 35,580 35,955 36,299 EBITDA 1, ,303 3,990 4,253 Depreciation (3.8) 405 (1.8) 1,621 1,686 1,800 EBIT ,682 2,304 2,454 Interest 1,301 1,356 (4.1) 1, ,432 5,993 5,862 Other income (50.9) 1,228 1,251 1,058 PBT (325) (539) NA (482) NA (1,522) (2,438) (2,350) Tax (66) (176) NA (132) NA (962) (731) (705) Core profit (259) (363) NA (350) NA (559) (1,707) (1,645) Extraordinary items (81) 42 (40) (1,663) 0 0 Reported net profit (179) (405) NA (310) NA (2,223) (1,707) (1,645) Equity capital # of shares (mn) EPS (INR) (0.3) (0.7) NA (0.5) NA (3.7) (2.8) (2.7) P/E (x) (4.8) (6.3) (6.5) EV/EBITDA (x) ROAE (%) (4.0) (14.1) (15.7) As % of net revenues Direct cost Other expenses EBITDA Reported net profit (2.1) (4.9) (3.2) (5.6) (4.3) (4.1) Tax rate NA 32.7 NA NA NA NA Change in estimate table FY13E FY14E New Old % change New Old % change Comments Sales 39,944 40,726 (1.9) 40,552 44,269 (8.4) On weaker execution EBITDA 3,990 3, ,253 4,422 (3.8) Adjusting for improvement in margin EBITDA margin PAT (1,707) (2,168) (21.3) (1,645) (1,755) (6.3) PAT margin (4.3) (5.3) (4.1) (4.0) 3 Edelweiss Securities Limited

4 Construction Company Description HCC is a leading civil engineering and construction company, engaged primarily in the construction of hydel and power projects, irrigation, water supply, urban infrastructure and transportation projects. It is developing Lavasa, an ambitious project aimed at creating a hill city near Mumbai and Pune. Apart from this, it is also involved in some other real estate development projects. HCC is also making inroads in the asset ownership space with entry into the roads space and has plans to build its BOT portfolio significantly going ahead. Investment Theme HCC with more than eight decades of experience in the engineering and construction (E&C) space, is amongst the most respected infrastructure majors in India. Its unmatched technical skills are evident in several marquee projects it has executed over the years. With a robust order book, the company is likely to chart a strong growth trajectory going ahead. With PPP projects gaining currency, HCC has drawn ambitious plans to leverage its E&C strength as far as the asset ownership space is concerned. The company plans to build a sizeable portfolio in the transportation (roads, metro rail, railways and airports) and energy (hydro, nuclear and thermal power) space. HCC, through its 100% owned subsidiary, HCC Real Estate (HREL), is developing Lavasa, free India s first hill city. We believe Lavasa has reached an inflexion point and is likely to redefine the company s profile. Lavasa has already surpassed HCC in terms of profitability and is likely to grow exponentially, thus emerging as a game changer for the company. It is on its way to emerge as a breakthrough project, changing the contours of domestic urban infrastructure development along with significant value enhancement for HCC. Key Risks HCC has ventured into real estate and BOT segments, both of which entail upfront investments with returns generally being back ended. In this context, fund raising in Lavasa has emerged as a key monitorable for the company. Notwithstanding this, there will be demands on the company s balance sheet since the core contracting business also requires funds. Also, working capital management has become a key issue for the company which has stretched its working capital cycle. The company s order book is geared towards hydel projects that are typically long gestation and mostly in difficult terrains. There are inherent risks in execution of such a long duration portfolio. 4 Edelweiss Securities Limited

5 Hindustan Construction Financial Statements Key Assumptions Year FY10 FY11 FY12 FY13E FY14E Macro GDP(Y o Y %) Inflation (Avg) Repo rate (exit rate) USD/INR (Avg) Company Order intake (INR bn) Y o Y growth (%) (37) (44) (65) Book to bill ratio (x) Order backlog (INR bn) Income statement (INR mn) Income from operations 36,292 40,907 39,882 39,944 40,552 Direct costs 26,477 28,902 29,657 30,023 30,276 Employee costs 3,944 4,676 4,392 4,399 4,466 Other expenses 1,593 1,920 1,530 1,533 1,556 Total operating expenses 32,013 35,498 35,580 35,955 36,299 EBITDA 4,279 5,409 4,303 3,990 4,253 Depreciation and amortisation 1,139 1,527 1,621 1,686 1,800 EBIT 3,140 3,882 2,682 2,304 2,454 Interest expenses 2,262 3,290 5,432 5,993 5,862 Other income ,228 1,251 1,058 Profit before tax 1,218 1,117 (1,522) (2,438) (2,350) Provision for tax (962) (731) (705) Core Profit (559) (1,707) (1,645) Extraordinary items 0 0 (1,663) 0 0 PAT before minority interest (2,223) (1,707) (1,645) Adjusted net profit (2,223) (1,707) (1,645) Diluted shares (mn) EPS (INR) fully diluted (3.7) (2.8) (2.7) Dividend per share Dividend payout (%) Common size metrics- as % of net revenues Operating expenses EBITDA margins Net profit margins (5.6) (4.3) (4.1) Annualised growth metrics (%) Revenues (2.5) EBITDA (0.8) 26.4 (20.5) (7.3) 6.6 EPS (45.1) (12.8) (413.0) (23.2) (3.6) 5 Edelweiss Securities Limited

6 Construction Balance sheet (INR mn) As on 31st March FY10 FY11 FY12 FY13E FY14E Equity capital Reserves & surplus 14,869 14,615 12,394 10,688 9,043 Shareholders funds 15,172 15,222 13,001 11,294 9,649 Secured loans 9,630 22,361 24,252 27,252 29,752 Unsecured loans 15,517 13,489 20,317 20,317 20,317 Borrowings 25,147 35,851 44,569 47,569 50,069 Net deferred tax 1,426 1, (29) (734) Sources of funds 41,745 52,737 58,272 58,836 58,985 Gross block 18,142 19,875 20,562 21,962 23,862 Depreciation 6,645 8,032 9,318 11,004 12,803 Net block 11,497 11,843 11,245 10,959 11,059 Capital work in progress Total Fixed Assets 11,845 12,100 11,502 11,316 11,517 Investments 4,087 5,313 5,847 6,447 6,447 Inventories 35,652 37,837 37,554 38,017 35,021 Sundry debtors 27 9,903 11,777 11,796 11,975 Cash and equivalents 1,883 1,674 1,600 3,416 8,043 Loans and advances 8,681 17,220 19,597 19,628 19,926 Total current assets 46,242 66,634 70,528 72,857 74,964 Sundry creditors and others 18,520 30,604 29,149 31,329 33,481 Provisions 1, Total CL & provisions 20,430 31,310 29,606 31,787 33,945 Net current assets 25,813 35,324 40,922 41,070 41,020 Uses of funds 41,745 52,737 58,272 58,836 58,985 Book value per share (BV) Cash flow statement (INR mn) Net profit (2,223) (1,707) (1,645) Add: Non Cash Charges Add: Depreciation 1,139 1,527 1,621 1,686 1,800 Add: Others (7) (875) (2,754) (731) (705) Gross cash flow 1,947 1,362 (3,355) (752) (551) Less: Changes in W. C. 3,608 4,772 1,954 (1,669) (4,677) Operating cash flow (1,662) (3,410) (5,309) 917 4,126 Less: Capex 2,301 2,336 1,557 1,500 2,000 Free cash flow (3,963) (5,745) (6,865) (583) 2,126 Cash flow metrices Operating cash flow (1,662) (3,410) (5,309) 917 4,126 Financing cash flow 6,150 10,422 9,856 3,000 2,500 Investing cash flow (4,144) (7,221) (4,621) (2,100) (2,000) Net cash flow 344 (210) (74) 1,817 4,626 Capex (2,301) (2,336) (1,557) (1,500) (2,000) Dividends paid (284) (282) Share/Warrents issuance / (buyback) 4, Edelweiss Securities Limited

7 Hindustan Construction Ratios ROAE (%) (4.0) (14.1) (15.7) ROACE (%) Current ratio Debtors (days) Inventory days Interest coverage ratio (x) Average working capital turnover (x) Average capital turnover ratio (x) Net debt/ Equity Debt/Equity Creditor Days Cash conversion cycle Debt/EBITDA Adjusted debt/equity Operating ratios Total asset turnover Fixed assets t/o (x) Equity turnover Valuation parameters Diluted EPS (INR) (3.7) (2.8) (2.7) Y o Y growth (%) (45.1) (12.8) (413.0) (23.2) (3.6) CEPS (INR) (1.0) (0.0) 0.3 Diluted P/E (x) (4.8) (6.3) (6.5) Price/BV(x) EV/Sales (x) EV/EBITDA (x) Dividend yield Peer comparison valuation Market cap P/BV(x) EV/EBITDA(x) RoE (%) Price (INR mn) 2013E 2014E 2013E 2014E 2013E 2014E BL Kashyap & Sons 10 2, Consolidated Construction 14 2, (8.1) 0.1 IVRCL Infra. & Projects 42 12, Ramky Infrastructure 102 5, Sadbhav Engineering , Simplex Infrastructures , Average Hindustan Construction Co , (14.1) (15.7) Source: Edelweiss research 7 Edelweiss Securities Limited

8 Construction Edelweiss Securities Limited, Edelweiss House, off C.S.T. Road, Kalina, Mumbai Board: (91 22) , Vikas Khemani Head Institutional Equities Nischal Maheshwari Co Head Institutional Equities & Head Research Nirav Sheth Head Sales Coverage group(s) of stocks by primary analyst(s): Consolidated Construction Co., Hindustan Construction Co., IL&FS Transportation Networks, IRB Infrastructure, IVRCL Infra, Jaiprakash Associates, BL Kashyap & Sons Ltd, Nagarjuna Construction Co, Ramky Infrastructure, Sadbhav Engineering, Simplex Infrastructures Ltd Recent Research Date Company Title Price (INR) Recos 19 Oct 12 J Kumar Infraprojects Zooming on growth expressway; Visit Note 03 Sep 12 Construction Bull s eye: DFCC optimistic on meeting targets; EdelFlash 30 Aug 12 IVRCL Infra Too much to do; Result Update 223 Not Rated 39 Hold Distribution of Ratings / Market Cap Edelweiss Research Coverage Universe Rating Interpretation Buy Hold Reduce Total Rating Distribution* * 1 stocks under review > 50bn Between 10bn and 50 bn < 10bn Market Cap (INR) Rating Buy Hold Reduce Expected to appreciate more than 15% over a 12 month period appreciate up to 15% over a 12 month period depreciate more than 5% over a 12 month period 8 Edelweiss Securities Limited

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