Nagarjuna Construction Co bets on high-growth businesses

Given the huge investments planned in infrastructure development over the coming years, construction companies are expected to benefit from improved environment for order execution. Nagarjuna Construction Co, one of the largest construction companies in India, would benefit from its diversified presence in multiple segments apart from growing contribution from high-margin new segments.

Business: Nagarjuna Construction Co (NCC) provides construction services in India and operates through seven broad business divisions. The building and housing segment, where in the company is engaged in construction of housing projects and industrial & commercial buildings, is the largest contributor to topline numbers, accounting for 25% of first half yearly revenues.

The other segments include transportation (highways, flyovers and bridges), water & environment (water supply, treatment and drainage systems), electrical & irrigation.

The company has in recent years diversified into new areas like taking balance of parts (BOP) projects for power plants, refinery expansion, setting up oil & gas pipelines, engineering, procurement & construction (EPC) projects for metal plants, mining and railways. These new businesses now contribute almost 11% to consolidated revenues and the company is expecting these segments to be the growth driver in next 3-5 years.

The company has presence in international markets such as Oman and the UAE through subsidiaries, where it undertakes projects related to building & housing, transportation and water & environment. The company derives close to 20% of consolidated revenues from these regions.

Apart from the core construction business, the company also engages in infrastructure development, where it owns assets and is able to generate stable revenues on ongoing basis.
NCC currently has a portfolio of five BOT road projects and three upcoming power projects.
Of the five, two road projects are operational and rest are expected to start contributing to revenues from FY12.

In case of power projects, the Himachal Sorang (100 mw plant) is expected to be completed by FY13, while the other two — with capacities of 1320 mw and 280 mw — would take more than 3-4 years for completion.

The company has a real estate development division with presence across six cities in India and Dubai. It plans to come up with 17 real estate projects, of which 12 are ongoing. However, no fresh investments have been planned in this segment due to slowdown.

Investment rationale: With the economy expected to grow at over 8.5%, spending on infrastructure is expected to almost double in the upcoming XIIth Five-Year-Plan from around $500 billion in the current plan ending 2012.

Also, as we near the end of this 5-year plan, execution is set to pick up, which would result in higher revenues for all construction companies.

Nagarjuna has a well-diversified order book both in terms of segments and region. The company’s open order book at end of September 2010 stood at Rs16,075 crore. While building & housings constitutes about 33% of the open order book, the other segments — water & environment, irrigation, transportation and new businesses (power, metals, mining and oil and gas) — contribute 14%, 9%, 6% and 20%, respectively.

International orders form 17% of the total order book. The company bagged orders worth Rs3,495 crore in the first half of the current fiscal and management has guided for year-end order inflows of Rs1,000 crore. The company has maintained a book-to-bill ratio of 2.7X over last three years and is looking to ramp up execution further.

NCC would benefit from its focus on high-growth power, mining and oil & gas projects, which would see increased activity in coming years. Also, its entry into development business bodes well as it would ensure stable revenue stream for company on long-term basis.

Concerns: The company faces typical industry specific risks such as weaker-than-expected economic growth, rising interest rates, delays in land acquisition or getting environmental clearance, and increasing competition. Any delay in getting environmental clearance for its 1320 mw power plant or likely relocation to new place would also impact the company’s plans and projected revenues.

Valuations: NCC’s revenues are expected to grow at a compounded annual growth rate of 20% over FY10-FY12E, while net profits are expected to grow at slightly lower pace of 12% over the same period, due to rising interest costs.

At CMP of Rs141.70, the stock trades at 12.53 times its expected FY11 earnings and 10.24 times its FY12E earnings, respectively. Considering relatively cheaper valuations and diversified order book, the stock can be bought on every decline from long term perspective.

Disclaimer: The writer does not hold any shares in the company