Erbud. Results Preview. Quarterly. 86/2013/RP (147) October 9, Analyst: Andrzej Bernatowicz, +48 (22)

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1 Quarterly Results Preview 86/2013/RP (147) October 9, 2013 Analyst: Andrzej Bernatowicz, +48 (22) Erbud Sector: Construction Market Cap.: US$ 104 m Fundamental rating: Buy ( ) Reuters code: ERBA.WA Market relative: Overweight ( ) Av. daily turnover: US$ 0.04 m Price: PLN 25.5 Free float: 31% 12M EFV: PLN 32.6 ( ) 12M range: PLN Buy on earnings momentum. Erbud equities constitute a bet on a strong improvement in the Company s FY14-FY15 results driven by (i) rebound in developer activities, (ii) growing power segment, and (iii) improving climax in general construction. The Company enjoys also a healthy balance sheet with slight excess cash position. Legal risk of Modlin case is manageable, in our view. We maintain our LT fundamental Buy recommendation with ST market-relative Overweight bias for Erbud s equities. Our 12M EFV goes up to PLN 32.6 per share (from PLN 26.7 per share). We expect also strong 2H13 financial results and maintain our ST market-relative Overweight bias. Good 3Q13E results. We think that Erbud s 3Q13 financial results due to be released on November 14 will show a significant yoy growth across all profit lines. The growth should be mainly fuelled by (i) power construction (Engorem acquisition + business growth), (ii) roads & engineering showing profit vs. loss in 3Q12, and (iii) lower net debt yoy translating into sinking financial costs. We expect that CFO will be marginally positive, with strong flows coming traditionally in 4Q. Strong improvement in ? We think that Erbud will significantly improve its financial results in The growth should be fuelled mainly by (i) a significant improvement in developer activities (2013 is a cycle bottom to us), and (ii) development in power construction. We see also a chance for improvement in general construction (margins and volumes are cyclical, and it seems that we are in the bottom currently), but due to demanding environment, asymmetrical risk profile and lower yoy backlog, we remain conservative in our assumptions. Healthy developer leg. The Company s housing developing arm operates in Bydgoszcz and Toruń, which seem to be relatively less competitive markets. Whereas 2013 is most probably cyclebottom, we believe in results improvement beginning from We think that due to its markets of operation Budlex is wellpositioned to benefit from MdM government incentive program. Recent contract with Eiffage for construction of Deptak project in Poznań setting deadline for December 2014 gives hope that eventually Company may sell this project in 2015 (and show a significant profit in its P&L) and reinvest proceeds in landbank (which explains our increased CAPEX assumption for ). Valuation and financial forecast. We fine-tuned our financial forecasts for Erbud. Our valuation goes up to PLN 32.6 per share (from PLN 26.7 previously), driven mainly by (i) inclusion of Deptak project (PLN 2.7 per share), (ii) upward revision of power segment expectations, and (iii) rallying peer companies. Guide to adjusted profits No factors necessitating adjustments. Key data IFRS consolidated E 2014E 2015E Sales PLN m 1, , , ,520.2 EBITDA PLN m EBIT PLN m Net profit PLN m EPS PLN EPS yoy chng % n.m Net debt* PLN m P/E x P/CE x EV/EBITDA x EV/EBIT x Gross dividend yield % DPS PLN No. of shares (eop) * In our net debt calculation we utilize only excess cash, i.e. the cash that in our opinion is not needed for current operations. Loan to Deptak project is not included in net debt calculation. Stock performance Volume (m) Source: ISI WIG Erbud Upcoming events 1. Release of 3Q13 financial results: November 14, Catalysts 1. Decent 3-4Q13E financial results 2. Strong improvement in FY14E-FY15E financial results 3. Strong balance sheet 4. Prospects in power segment 5. Lawsuit against Bank Millenium for PLN 71 million Risk factors 1. Contract risk 2. Legal risk of Modlin case

2 Erbud We took a conservative approach towards valuation using in our net debt calculation only the cash that we consider excessive (which is c. PLN 100 million less than the actual amount of cash). We think that taking the whole eop cash figure to the net debt calculation is a frequent reason for inflated valuations of cashrich companies like Budimex. We consider it improper because (i) the more a company dependent on public investor the more seasonally inflated 4Q cash flow, and (ii) general contractors (especially those with negative NWC) need strong cash position to improve their negotiation power against suppliers. Fig. 1 Deptak project; Key data Completion date December 2014 Location Top location in Poznań Rentable area (sq m) 9,700 Monthly rent per sq m (EUR) 20.0 NOI (EUR m) 2.3 Yield 7.0% Project value (EUR) 33.3 Project value (PLN) Plot cost (PLN m) 25.6 CAPEX (PLN m) 37.3 Debt (PLN m to be drawn) 69.1 LTV 50% Budlex's stake in Deptak 50% Erbud's stake in Budlex 90% Value of Erbud's stake not incorporated in FY13E 34.4 net debt (PLN m)* Project's profit margin 55% No. of shares 12.7 Value of Erbud's stake (PLN per share) 2.7 * Plot acquisition cost is incorporated in current net debt and therefore is not subtracted in this valuation. Fig. 2 Erbud; 3Q13 results' forecast IFRS consolidated PLN m 3Q13E (IDM) yoy change yoy change Realization of the FY figures in 3Q: Realization of the FY figures in 1-3Q: 2Q13A 3Q12A 1-3Q13E 1-3Q E E 2012 Sales % % 28% 26% 68% 70% General construction % % 27% 23% 68% 69% Housing development % % 16% 26% 73% 54% Roads & engineering % % 41% 46% 67% 83% Power % % 40% 35% 76% 68% Gross profit on sales % % 28% 23% 69% 71% Gross profit on sales margin 6.6% 5.8% 5.4% - 6.8% 6.2% General construction 6.0% 5.0% 6.3% - 6.5% 4.0% Housing development 18.0% 16.0% 24.7% % 21.8% Roads & engineering 4.0% 3.5% -4.0% - 3.3% 14.9% Power 15.0% 17.8% 11.4% % 11.7% EBIT % % 35% 32% 63% 80% EBIT margin 2.8% 1.8% 2.6% - 2.1% 2.4% Net profit % % 40% 24% 54% 70% Net margin 1.9% 0.6% 1.1% - 1.0% 1.2% Fig. 3 Erbud; Changes in IDM's forecast IFRS consolidated PLN m 2013E 2014E 2015E current previous change current previous change current previous change Sales 1, , % 1, , % 1, , % EBIT % % % NI % % % Net debt % % % Source: DM IDMSA estimates 2????????????????????????

3 Erbud Fig. 4 Erbud; DCF model PLN m E 2014E 2015E 2016E 2017E 2018E 2019E 2020E >2020E Sales 1, , , , , , , , ,857.8 yoy change -6% 9% 7% 7% 4% 3% 3% 3% EBIT margin 2.1% 2.3% 2.6% 2.8% 3.0% 3.0% 3.1% 3.1% 3.1% EBIT yoy change 0% 28% 13% 15% 5% 4% 4% 4% Effective cash tax rate (T) 21% 25% 21% 21% 21% 21% 21% 21% 21% EBIT * (1-T) yoy change -5% 36% 13% 15% 5% 4% 4% 4% EBITDA yoy change 1% 23% 11% 13% 5% 3% 3% 3% EBITDA margin 2.7% 2.8% 3.2% 3.4% 3.5% 3.6% 3.6% 3.6% 3.6% Depreciation EBIT * (1-T) + D % chng yoy -3% 27% 11% 13% 5% 3% 3% 3% Capex Change in NWC Free cash flow Cost of equity Risk free rate (nominal) 4.0% 4.0% 4.0% 4.0% 4.0% 4.0% 4.0% 4.0% 4.0% 4.5% Equity risk premium 5.0% 5.0% 5.0% 5.0% 5.0% 5.0% 5.0% 5.0% 5.0% 5.0% Unlevered beta Beta djusted for leverage Required rate of return 11.5% 11.5% 11.5% 11.5% 11.5% 11.5% 11.5% 11.5% 11.5% 12.0% Cost of debt Cost of debt (pre-tax) 7.1% 7.1% 7.1% 7.1% 7.1% 7.1% 7.1% 7.1% 7.1% 7.5% Effective tax rate 21% 25% 21% 21% 21% 21% 21% 21% 21% 21% After-tax cost of debt 5.6% 5.3% 5.6% 5.6% 5.6% 5.6% 5.6% 5.6% 5.6% 5.9% WACC Weight of debt 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% Weight of equity 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% Cost of equity 11.5% 11.5% 11.5% 11.5% 11.5% 11.5% 11.5% 11.5% 11.5% 12.0% After-tax cost of debt 5.6% 5.3% 5.6% 5.6% 5.6% 5.6% 5.6% 5.6% 5.6% 5.6% WACC 11.5% 11.5% 11.5% 11.5% 11.5% 11.5% 11.5% 11.5% 11.5% 12.0% Discount multiple Discount factor PV of free cash flow Sum of FCFFs PVs Weight of debt in the residual period 0% Weight of equity in the residual period 100% Average cost of equity in the definite period 11.5% Average WACC in the definite period 11.5% WACC in the residual period 12.0% Residual growth of FCFFs 1.5% Residual value Present value of the residual value EV of Erbud's construction business Excess cash, eop Interest-bearing debt, eop Deptak project 34.4 Minorities in Budlex 7.0 Equity value No. of shares (m) month forward fair value of Erbud (PLN) 33.3???????????????????????? 3

4 Erbud Fig. 5 Domestic construction companies; Multiples P/E EV/EBITDA 2013E 2014E 2015E 2013E 2014E 2015E ZUE Budimex Trakcja Mostostal-Warszawa Median Erbud Multiples as of October 8 close. Source: Bloomberg, DM IDMSA estimates Fig. 6 Foreign construction companies; Multiples P/E EV/EBITDA 2013E 2014E 2015E 2013E 2014E 2015E Acciona ACS Aker Solutions Amec Balfour Beatty Bilfinger Berger Bouygues Eiffage Enka FCC Ferrovial Hochtief NCC OHL PEAB Sacyr Vallehermoso n.m Saipem Skanska Strabag Technip Vinci Median Erbud Fig. 7 Erbud; Peers valuation summary P/E EV/EBITDA 2013E 2014E 2015E 2013E 2014E 2015E Domestic Domestic valuation Domestic valuation 30.6 Foreign Foreign valuation Foreign valuation 24.6 Total (50% domestic, 50% foreign) 27.6 Deptak project value (PLN m) 34.4 No. of shares (m) 12.7 Deptak project value (PLN per share) 2.7 Total value per share 30.3 Source: DM IDMSA estimates Fig. 8 Erbud; Valuation summary DCF (75%) 33.3 Peer companies (25%) 30.3 Final valuation 32.6 Current share market price 25.5 Upside (downside) to the current market price 22% Source: DM IDMSA estimates Multiples as of October 8 close. Source: Bloomberg, DM IDMSA estimates 4????????????????????????

5 Erbud Financial statements (IFRS consolidated) Fig. 9 Erbud; Balance sheet PLN m E 2014E 2015E 2016E 2017E 2018E 2019E 2020E Fixed assets Intangibles Goodwill Tangible fixed assets LT investments LT deferred tax Others Current assets Inventories ST receivables Construction contracts receivables Security deposits Cash & equivalents Other Total assets Equity Minorities Liabilities & reserves LT liabilities Non-interest-bearing Interest-bearing Reserves ST Liabilities Non-interest-bearing Construction contracts Security deposits Interest-bearing Reserves Deferred liabilities Total liabilities and equity Fig. 10 Erbud; Income statement PLN m E 2014E 2015E 2016E 2017E 2018E 2019E 2020E Sales 1, , , , , , , , ,857.8 COGS -1, , , , , , , , ,720.1 Gross profit on sales Selling costs General administration costs Net profit on sales Other operating income Other operating costs EBIT Financial income Financial costs Pre-tax income Income tax Minority interest in net income Net income EBITDA ???????????????????????? 5

6 Erbud Fig. 11 Erbud; Cash flow PLN m E 2014E 2015E 2016E 2017E 2018E 2019E 2020E Gross income (loss) Depreciation and amortization NWC change: Change in inventories Change in receivables Change in payables Change in construction contracts Change in deferred assets/'liabilities Other Operating cash flow Capital expenditures Other Investing cash flow Change in interest-bearing debt Dividends and other payments to owners Interest Other Financing cash flow Total cash flow Fig. 12 Erbud; Ratios E 2014E 2015E 2016E 2017E 2018E 2019E 2020E Sales growth (yoy) -9% -6% 9% 7% 7% 4% 3% 3% 3% Gross profit growth (yoy) 131% 4% 15% 9% 10% 4% 3% 3% 3% EBITDA growth (yoy) n.m. 1% 23% 11% 13% 5% 3% 3% 3% EBIT growth (yoy) n.m. 0% 28% 13% 15% 5% 4% 4% 4% Net income growth (yoy) n.m. 1% 46% 38% 20% 4% 3% 3% 3% A/P turnover days Inventory turnover days A/R turnover days Cash cycle NWC/Sales 6% 8% 7% 7% 6% 6% 6% 6% 6% Gross margin 6.1% 6.7% 7.1% 7.2% 7.4% 7.4% 7.4% 7.4% 7.4% EBITDA margin 2.7% 2.8% 3.2% 3.4% 3.5% 3.6% 3.6% 3.6% 3.6% EBIT margin 2.1% 2.3% 2.6% 2.8% 3.0% 3.0% 3.1% 3.1% 3.1% Pre-tax margin 1.7% 1.8% 2.3% 2.9% 3.3% 3.3% 3.3% 3.3% 3.3% Net margin 1.2% 1.3% 1.8% 2.3% 2.6% 2.6% 2.6% 2.6% 2.6% ROE 7.5% 7.0% 9.4% 11.9% 13.6% 14.0% 14.4% 14.8% 15.2% ROA 2.2% 2.1% 3.1% 4.3% 4.9% 5.0% 5.0% 5.1% 5.1% Current Ratio Quick Ratio Net debt/ebitda* * In our net debt calculation we utilize only excess cash, i.e. the cash that in our opinion is not needed for current operations. 6????????????????????????

7 BASIC DEFINITIONS A/R turnover (in days) = 365/(sales/average A/R)) Inventory turnover (in days) = 365/(COGS/average inventory)) A/P turnover (in days) = 365/(COGS/average A/P)) Current ratio = ((current assets ST deferred assets)/current liabilities) Quick ratio = ((current assets ST deferred assets inventory)/current liabilities) Interest coverage = (pre-tax profit before extraordinary items + interest payable/interest payable) Gross margin = gross profit on sales/sales EBITDA margin = EBITDA/sales EBIT margin = EBIT/sales Pre-tax margin = pre-tax profit/sales Net margin = net profit/sales ROE = net profit/average equity ROA = (net income + interest payable)/average assets EV = market capitalization + interest bearing debt cash and equivalents EPS = net profit/ no. of shares outstanding CE = net profit + depreciation Dividend yield (gross) = pre-tax DPS/stock market price Cash sales = accrual sales corrected for the change in A/R Cash operating expenses = accrual operating expenses corrected for the changes in inventories and A/P, depreciation, cash taxes and changes in the deferred taxes DM IDM S.A. generally values the covered non bank companies via two methods: comparative method and DCF method (discounted cash flows). The advantage of the former is the fact that it incorporates the current market assessment of the value of the company s peers. The weakness of the comparative method is the risk that the valuation benchmark may be mispriced. The advantage of the DCF method is its independence from the current market valuation of the comparable companies. The weakness of this method is its high sensitivity to undertaken assumptions, especially those related to the residual value calculation. Please note that we also resort to other valuation techniques (e.g. NAV-, DDM- or SOTP-based), should it prove appropriate in a given case. Banks Net Interest Margin (NIM) = net interest income/average assets NIM Adjusted = (net interest income adjusted for SWAPs)/average assets Non interest income = fees&commissions + result on financial operations (trading gains) + FX gains Interest Spread = (interest income/average interest earning assets)/ (interest cost/average interest bearing liabilities) Cost/Income = (general costs + depreciation + other operating costs)/ (profit on banking activity + other operating income) ROE = net profit/average equity ROA = net income/average assets Non performing loans (NPL) = loans in substandard, doubtful and lost categories NPL coverrage ratio = loan loss provisions/npl Net provision charge = provisions created provisions released DM IDM S.A. generally values the covered banks via two methods: comparative method and fundamental target fair P/E and target fair P/BV multiples method. The advantage of the former is the fact that it incorporates the current market assessment of the value of the company s peers. The weakness of the comparative method is the risk that the valuation benchmark may be mispriced. The advantage of the fundamental target fair P/E and target fair P/BV multiples method is its independence of the current market valuation of the comparable companies. The weakness of this method is its high sensitivity to undertaken assumptions, especially those related to the residual value calculation. Assumptions used in valuation can change, influencing thereby the level of the valuation. Among the most important assumptions are: GDP growth, forecasted level of inflation, changes in interest rates and currency prices, employment level and change in wages, demand on the analysed company products, raw material prices, competition, standing of the main customers and suppliers, legislation changes, etc. Changes in the environment of the analysed company are monitored by analysts involved in the preparation of the recommendation, estimated, incorporated in valuation and published in the recommendation whenever needed. KEY TO INVESTMENT RANKINGS This is a guide to expected price performance in absolute terms over the next 12 months: Buy fundamentally undervalued (upside to 12M EFV in excess of the cost of equity) + catalysts which should close the valuation gap identified; Hold either (i) fairly priced, or (ii) fundamentally undervalued/overvalued but lacks catalysts which could close the valuation gap; Sell fundamentally overvalued (12M EFV < current share price + 1-year cost of equity) + catalysts which should close the valuation gap identified. This is a guide to expected relative price performance: Overweight expected to perform better than the benchmark (WIG) over the next quarter in relative terms Neutral expected to perform in line with the benchmark (WIG) over the next quarter in relative terms Underweight expected to perform worse than the benchmark (WIG) over the next quarter in relative terms The recommendation tracker presents the performance of DM IDMSA s recommendations. A recommendation expires on the day it is altered or on the day 12 months after its issuance, whichever comes first. Relative performance compares the rate of return on a given recommended stock in the period of the recommendation s validity (i.e. from the date of issuance to the date of alteration or in case of maintained recommendations from the date of issuance to the current date) in a relation to the rate of return on the benchmark in this time period. The WIG index constitutes the benchmark. For recommendations that expire by an alteration or are maintained, the ending values used to calculate their absolute and relative performance are: the stock closing price on the day the recommendation expires/ is maintained and the closing value of the benchmark on that date. For recommendations that expire via a passage of time, the ending values used to calculate their absolute and relative performance are: the average of the stock closing prices for the day the recommendation elapses and four directly preceding sessions and the average of the benchmark s closing values for the day the recommendation expires and four directly preceding sessions. Distribution of IDM s current recommendations Buy Hold Sell Suspended Under revision Numbers Percentage 33% 48% 16% 3% 0% Distribution of IDM s current recommendations for companies that were within the last 12M IDM customers in investment banking Buy Hold Sell Suspended Under revision Numbers Percentage 0% 83% 0% 17% 0% Distribution of IDM s current market relative recommended weightings Overweight Neutral Underweight Suspended Under revision Numbers Percentage 29% 47% 22% 3% 0% Distribution of IDM s current market relative recommended weightings for the companies that were within the last 12M IDM customers in investment banking Overweight Neutral Underweight Suspended Under revision Numbers Percentage 0% 67% 17% 17% 0%

8 LT fundamental recommendation tracker Recommendation Issue date Reiteration date Expiry date Performance Relative performance Price at issue/ reiteration (PLN) Erbud Buy Not later than 37% 25% M EFV (PLN) Market-relative recommendation tracker Relative recommendation Issue date Reiteration date Expiry date Price at issue/ reiteration (PLN) Relative performance Erbud Overweight Not later than %

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10 Institutional sales Tomasz Dudź tel.: +48 (22) Marcin Kozerski tel.: +48 (22) Bartłomiej Chorzępa tel.: +48 (22) Marcin Fereniec tel.: +48 (22) Marcin Przeperski tel.: +48 (22) Research Sobiesław Pająk, CFA (Equity strategy, Media & Entertainment, IT software & services) tel.: +48 (22) Sylwia Jaśkiewicz, CFA (Construction materials, Consumer staples & discretionary, Utilities) tel.: +48 (22) Maciej Wewiórski (Commodities, Residential construction, Real estate) tel.: +48 (22) This report is for information purposes only. Neither the information nor the opinions expressed in the report constitute a solicitation or an offer to buy or sell any securities referred herein. The opinions expressed in the report reflect independent, current judgement of DM IDM S.A. Securities. This report was prepared with due diligence and scrutiny. The information used in the report is based on all public sources such as press and branch publications, company s financial statements, current and periodic reports, as well as meetings and telephone conversations with company s representatives prior to the date of report's release. We believe the above mentioned sources of information to be reliable, however we do not guarantee their accuracy and completeness. All estimates and opinions included in the report represent our judgment as of the date of the issue. The legal entity supervising DM IDM S.A. is Financial Supervision Commission in Warsaw (KNF in Polish abbreviation). IDM does not take any responsibility for decisions taken on the basis of this report and opinions stated in it. Investors bear all responsibility for investment decisions taken on the basis of the contents of this report. The report is intended exclusively for private use of investors customers of IDM. No part or excerpt of the report may be redistributed, reproduced or conveyed in any manner or form written or oral without the prior written consent of IDM. This report is released to customers the moment it is issued and the whole report is made available to the public one month after the issuance. The analyst(s) responsible for covering the securities in this report receives compensation based upon the overall profitability of IDM which includes profits derived from investment banking activities, although the analyst compensation is not directly related thereto. IDM releases analytical reports via mail or electronic mail to selected clients (professional clients). Apart from mentioned above, there are no ties of any kind between DM IDM S.A., the analyst/analysts involved in the preparation of the report and his/her relatives and the company/ companies analyzed in this publication, especially in the form of: i) offering of financial instruments in the primary market or/and Initial Public Offer within 12 months preceding the issue of this report, ii) purchasing and selling of financial instruments for own account due to tasks connected with organization of the regulated market, iii) purchasing and selling of financial instruments due to underwriting agreements and iv) the role of a market maker for securities analysed by IDM. The analysed company/companies does/do not possess DM IDM S.A. shares. IDM has not signed with the company/companies any contracts for recommendation writing. Investors should assume that DM IDM S.A. is seeking or will seek business relationships with the company/companies described in this report. The report was not shown to the analyzed company/companies before the distribution of the report to clients. Michał Sobolewski, CFA (Financials) tel.: +48 (22) m.sobolewski@idmsa.pl Jakub Viscardi (Telco, Consumer staples & discretionary, IT hardware distribution) tel.: +48 (22) j.viscardi@idmsa.pl Łukasz Prokopiuk, CFA (Chemicals, Oil & gas, Mining) tel.: +48 (22) l.prokopiuk@idmsa.pl Andrzej Bernatowicz (Construction, Video games) tel.: +48 (22) a.bernatowicz@idmsa.pl Michał Czerwiński (Associate) tel.: +48 (22) m.czerwinski@idmsa.pl Bernard Gaworczyk (Associate) tel.: +48 (22) b.gaworczyk@idmsa.pl Copyright 2013 by DM IDMSA Dom Maklerski IDMSA Mały Rynek Kraków Information: (+48)