Ambit Indian Construction Thematic 2010-12-16

December 16, 2010
Construction
THEMATIC
Future Growth ≠ Future Cash Analyst contacts

Nitin Bhasin
Tel: +91 22 3043 3241
In spite of the infrastructure deficit in the country, the Indian nitinbhasin@ambitcapital.com
infrastructure sector is not endowed with a multitude of investing
Chhavi Agarwal
opportunities. Whilst we prefer construction companies to
Tel: +91 22 3043 3203
infrastructure developers, the former’s penchant for orders and asset
chhaviagarwal@ambitcapital.com
ownership has resulted in mismanaged balance sheets. Whilst some
valuation driven opportunities are cropping up, stock valuations
continue to face challenges on account of weak financial performance
and equity market dependent embedded values.
The construction sector’s poor investment returns over the last five years has Nagarjuna Construction BUY
been a symptom of order chasing, capital misallocation, contentious
CMP: Rs138
accounting quality, equity dilution and serial execution disappointments. But
now with the 6-30% decline in stock prices (excl. L&T and Sadbhav) over the Target Price: Rs165
last six months and giving the obvious infrastructure deficit in the country, are Previous TP: Rs210
valuations pricing in the worst? We do not think so. Upside (%): 19
Weak cash generation could continue for some more time EPS (FY11E): Rs8.8
Change from previous (%): (11)
Our primary data checks throughout the ecosystem — with equipment lessors, Variance from consensus (%): (4)
unlisted companies, banks and sub-contractors — do not point to near-term
improvement in execution and payments. We expect working capital turnover Mkt cap: Rs35bn/US$778mn
to further decline in FY11 from the already low and declining levels of the last 3Mavg. daily trade val.: Rs236mn/US$5mn
few years. We expect free cash flow for most companies from FY13 onwards.
Interest rates and inflationary headwinds
Rising interest rates and the lack of cheap funding (through commercial
paper) have already started impacting PBT margins of the sector. Given IVRCL Infrastructure SELL
expectation of further rises, we do not expect PBT margins to return to the
CMP: Rs126
high levels of 2HFY11. Moreover, increasing inflation is also impacting
employees’ costs, which we expect could rise 10-12% in FY11 on a YoY basis. Target Price: Rs109
Previous TP: Rs190
Double whammy of ever rising developer ambitions
Upside (%): (13)
Infrastructure development ambitions of the construction companies not only EPS (FY11E): Rs6.6
increase balance sheet risk but also force equity dilution in the non-cash Change from previous (%): (30)
generating parent companies. Furthermore, the current order books and the Variance from consensus (%): (21)
resultant execution expectations are building in smooth execution of captive
orders, which are not only dependent upon the parent’s financial health but Mkt cap: Rs34bn/US$748mn
also on the external equity environment. We find IVRCL to be most vulnerable 3M avg. daily trade val: Rs330mn/US$7mn
on this front.
Valuation: Superficially cheap

Whilst valuations for most of the construction companies (4-9x one-year
forward earnings excl. embedded values) appear attractive vis-à-vis historical
standards, we believe that valuations are facing challenges not only on
account of core construction financial performance (revenue growth, earnings
and most importantly, cashflows) but also on account of embedded values,
which seem to need more equity in the near term. Whilst some valuation
driven opportunities are cropping up, we advise investors to favor construction
companies with: (a) minimal equity investment needs in infra
SPVs/subsidiaries and (b) low leverage. We are assuming coverage on
Nagarjuna with a BUY on Nagarjuna Construction, but downgrade IVRCL to
SELL.
Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit
Capital may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.
Please refer to disclaimer section on the last page for further important disclaimer.
Construction
CONTENT
SECTOR
An unappreciated fact: Poor returns............................................... 3
Poor returns, a function of the industry behavior.......................... 4
The construction opportunity is huge .............................................. 9
So are construction stocks set to fly?............................................. 10
Valuations: Superficially attractive ............................................... 15
COMPANIES
Nagarjuna Construction ................................................................ 21
IVRCL.............................................................................................. 33
Ambit Capital Pvt Ltd 2

Construction
An unappreciated fact: Poor returns

Whilst the construction sector revenues have grown at a 16% CAGR over the last
five years to Rs4,883bn, we find that the stock price returns from leading players in
the industry have been poor (with L&T being the notable exception).
Exhibit 1: Construction companies have generated poor share price returns
CMP Mcap 1 month 3m 6m 1yr 2 yr 3 yr 4 yr 5 yr 7 yr 10 yr
(Rs) (Rsbn) return return return return CAGR CAGR CAGR CAGR CAGR CAGR
Construction cos
L&T 1,989 1,209 -5% 4% 30% 18% 56% -2% 29% 35% 42% 38%
IVRCL 126 33 -7% -21% -26% -27% 24% -21% -11% 11% 35% 35%
Punj Lloyd 109 36 -11% -4% -24% -46% -16% -42% -13% NA NA NA
Nagarjuna 138 35 -3% -14% -18% -8% 33% -26% -9% 2% 41% 49%
Simplex 442 22 -8% -8% -6% -17% 67% -12% 4% 12% 58% NA
CCCL 66 12 -5% -24% -19% -13% 21% -28% NA NA NA NA
Patel 322 22 -13% -18% -24% -28% 47% -28% -8% 2% 41% 34%
Sadbhav 129 17 -10% -16% 2% 31% 103% 5% 34% NA NA NA
Madhucon 123 9 -12% -19% -20% -25% 96% -15% -6% NA 43% NA
HCC 46 28 -25% -28% -23% -32% 40% -25% -10% -6% 33% 36%
Gammon 173 22 -7% -20% -17% -24% 59% -34% -19% -15% 9% 27%
Ahluwalia Contracts 158 10 -11% -26% -30% -11% 122% -23% NA NA NA NA
Indices
BSE 30 index 19,747 -3% 2% 16% 17% 42% -1% 11% 16% 20% 17%
BSE100 index 10,352 -4% 0% 14% 16% 44% -2% 12% 16% 21% 17%
BSE200 index 2,461 -5% 0% 14% 17% 46% -2% 12% 16% 20% 18%
CNX Infra. index 3,401 -5% -5% 5% -2% 15% NA NA NA NA NA
BSE Capital Goods
15,420 -4% 1% 17% 12% 48% -8% 15% 22% 33% 36%
index
Source: Ambit Capital research, Bloomberg,
Note: Share prices and market cap data is as on Dec 14, 2010

Construction
Poor returns, a function of the

industry behavior
We believe that the poor returns of the last five years are driven by the multiple
reasons discussed in the following pages:
High competitive intensity
Exhibit 2: Porter’s analysis of Indian construction industry
Competitive intensity Bargaining power of buyers

HIGH HIGH
Highly unorganised sector with more than Major project sponsors are government
120,000 firms of which nearly 25% are bodies and corporates, which tender and
very small firms award projects mainly on lowest cost
basis, keeping bargaining power of
Limited number of large players, which is buyers very high
also a function of limited number of large
projects Increased business activity or change in
project sizes does not shift the bargaining
International companies such as power in favor of a few construction
HOCHTIEF, Leighton, Vinci and Malaysians companies as smaller companies vie for
are increasing their presence in India but these projects through tie-ups with other
through JVs with the Indian companies Indian/international players
Bargaining power of suppliers

MEDIUM
Fragmented nature of the construction

industry does not provide it with any
advantages in cement and steel sourcing
Continuing shortage of skilled manpower

and subcontractors
Barriers to entry Threat of substitution

MEDIUM LOW
A new entrant can establish itself by
competing for smaller contracts, rather There is no threat of substitution but the
than attempting to rival the majors projects can get delayed or cancelled
Rising scale of projects is increasing the

financial and technical prequalifications,
keeping a dozen or so firms in the fray
Improving Unchanged Deteriorating
Source: Ambit Capital research, Industry

Construction
Persistent inability to generate cashflow

What concerns us the most about Indian construction companies is the continuing
inability to generate free cash. In spite of increasing scale, geographical and
segmental diversification, poor working capital management and high capex have
kept operational as well as free cash flow (FCF) absent. High revenue growth and
the resultant working capital needs over the past 5-6 years have kept cash flow
from operations (CFO) much lower than EBITDA and kept FCF negative for nearly
all of the construction companies. Whilst CFO turned positive for some in FY09
and FY10, capex pushed FCF into the red even in those two years.
Exhibit 3: Little improvement in CFO/EBITDA Exhibit 4: Free cash has been always absent!
(%) FY05 FY06 FY07 FY08 FY09 FY10 (Rsmn) FY06 FY07 FY08 FY09 FY10
Punj Lloyd -60 1.4 13.8 -80 -214 -737 Punj Lloyd (2,684) (5,613) (13,607) (16,707) (1,4386)
IVRCL -1 -76 -54 -104 11 34 IVRCL (1,553) (2,542) (5,402) (1,685) 601
Nagarjuna -84 -214 61 -14 -40 5 Nagarjuna (4,597) (689) (2,080) (1,563) (1,389)
HCC 130 -53 -224 47 24 13 HCC (3,155) (9,487) (491) (1,170) (2,007)
Simplex -57 -13 -8 20 17 25 Simplex (1,121) (1,929) (2,565) (3,346) (57)
Gammon 21 -32 -2 53 31 -21 Gammon (1,571) (1,788) (244) (494) (3,441)
Soma 44 10 -20 31 -39 82 Soma (2,353) (2,300) (1,440) (3,510) 2,295
CCCL -70 -33 -55 -35 10 -38 CCCL (208) (789) (793) (589) (1,063)
Patel 51 -97 -95 -70 -100 -41 Patel (1,501) (1,898) (2,812) (2,846) (1,731)
Sadbhav 4 223 114 -20 40 63 Sadbhav 448 469 (650) 1,521 934
Madhucon 15 -101 105 116 15 66 Madhucon (1,090) (265) 388 (646) 581
Source: Company, Ambit Capital research Source: Company, Ambit Capital research
Misallocation of cash and equity raisings

Construction companies continue to risk their limited cash resources in ambitious
asset and real estate investments and in providing loans and advances to
seemingly “unrelated parties”. As explained below, these drains on cash have
driven frequent equity dilutions, which have obviously impacted shareholders’
returns.
Regular equity raisings for fulfilling asset ambitions
Most Indian construction companies have taken to asset development in the last 5-
6 years. Multiple equity raisings and a simultaneous rise in investments in and
loans to subsidiaries indicate that most of the equity raisings were for funding
asset ownership rather than for the core construction business.
Exhibit 5: Multiple equity raisings funding asset ownerships and unclassified Exhibit 6: High proportion of FY10
loans and advances net worth in subsidiaries
Equity Investments Loans to Incr. in
(A) + (%) Investments Loans
raisings over in subs. over subs. over unclassified loans
(Rsmn) (B)+
FY04-10 FY04-10 FY04-10 over FY04-10
(C) IVRCL 32 15
(A) (B) (C)
IVRCL 9,999 5,991 2,311 2,494 10,796 Nagarjuna 32 19
Nagarjuna 14,599 7,393 3,321 1,200 11,914 HCC 26 31
HCC 15,047 3,533 4,726 1,908 10,167 Simplex 0 0
Simplex 4,933 - - 3,117 3,117 Gammon 6 26
Gammon 8,933 529 4,727 995 6,251 CCCL 5 0
CCCL 2,937 318 - 891 1,209 Patel 24 13
Patel 7,693 3,501 1,856 6,108 11,465 Sadbhav 29 30
Sadbhav 2,830 1,376 1,423 660 3,459 Madhucon 54 0
Source: Company, Ambit Capital research, Industry Source: Company, Ambit Capital research

Construction
Cash parked in unclassified loans and advances

Rising loans and advances has been very common amongst most of the Indian
infrastructure construction and realty companies and these loans and advances
form a large portion of the net assets and net worth of construction companies
(exhibits 7 and 8). We believe that many of the Indian companies and promoters
may have provided these loans and advances to seemingly unrelated parties in
which promoters might have indirect interests. We highlight that not only have
these loans and advances in construction companies increased from small
amounts in FY05 to much higher amounts in FY10 but also that this increase in
loans and advances coincided with equity raisings at the parent level.
Exhibit 7: Unclassified loans and advances as %age of Exhibit 8: Unclassified loans and advances as a %age
net worth of assets
(%) FY06 FY07 FY08 FY09 FY10 (%) FY06 FY07 FY08 FY09 FY10
IVRCL 16 22 20 18 21 IVRCL 10 14 10 8 9
Nagarjuna 26 28 33 7 4 Nagarjuna 22 17 21 4 2
HCC 12 34 36 41 39 HCC 5 10 9 7 7
Simplex 23 46 28 31 35 Simplex 8 13 14 13 14
Gammon 22 23 16 44 36 Gammon 11 9 6 10 9
CCCL 1 19 14 19 18 CCCL 0 12 11 15 13
Patel 94 29 42 65 65 Patel 24 17 17 28 27
Sadbhav 24 23 24 20 28 Sadbhav 17 8 8 5 24
Note: All above calculations except for Simplex are on consolidated Note: All above calculations except for Simplex are on a
basis; net worth excludes revaln. reserves consolidated basis; net worth excludes revaln. reserves
Given that a number of companies could have given the loans and advances as
advances to their suppliers or creditors, we compare the year-end loans and
advances with the respective year’s revenues and find that whilst in some cases the
loans and advances are moving with revenues, IVRCL’s unclassified loans and
advances show minimum movement for four years and are at about Rs2.3-2.9bn.
Also, Nagarjuna’s unclassified loans and advances have been continuously
reducing — FY10: Rs0.4bn from FY09: Rs0.7bn
The transitory competitive positioning of the players

We find it difficult to make meaningful distinctions amongst the mid-size
construction players (excl. L&T) on the basis of competitive advantages.
However, experience suggests that a strong player can lose its competitive edge in
the industry through a few bad contracts or a couple of poor performance years
(Punj Lloyd is the most recent example). When we assess the industry’s top 10
players on three key metrics — prequalifications, political proximity and cost
structure — we find that most of the players have or can easily manage the first
two but have to focus on cost efficiency as the government-sponsored order flows
are based on lowest cost bidding.
Exhibit 9: Key competitive assessment metrics

Strengths of
Metric Description Importance
players
Measured on the basis of: experience in the respective segment,
Prequalifications networth, equipment, recent turnover, technology, management and Low to medium High
employees
Access to the government/bureaucratic machinery which can be
Political proximity leveraged to influence post prequalifications for bagging projects in Medium to High High
states
Assessed through past financial ratios: (a) Fixed cost as a percentage of
Cost structure to total costs, (b) Debt-equity, (c) Gross block turnover, (d) Working capital
High Low
bid low turnover, (e) Financial expense as percentage of debt, (f) Financial
expense as percentage of sales
Source: Ambit Capital research, Company, Industry

Construction
Assessing current competitive positioning

We map the competitiveness of the leading Indian construction companies on
prequalification and cost structure and find that amongst the largest players
(excluding L&T), Nagarjuna appears to be the strongest with others close
behind. We exclude L&T as it has a large fabrication and international
hydrocarbon business.
We highlight that where Nagarjuna, CCCL and Simplex are strong in the building
structure segment, IVRCL is a leader in the irrigation segment with no
meaningful second largest player in the same arena. Whilst Punj Lloyd is a
relatively strong player on our competitive landscape, we find that while the
company has strong prequalifications (thanks to a large order book, net worth and
international revenues), on cost competitiveness Punj is relatively poor.
Exhibit 10: Competitive assessment of the mid-size Indian construction companies

Latest
Dominant Competitive Competitive
FY10 reported Market 1HFY11 Revenue Overall
segment in standing on standing on cost
revenues order cap Networth CAGR competitive
order book prequalificatio structure
(Rsbn) book (Rsbn) (Rsbn) FY07-10 ness
and revenues n (40% weight) (60% weight)
(Rsbn)
Infra and Oil &
Punj Lloyd 118 254 32 35 11%
Gas
Water supply &
IVRCL 53 240 33 19 32%
irrigation
Building &
Nagarjuna 48 161 32 23 19% industrial
structures
HCC 36 197 24 15 16% Power
Building
Simplex 46 130 20 10 39%
Structures
Gammon 45 144 20 19 40% Power
Soma(a) 25 151 NA 8 31% Transport
Building
CCCL 20 45 12 6 32%
Structures
Patel 24 105 22 15 29% Power
Sadbhav 13 78 18 5 37% Transport
Madhucon 14 46 9 6 44% Transport
Source: Company, Ambit Capital research, Industry, Bloomberg,
Note: (a) Soma is unlisted and its order book is as of Mar-10; (b) We use FY10 financials for competitive analysis; (c)We do not
consider L&T and Era Infra due to diverse nature of their businesses; (d) We use the latest order book reported by the companies;
(e)Market cap as on Dec 14, 2010
Note : - Strong; - Relatively Strong; - Average; - Relatively weak.
Shift in competitive standing

Whilst the current competitive positioning is an indication of recent performance,
we also check the movement on the competitive canvas of the construction
companies over the past three years. We note that whilst the prequalification
standing remains more or less the same over FY08-10, the relative
competitiveness of these companies on cost structure changes over time, thereby
impacting the overall competitive standing of the companies. Nagarjuna’s
comparatively lower debt:equity, high gross block and working capital
turnover have helped it remain the strongest player on the cost competitive
metrics.
Construction
Exhibit 11: Nagarjuna remains the strongest player

FY08 FY09 FY10
IVRCL
Nagarjuna
HCC
Simplex
Gammon
Soma
CCCL
Patel
Sadbhav
Madhucon
Source: Company, Ambit Capital research, Industry
Note: - Strong; - Relatively Strong; - Average; Relatively weak.
Contentious accounting policies

In our recent accounting thematic, Indian Accounting – Accounting Quality Matters,
dated November 30, 2010, our analyst Bhargav Buddhadev has highlighted that
housing related companies (including construction, realty and cement sectors) are
the biggest contributor to the 50 weakest companies ranked by accounting quality.
Of the 35 companies in the BSE’s housing related sector, 12 are from the
construction sector. Furthermore, barring one year (FY07 wherein it was ranked
second in the bottom 50 category), housing related companies have been the
biggest contributors to the bottom 50 list across all years.
Of the 10 construction companies in Bhargav’s total dataset of 360 companies, 4
of the construction companies appear in the worst 50. However, what worries us
most is the below average accounting score of the construction companies
amongst its broader peerset of housing related companies. As per Bhargav’s
research, the weak accounting score for housing related companies seems to be
on account of poor cash generation (CFO/EBITDA is low), expense manipulation
(the fall in the depreciation rate is high and provision for doubtful debts is low) and
cash pilferage (“other loans and advances” as a percentage of revenues is high).
Exhibit 12: Accounting quality checks Exhibit 13: Low mcap constrn. companies have weak accounting scores
# in Avg Housing
Sector/ Market No of # in Average Construct
# of cos. worst a/cing Housing Construct related
dataset cap compani worst accounti ion in
50 score related ion in worst
buckets es 50 (A) ng score worst 50
Entire 50
360 50 196
dataset 1 50 2 224 4 1 1 0
Housing
35 12 183 2 100 8 204 5 1 1 0
related
Construction 10 4 160 3 100 20 190 15 6 6 2
Worst 50 50 50 131 4 110 20 181 11 4 4 2
Source: Company, Ambit Capital research, Total 360 50 196 35 12 12 4
Capitaline Source: Company, Ambit Capital research, Capitaline
Note: Bucket 1 is the 50 largest companies in the country by market cap and bucket 4 is the
bottom half of the BSE 500.

Construction
The construction opportunity is huge

India to be driven by infrastructure investment
India’s infrastructure deficiency and rising infrastructure requirements portends
rapid growth over the next decade for the Indian construction industry. Whilst real
estate development and industrial capex are also the drivers for the construction
industry, infrastructure will be the key demand driver over next decade or two. As
per our economist, Ritika Mankar, with the high GDP growth period and a
consistent 33% investment: GDP ratio behind us, India is poised for a capex boom,
which will mean increasing investments in infrastructure as well as industrial
capacities over the next 5-10 years (see Ritika’s note on Five Megathemes, dated
November 19, 2010).
Exhibit 14: Infrastructure spend by the government is Exhibit 15: India on the verge of a capex boom in
rising infrastructure and industrial capacities
20% 44 25
33 20
18%
15
16% 22
10
11 5
14%
0 0
12%
1980
1983
1986
1989
1992
1995
1998
2001
2004
2007
2010 (E)
2013 (E)
2016 (E)
10%
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
GFCF as a share of GDP % (LHS)

Infra spends share in total Union Govt Expenditure GDP growth rate % (RHS)
Source: Union Budgets, Ambit Capital research Source: WP, MoSPI, Ambit Capital research
Can the construction industry deliver?

Whilst industrial capex will be driven by corporates, infrastructure investments will
be driven by the Indian government’s five year plans which continue to get larger.
The government’s indication of a US$1tn XIIth Five Year Plan (FY12-17) following
the US$0.5tn XIth Five Year Plan (FY07-12) signifies at least a potential US$455mn
construction opportunity over FY12-17 (considering 65% construction intensity and
30% slippage). This is obviously considerably larger than the opportunity presented
by the XIth plan.
Exhibit 16: Share of const. sector in GDP set to rise Exhibit 17: Construction opportunity growing bigger
6,000 12% (Rsbn)

4,883
4,500 23,000 20,475
4,500 3,815 19,000
3,223 3,295
2,735 15,000
3,000 8%
11,000
7,000 3,067
1,500 1,562
3,000 459
- 4% (1,000)
FY10 Latest order Construction Construction
FY06 FY07 FY08 FY09 FY10 1HFY11
revenues for book for opportunity orders
Nominal construction sector GDP (Rs bn) (LHS) Top-12 (excl Top-12 (excl over next 18 opportunity
GDP growth rate L&T) L&T) months* over FY12-
Real construction sector growth 17 **
Source: Ambit Capital research, Industry Source: Planning commission, Ambit Capital research
*65% (construction intensity) of the anticipated investment for the
remaining 11th plan (FY07-12); **calculated as 65% (construction
intensity) of the anticipated investment in the XIIth plan (FY12-17)

Construction
So are construction stocks set to fly?

Given the ever increasing growth opportunity and given the 13-30%
declines in stock prices (excl L&T and Sadbhav) in the last six months, a
commonly heard sentiment in the stockmarket is that construction stocks
are pricing in the worst. Furthermore, such bulls contend that these stocks
are set to fly with order inflows picking up and with execution improving
from the disappointing levels of the recent past. However, we find that
multiple challenges and headwinds lie ahead and this could hold back the
sector’s business performance and valuations.
Cash generation could be far away

Primary data checks, management teams and banks highlight
payment/execution delays
 Equipment lessors highlight that whilst there continues to remain high
inquiries and expectations of increased requirements from these inquiries, the
pick-up in the construction activity is not yet visible. Lessees continue to
face execution delays and payment delays which are impacting equipment
lessors, whose working capital is also getting stretched.
 Management teams of unlisted construction companies seem to be less

sanguine than their listed peers of a significant improvement in execution in
2HFY11. Whilst the listed players are guiding the stockmarket towards a 15-
40% YoY increase or 50-100% HoH increase in revenues, the unlisted players
are guiding towards a 10-15% YoY increase in 2HFY11. Most managements
are focusing in getting their house in order through continuous works reviews,
controlled (read less aggressive) order bidding and payment collections.
Further, all the management teams we met alluded to the fact that growth and
scale are not bringing in the desired effect of economies of scale and better
cash flows.
 Banks/financial institutions highlight that lending to the infrastructure

sector has been rising but the offtake for the short duration/working capital
loans is rising faster than long term project loans. Moreover, on the term loans
side as well, the shorter duration term loans are forming a larger part of the
increased lending.
Capex requirements could also increase

 Rising interest rates leading to higher equipment leasing costs. Unlisted
and listed company managements highlight that the capex requirements of the
companies could be higher in the near term due to the rising leasing costs (a
function of lessor’s finance costs) and due to the rising cost of equipment. Our
recent meetings with construction equipment and engine manufacturers for
construction equipment (such as Cummins) also support the view that
construction equipment prices are increasing by 5-10%.
 Labour inefficiency and poor availability of the right kind of labour,

which we believe could force companies to increase their capex on
technologically better equipment or on setting up larger training centers.
Payment/execution delays and higher capex to exacerbate the

extent of dismal gross block turnover and low working capital
turnover
With rising scale and increased experience of project execution one would have
expected the operations of most of these companies to become efficient over time.
Instead we find that barring a few companies, all of the companies’ gross block
turnovers have declined (exhibit 18). However, the most concerning aspect has
been the working capital turnover decline over the years across all the companies,

Construction
signifying a continuing inability to get paid on a timely basis. Despite being well
diversified — segmentwise and geographically — construction companies face
payment delays from their customers; this highlights that it is not a particular
segment or geography which poses payment and execution risk.
Exhibit 18: Gross block turnover has been declining Exhibit 19: Working capital turnover has been declining
with scale for most of the companies with scale
(X) FY05 FY06 FY07 FY08 FY09 FY10 (X) FY05 FY06 FY07 FY08 FY09 FY10
Punj Lloyd 2.5 2.0 3.7 3.9 5.0 3.6 Punj Lloyd 3.1 2 4.1 4.1 4.2 2.5
IVRCL 10.1 11.1 11.1 10.8 9.0 7.5 IVRCL 2.7 2.4 2.7 2.9 2.9 2.8
Nagarjuna 7.7 8.7 7.6 6.0 6.5 6.9 Nagarjuna 6.5 3.5 4.0 4.1 3.4 3.0
HCC 2.5 2.9 2.5 2.5 2.1 2.1 HCC 6.6 2.5 1.7 2.1 2.0 1.8
Simplex 5.7 5.6 4.8 4.8 4.8 3.7 Simplex 3.8 3.5 3.2 3.9 4.8 3.7
Gammon 2.4 3.4 3.3 3.3 4.1 4.0 Gammon India 4.1 3.0 2.8 3.1 3.7 3.2
CCCL 31.8 25.4 21.4 19.2 14.4 11.3 CCCL 11.6 4.5 4.5 5.1 4.6 3.5
Patel 2.4 3.1 3.9 3.7 3.8 4.6 Patel Engg 2.2 2.3 1.8 1.3 1.2 1.2
Industry 3.1 3.4 3.9 4.0 4.3 3.6 Industry 2.8 1.7 2.4 2.4 2.5 2.0
Gross Block is calculated excluding Revaluation reserves Working capital is calculated excluding Loans and Advances to
subsidiaries
Near-term headwinds
Rising interest rates could pull PBT margins lower
Construction is a highly working capital intensive sector in which funds availability
and the cost of funds can have a major impact on profitability. Over the course of
the last few quarters, we have seen that changes in interest costs can impact PBT
margins and execution. In FY09 we saw lack of funds and rising interest rates
impacting PBT margins. On the other hand, in FY10, widespread borrowing
through 5-6% coupon commercial paper (CP) brought funding costs down for most
of the players, thus improving PBT margins. However, now with the CP avenue
becoming more expensive and with rising funds costs, we expect PBT margins of
most of the companies to be adversely impacted in the coming quarters. As per
management teams and banks, CP rates and working capital borrowing rates are
up by 250bps and 150bps, respectively in the last nine months.
Exhibit 20: Interest costs have started rising; will PBT margins be adversely hit?
15% 13%
12%
12%
9%
6%
11%
3%
0% 10%
Q1FY09
Q2FY09
Q3FY09
Q4FY09
Q1FY10
Q2FY10
Q3 FY10
Q4 FY10
Q2 FY11
Nov-10
Oct-10
Dec-10
Q1 FY11
SBI PLR (Avg) (RHS) Avg PBT margin(%) AA -1 year rate CP 6M rate
Source: Company, Ambit Capital research, Industry, Bloomberg.

The construction companies featured for calculation of average PBT margins are IVRCL, Nagarjuna, HCC,
Simplex, CCCL and Gammon India
Furthermore, the use by the construction companies of sub-contracting and leasing

of equipment magnifies the effect of rising interest rates. Our discussions with
various managements and sub-contractors highlight that when lending rates to big
corporates rise by 100bps, the lending rates for equipment leasing and sub-
contractors, which are primarily unorganized, rise by at least 200bps. Unorganized

Construction
sector borrowing is generally at a 150-200bps higher cost versus the rates that the
leading construction companies get.
Exhibit 21: Rising funding costs for low quality Exhibit 22: Subcontracting and equipment leasing costs
borrowers for the companies
12% (%) FY06 FY07 FY08 FY09 FY10

Subcontractor costs as a %age of total costs
11%
Punj Lloyd 23 29 30 37 29
10%
IVRCL 23 24 32 30 22
9% Nagarjuna 37 37 36 37 30
8% HCC 36 45 42 31 42
Simplex 42 43 33 33 35
7%
Gammon 34 38 45 27 31
6%
Machinery hire charges as a %age of total costs
Dec-08
Feb-09
Jun-09
Aug-09
Jun-10
Aug-10
Apr-09
Oct-09
Dec-09
Feb-10
Apr-10
Oct-10
Dec-10
Punj Lloyd 0.3 0.2 0.1 0.3 0.3
IVRCL 1.2 1.6 1.6 2.3 2.2
Nagarjuna 2.0 1.5 2.0 2.2 2.3
BBB 6M 6M BBBP 1 yr 1 yr AA 1 yr 1 yr
Gammon India 1.0 0.2 0.1 0.1 0.1
Source: Bloomberg, Ambit Capital research Source: Capitaline, Company, Industry, Ambit Capital research
Whilst management teams admit that debt availability and interest rates are vital
factors impacting their construction and infrastructure development ambitions,
none of them appear to be bothered about either debt availability or
rising interest rates. However, everyone expects working capital rates to further
increase from the current level. All management teams highlighted their unused
large working capital limits and the eagerness of banks to provide project finance
to their ‘strong’ companies. Moreover, management believes that there is enough
cushion in their past cash contract bids to absorb a 50-100bps rise in working
capital costs.
Inflationary pressures remain

Our economist, Ritika Mankar, has highlighted in her recent note on Five
Megathemes, dated November 19, 2010) that high inflation in India could be a
structural phenomenon and that this could impact the performance of companies
with high employees’ costs. Whilst employee cost constitutes a small part of the
costs of the construction companies, we highlight that there are labour costs
embedded in the sub-contractor costs as well. We believe high inflation could
impact the employees’ costs for the construction companies, thus further impacting
near-term margins. Managements have already highlighted in their meetings with
us and in their earnings calls that they are facing 10-11% average increase YoY in
their employees’ costs.
Exhibit 23: High inflation will lead to rising employees’ costs
9% 6%
8% 5%
7%
5%
6%
4%
5%
4% 4%
3% 3%
FY04 FY05 FY06 FY07 FY08 FY09 FY10 1HFY11
Inflation WPI % (LHS) Employee cost % of sales (RHS)
Source: Ambit Capital research, Bloomberg

Note: For calculation of employee costs the following companies are included:Punj Lloyd, IVRCL,
Nagarjuna, HCC,Simplex, Gammon, CCCL, Patel, Sadbhav, Madhucon

Construction
Sub-contractor issues and availability

Our discussions with the listed and unlisted players and with sub-contractors have
highlighted that given the growing construction opportunity a number of sub-
contractors are becoming frontline contractors and competing with their earlier
clients i.e. the large construction companies. Furthermore, a number of sub-
contractors highlighted that given the payment delays for their clients,
subcontractors are also choosing their clients and the contracts more carefully. We
believe this could be one more reason for the delays from some of the large
construction companies.
The double whammy of asset ambitions

We have highlighted earlier that most of the construction companies have
assumed developer roles and have a presence across assets, of which roads is the
dominant segment, followed by real estate. Construction companies have been
funding these ventures through debt/equity infusions. Whilst we appreciate this
asset opportunity, we do not find this opportunity to be any better than the core
external opportunity facing the sector since the captive asset orders that these
contractors have procured have not been fast moving contracts and are dependent
on equity infusion and financial closures which have not been easy to come by.
Hence the construction business visibility from captive asset orders can be
equally as uncertain as external orders.
Adjusting for captive orders, book-to-bill ratios are not that exciting
Whilst the construction companies have revenue visibility for three years or more,
captive orders account for more than 17% of the order book for most of the
companies. Excluding captive orders, the book-to-bill ratios for most of the
companies have fallen by eight months. As visible from the table below,
Nagarjuna is the only company with a very low proportion of captive order book.
Exhibit 24: Growth expectations based on the timely execution of captive assets
OB Book-to bill
Revenues OB as on Captive % Book-to bill
excluding (including
FY10 30th Sept 10 orders share (excluding
captive captive)
(Rsbn) (Rsbn) (Rsbn) in total captive) (x)
(Rsbn) (Rsbn)
IVRCL 53 240 55 23 185 4.5 3.5
Nagarjuna 48 161 2 1 159 3.4 3.3
HCC 36 197 34 17 163 5.4 4.5
Gammon 45 144 25 17 119 3.2 2.6
Patel 32 105 42 40 63 3.3 2.0
Madhucon 14 46 33 71 13 3.3 1.0
Total 228 893 190 21 703 3.9 3.1
Source: Company, Ambit Capital research
Equity raising is becoming necessary

Any meaningful growth/faster execution from the captive orders is dependent
upon the successful financial closure of the projects and equity infusion. Given the
rising debt:equity ratio (standalone and consolidated) for most of the companies,
equity raising appears to be the only route available for mobilizing captive
orders and taking the existing investments to fruition.

Construction
Exhibit 25: Equity requirements of asset development Exhibit 26: Little room to fund subsidiaries via more
….. debt
Equity and loans Equity investments
Companies to subsidiaries requirements Madhucon
(Rsmn) (Rsmn) Sadbhav
Patel
IVRCL 8,948 19,424
CCCL
Nagarjuna 11,722 11,983 Gammon
HCC 8,624 10,400 Simplex

HCC
Simplex 1 4,080
NCC
Gammon 6,271 10,000 IVRCL
Punj Lloyd
CCCL 339 1,500
0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0
Patel 5,432 16,235
Debt/Equity (Standalone) Debt/Equity (Consolidated)
Sadbhav 2,799 5,000
Note: Debt:equity is as on March 31, 2010

Construction
Valuations: Superficially attractive

Whilst valuations for most of the construction companies appear attractive
vis-à-vis historical valuations, we believe that valuations are facing
challenges not only on account of core construction financial performance
(revenue growth, earnings and, most importantly, cash) but also on
account of embedded values which seem to need more capital in the near
term.
Construction sector earnings: Slippery road ahead

Whilst the construction business multiples appear attractive, we believe these
seemingly cheap valuations can become expensive if consensus’ high estimates
are not met in 2HFY11. Our primary data checks support our view that most
companies will miss their 2HFY11 guidance and hence miss consensus estimates
which are implying 15-33% YoY and 25-90% QoQ growth in revenues. Moreover,
PBT earnings estimates are factoring a material improvement in margins, which we
believe will not be easy given the inflationary, execution and rising interest rate
headwinds. We believe that further slippages from hereon will not only impact
earnings but also lead to further de-rating of valuation multiples.
Exhibit 27: Consensus building a material execution Exhibit 28: Consensus estimates building in a material
pick-up pick-up in PBT margins
2HFY11E (%) FY11E 2HFY11E 1HFY11 2HFY10
FY11E 2HFY11E YoY HoH
revenues as a
(Rsmn) (Rsmn) (%) (%)
%age of FY11E IVRCL 5.5 6.5 3.5 6.5
IVRCL 62,748 41,222 32 91 66
Nagarjuna 6.2 6.4 6.0 6.7
Nagarjuna 57,334 34,498 27 51 60
HCC 43,731 24,664 21 29 56 HCC 4.0 4.8 2.8 4.9
Simplex 52,399 31,663 33 53 60 Simplex I 4.4 5.5 2.8 4.6
CCCL 22,384 12,409 14 24 55 CCCL 7.1 8.4 5.5 8.2
Gammon 57,442 32,545 21 31 57 Gammon 4.4 5.1 3.4 4.1
Source: Company, Ambit Capital research, Bloomberg Source: Company, Ambit Capital research, Bloomberg
Long-term cash flow-based valuations are preferred but we do not

have any history to build upon!
We believe DCF should be the preferred way to value a construction company. The
key valuation drivers will be the free cash flow generation based upon gross block
and working capital turnover and a discount rate apt for the risks inherent to the
industry.
Whilst, we prefer the cash flow based model, we find that most of these companies
have not been generating free cash flows and inspite of increasing size and scale,
there hasn’t been any improvement in asset turnovers or margins. Given the poor
track record of free cash flow generation and return on invested capital (RoIC), we
do build optimistic improvements in the cash flow generation profile for these
companies over the next ten years and in the terminal years. The key risk to a
DCF-based model is not growth or margins but the working capital turnover.

Construction
Exhibit 29: Free cash has been always been missing Exhibit 30: Working capital turnover has been
(Rsmn) FY05 FY06 FY07 FY08 FY09 FY10 declining with scale
Punj Lloyd (2,950) (2,684) (5,613) (13,607) (16,707) (14,386) (X) FY05 FY06 FY07 FY08 FY09 FY10
IVRCL (365) (1,553) (2,542) (5,402) (1,685) 601 Punj Lloyd 3.1 2.0 4.1 4.1 4.2 2.5
Nagarjuna (1,124) (4,597) (689) (2,080) (1,563) (1,389) IVRCL 2.7 2.4 2.7 2.9 2.9 2.8
HCC 1,060 (3,155) (9,487) (491) (1,170) (2,007) Nagarjuna 6.5 3.5 4.0 4.1 3.4 3.0
Simplex (793) (1,121) (1,929) (2,565) (3,346) (57) HCC 6.6 2.5 1.7 2.1 2.0 1.8
Gammon (257) (1,571) (1,788) (244) (494) (3,441) Simplex 3.8 3.5 3.2 3.9 4.8 3.7
Gammon
Soma (845) (2,353) (2,300) (1,440) (3,510) 2,295 4.1 3.0 2.8 3.1 3.7 3.2
India
CCCL (156) (208) (789) (793) (589) (1,063) CCCL 11.6 4.5 4.5 5.1 4.6 3.5
Patel (24) (1,501) (1,898) (2,812) (2,846) (1,731) Patel Engg 2.2 2.3 1.8 1.3 1.2 1.2
Sadbhav (51) 448 469 (650) 1,521 934 Industry 2.8 1.7 2.4 2.4 2.5 2.0
Madhucon 36 (1,090) (265) 388 (646) 581
Gross Block is calculated excluding Revaluation reserves Working capital is calculated excluding Loans and Advances to
subsidiaries
Earnings-based valuations should not be a function of opportunity

but of past performance (absolute and relative)
Whilst the opportunity is unquestionably large for the construction industry, we do
not believe that the opportunity should be governing the earnings multiple for
these companies. Earnings multiples should be a function of the past returns that
the companies have delivered and a function of the performance relative to the
financial performance of the wider indices such as BSE30, BSE100, BSE200 and
CNX Infra.
Poor return ratios for most of the past should keep multiples low
We adjust invested capital for the investments made in subsidiaries and find that
most of the companies have made poor post-tax RoICs. Further, RoEs have also
been very low for the last five years.
Exhibit 31: Low RoICs for most companies Exhibit 32: Low and declining RoEs for most companies
(%) FY06 FY07 FY08 FY09 FY10 Mean (%) FY06 FY07 FY08 FY09 FY10 Mean
Punj Lloyd 7.0 8.2 8.5 2.1 -0.2 5.1 Punj Lloyd 5.0 15.3 12.0 -0.2 0.7 6.6
IVRCL 15.3 15.7 16.2 14.5 12.3 14.8 IVRCL 15.3 15.7 16.2 14.5 12.3 14.8
Nagarjuna 18.4 15.5 16.0 12.7 13.3 15.2 Nagarjuna 16.4 11.7 12.4 9.4 11.8 12.3
HCC 8.2 3.8 7.9 9.1 7.2 7.2 HCC 12.9 11.6 11.3 13.5 6.5 11.2
Patel 23.9 16.3 14.6 12.4 10.6 15.6 Patel 44.2 24.9 19.6 19.4 16.7 24.9
Simplex 11.9 11.9 12.6 11.6 8.5 11.3 Simplex 24.5 21.1 17.5 14.9 13.5 18.3
Gammon 19.4 9.4 10.5 15.1 12.9 13.5 Gammon 15.6 9.0 7.2 9.9 6.9 9.7
CCCL 12.2 12.5 16.9 12.4 16.5 14.1 CCCL 43.3 23.1 29.0 27.7 15.0 27.6
Sadbhav 13.9 18.3 25.0 22.7 18.0 19.6 Sadbhav 14.9 19.4 24.2 20.1 14.7 18.7
Madhucon 14.8 9.4 15.4 15.2 16.5 14.3 Madhucon 12.9 9.7 10.0 9.1 8.2 10.0
Source: Company, Ambit Capital research, Bloomberg Source: Company, Ambit Capital research, Bloomberg
Relative earnings growth to the broader market points to low multiples

We find that barring FY06, net earnings growth for the ten largest construction
companies has either been in line or below the BSE30 earnings. More recently, the
sector’s earnings growth has been significantly lower than market-wide earnings
growth. The 5-year CAGR of net earnings growth of these construction companies
has also been materially lower than that of the BSE30. Using the BSE30 as a
benchmark suggests that the relative earnings multiples for the construction
companies’ construction earnings should be at a significant discount to the
broader market.
Construction
Exhibit 33: Net earnings growth of construction companies versus various indices
5 year
(%) FY05 FY06 FY07 FY08 FY09 FY10
CAGR
IVRCL 45 64 52 49 7 -69 4.4
Punj Lloyd -5 -45 255 82 -163 -52 -201.5
NCC 81 82 11 40 -5 51 32.5
Simplex 156 68 29 68 37 3 38.7
CCCL 94 138 151 86 -18 26 62.9
Patel 70 87 51 34 18 -110 -185.4
Sadbhav 40 98 91 98 21 -15 50.4
Madhucon -17 105 26 14 -1 -2 23.2
HCC 107 69 -71 196 15 -35 1.9
Average for the above
40 46 38 64 -40 -24 8.5
companies
BSE 30 index 39 21 39 37 -10 19 19.9
BSE100 index 28 12 48 34 -13 24 19.1
BSE200 index 31 11 48 32 -12 25 19.0
CNX Infra. index 34 16 69 51 -3 -1 23.3
Source: Company, Ambit Capital research, Industry, Bloomberg
Relative one-year forward multiples
Exhibit 34: One-year forward EPS multiples Exhibit 35: One-year forward EPS multiples
60 60
50 50
40 40
30 30
20 20
10 10
- -
Apr-05
Apr-06
Apr-07
Apr-08
Apr-09
Apr-10
Apr-05
Apr-06
Apr-07
Apr-08
Apr-09
Apr-10
IVRCL (SA) NCC (SA) BSE 30 Index BSE100 Index
Larsen & Turbro (SA) Simplex Infrastructure Ltd BSE200 Index CNX Infra. Index
Average BSE Capital Goods Index Average
Source: Bloomberg, Ambit Capital research Source: Bloomberg, Ambit Capital research
Embedded values – hope is not an investment

strategy
Embedded values form a significant portion (27-88%) of the consensus valuation
of the construction companies. We note that whilst the construction earnings and
the core business have been performing below expectation, consensus has been
continuously upgrading its embedded value estimates for the assets. We believe
such upgrades were a function of the buoyancy in the stockmarket in the hope that
these assets will soon become operational and deliver the long promised returns.
However, we see that for most of the players, there have been shortfalls and
delays for most of their captive projects and this could impact embedded values in
the near term.

Construction
Exhibit 36: Asset development experience of most of the players has been uninspiring
Company Comments
 Chennai desalination plant was delayed by one year owing to technical glitches and impending approvals
 Amritsar-Jalandhar road project delayed by 16 months and the cost overruns were 50%
IVRCL  IOTL Utkal tankage project was delayed because of awaiting approval of drawings by the appointment
consultant
 Salem-Kumarapalayam road project was delayed by 18 months, resulting in cost overruns of Rs0.8bn
 Kumarapalayam – Chengapalli BOT project was delayed by 8 months leading to cost overrun of Rs134mn
 Sompeta power project is facing environmental issues from MoEF, Rs 450mn invested in land acquisition is
a sunk cost
 Dubai real estate project progress has declined because of slowdown in Dubai's property market
Nagarjuna  OB Infra road project is delayed by 14 months because of continued delays in land acquisition for last 3
years leading to non-receipt of annuities and burden of penal interest rates
 Western-UP Road Project and Pondicherry road project have been delayed by 2 years, resulting in a toll
collection loss of Rs 2mn and 1mn per day, respectively.
 Bangalore Elevated Tollways Projects was delayed for 12 months, resulting in the cost overrun of Rs 1.3bn
 Mumbai-Nashik Expressway road BOT is delayed by more than 24 months due to land acquisition issues
Gammon India  Punjab Biomass Power project started commencement 10 months late because of lack of state government
approval to draw water for the plant from the Bhakra-Beas canal
HCC  Lavasa project is facing environmental issues from MoEF
Sadbhav  Nagpur–Seoni Expressway BOT project is delayed due to issues related to land acquisition
Moreover, most companies have a large impending equity requirement, which

(given the absence of or minimal cash flows from existing assets) must be met
through either equity infusion from external markets or the parent companies.
Given the already stretched balance sheets of most of the parents, we believe debt
raising by parent companies for equity infusion into subsidiaries may be a
challenge, thus increasing the dependence on the external market for equity.
Exhibit 37: Impending equity requirements Exhibit 38: Prime candidates for equity raisings
Equity and loans to Additional equity 3.8

Avg CE Turnover FY08-10(x)
(Rsmn) subsidiaries needed in next CCCL

3-4 years 3.3
IVRCL
IVRCL 2.8 Nagarjuna
8,948 19,424 Simplex
Nagarjuna 11,722 11,983 2.3
HCC 8,624 10,400 1.8 Sadbhav Madhucon
Simplex HCC
1 4,080 1.3 Patel
Gammon
CCCL 6,271 10,000 0.8
Patel 339 1,500 0.4 0.8 1.2 1.6 2.0 2.4
Sadbhav 5,432 16,235 H1FY11 Debt-Equity
Source: Ambit Capital research, Company Source: Ambit Capital research, Company
Size of the bubble indicates FY10 RoE
Our approach to valuation

Given the combination of the core construction business and embedded values for
the construction companies we use the following approach for valuing construction
stocks:
 Construction business: The core business should be valued on cash flows

using a 13.5% WACC and a 5% terminal growth rates. We do not expect
material improvements in EBITDA margins but expect some gradual
improvement in the gross and working capital turnover from hereon.

Construction
 Embedded values: Rather than using management guided equity IRRs, we

would use P/B multiples for equity and loans exposures and discounts to the
market value of the listed subsidiaries (as in the case of Gammon and IVRCL).
For equity investments we would use 1-1.5x P/B depending upon disclosures
given on the BOT assets, stage of development etc. and 0.75-1x on the loans
and advances to these subsidiaries.
Relative valuations – stripping out the embedded values

Nearly all of the leading Indian construction companies have taken up the role of
developer in the last 5-6 years with some of them having large portfolios of roads,
power assets and real estate. Roads remain the most common, followed by real
estate and power projects. Given that the embedded valuation from these BOT
assets may vary amongst these companies, comparing them on relative valuations
sometimes does not make sense. Moreover, if the BOT assets have contracted the
EPC business to the parent construction company, that may not be a true reflection
of the competitive standing of these companies.
Hence we provide the relative valuations for these companies on a standalone
basis after deducting the embedded value derived from holdings in listed entities
and unlisted BOT or real estate assets. In the case of listed investments, we use a
33% discount to the listed price as we have noticed holding companies trade at a
discount of 30-70% of their investment value depending upon the state of the
equity markets. In the case of unlisted assets we use consensus estimates for the
embedded value.
Exhibit 39: Relative valuation on standalone basis

Embedded P/E (X) - P/B (X) - EV/EBITDA (X) -
Price excl.
Market Embedded Embedded value as adjusted for adjusted for adjusted for
Company CMP embedded
cap value value %age of embedded embedded embedded
value
market cap value value value
(Rs) (Rsbn) (Rs/share) (Rsbn) (Rs) FY11 FY12 FY11 FY12 FY11 FY12
L&T 1,987 1,208 539 327 1,448 27.1 23.3 18.8 4.1 3.5 15.9 12.8
Punj Lloyd 109 36 0 0 109 0.0 21.8 12.3 1.1 1.0 8.4 6.8
IVRCL 126 34 50 13 76 39.7 11.5 9.1 1.0 0.9 7.3 6.6
Nagarjuna 138 35 44 11 94 31.9 10.7 8.7 1.0 0.9 6.5 5.8
HCC 46 28 38 23 8 82.9 4.1 3.3 0.3 0.3 5.3 4.9
Patel 322 22 152 11 170 47.2 6.6 6.2 0.8 0.8 6.8 7.0
Simplex 442 22 0 0 442 0.0 14.2 11.4 2.0 1.7 6.8 5.7
Gammon 173 22 86 11 88 49.4 7.3 6.1 0.6 0.5 5.3 4.7
CCCL 66 12 0 0 66 0.0 14.3 10.1 1.9 1.6 7.4 5.8
Madhucon 123 9 108 8 15 87.9 2.0 1.6 0.2 0.2 4.8 3.9
Sadbhav 129 17 67 9 62 51.8 8.8 7.3 1.6 1.3 6.4 5.7
Average (excluding L&T and Punj) 43.4 8.8 7.1 1.0 0.9 6.3 5.5
Average 38.0 11.3 8.6 1.3 1.1 7.3 6.3
Source: Company, Ambit Capital research, Industry, Bloomberg,
Note: (a)Share prices and market cap data is as on Dec 14, 2010 (b) We have used our estimates for Nagarjuna and IVRCL and consensus estimates
for others.

Construction
Relative valuation – multiple ways to look at these
Exhibit 40: IVRCL looks inexpensive whilst Simplex Exhibit 41: Patel appears inexpensive whilst Sadbhav
appears expensive seems expensive
50 2.5
Simplex Nagarjuna Simplex
40 2.0 CCCL
sadbhav
EV (bn)
Patel IVRCL
P/B FY11E
30 1.5
Nagarjuna
20 CCCL 1.0 Gammon
HCC Patel
Sadbhav Gammon IVRCL
10 0.5 HCC
Madhucon
0 Madhucon -
0 100 200 300 0% 5% 10% 15% 20%
(0.5)
Order Book (bn) ROE FY10
Source: Bloomberg, Ambit Capital research, Company Source: Bloomberg, Ambit Capital research, Company
Note : Size of the bubble denotes book-to-bill ratio based on last reported Note : Size of the bubble denotes Investment in subsidiaries as %age of
order books Networth
Exhibit 42: IVRCL appears inexpensive and CCCL looks Exhibit 43: Sadbhav appears inexpensive and HCC
expensive looks expensive
18 9
CCCL
Patel
EV/EBITDA FY11E (X)
15 Simplex 8 CCCL
Simplex
P/E FY11E
IVRCL
12 7
Nagarjuna Sadbhav Sadbhav
9 6 Nagarjuna
IVRCL Madhucon
Gammon 5
6 HCC
Gammon
Patel HCC 4
3
3
0% 20% 40% 60% 80% 100%
0% 10% 20% 30% 40% 50%
PAT CAGR FY10-12E
EBITDA CAGR FY10-12E
Source: Bloomberg, Ambit Capital research, Company Source: Bloomberg, Ambit Capital research, Company,
Note : Size of the bubble denotes stand-alone PAT margin for FY10 Note : Size of the bubble denotes stand-alone EBITDA CAGR for FY08-10
Summary of our recommendations

Exhibit 44: Summary of our recommendations and estimates in the Indian construction sector
Const.
Mkt. Const.
Target Embedded Upside/ business Competitive
Co. cap Stance CMP business Comments
price value (downside) implied positioning
(Rsbn) value
P/E FY12
FCF is expected to turn
positive by FY14 due to poor
working capital and gross
IVRCL 33 Sell 126 109 50 59 -13.1% 7.0
block turnover, despite
marginal improvements in
PBT margins
FCF is expected to turn
positive in FY13 on account
of marginal improvement in
NCC 34 Buy 138 165 44 121 19% 8.5
working capital and gross
block turnover and stable
PBT margins
Source: Ambit Capital research, Company, Industry, Bloomberg

Construction December 16, 2010
Nagarjuna Construction
Bloomberg: NJCC IN Equity
Reuters: NGCN.BO BUY RE-INITIATING COVERAGE
Simply Valuation Is The Reason Analyst contacts

Nitin Bhasin
Although we anticipate near-term challenges for the business, we Tel: +91 22 3043 3241
remain buyers of Nagarjuna (NCC) due to its negligible captive orders, nitinbhasin@ambitcapital.com
diversified order book and low equity needs for asset development. Chhavi Agarwal
However, we reduce our valuation to Rs165 (from Rs210) and note that Tel: +91 22 3043 3203
further upgrades would require an improvement in cash flows. chhaviagarwal@ambitcapital.com
Nagarjuna Construction (NCC) is down 14% over the last three months, in line
Recommendation
with the sector, due to the uncertainty around its 1,200MW power project and
deteriorating working capital turnover. Whilst we are concerned about the CMP: Rs138
near-term business challenges, we believe the current valuations are
Target Price : Rs165
favourable for buying the stock for the following reasons.
Previous TP: Rs210
Stability in cost competitiveness keeps it ahead of the pack Upside (%) 19
NCC stands out at the top in our competitive mapping (based on FY10 EPS (FY11E): Rs 8.8
financials) of the top-10 construction companies; NCC was at the top in Change from previous (%): (11)
competitive mapping based on FY09 financials as well. Relatively low debt- Variance from consensus (%): (4)
equity (0.7x), high gross block turnover (6.9x) and industry average working
capital turns (3.0x) helped it maintain its cost competitiveness when the sector Stock Information
was reeling from poor execution in FY10. Further, it has maintained its PBT
Mkt cap: Rs35bn/US$778mn
margins in 1HFY11 (5.9% v/s 5.9% in 1HFY10), while peers posted declines of
20-200bps. 52-wk H/L: Rs198/115
Diversified order book with negligible captive dependence 3Mavg. daily trade val.: Rs236mn/US$5mn
Beta: 1.6x
We expect execution over the next 12 months to be better than 1HFY11E (up
11% YoY) due to a diversified order book, not only region-wise (India 78% and BSE Sensex: 19,696
international 22%) but also segment-wise (largest segment buildings/housing: Nifty: 5,904
33%). We expect 22% YoY increase in 2HFY11E standalone revenues
(guidance 30%) leading to 17% YoY increase in FY11 revenues. Except the Stock Performance (%)
water and environment segment (14% of the order book), we find rest of the
1M 3M 12M YTD
NCC’s segments relatively buoyant.
Absolute -12.6 -14.1 -17.7 -18.4
Valuation, a function of steady progress and sound embedded values Rel. to Sensex -7.1 -19.6 -32.0 -31.2
We expect standalone operations to turn FCF positive in FY13 on account of
marginal improvement in working capital turnover and stable PBT margins. Performance (%)
Our SOTP-based valuation is Rs165/share (DCF-based value of Rs98/share for 25,000 200
the Indian construction business, Rs23 for international business and Rs44 for 180
20,000
the embedded assets). Adjusting for BOT assets/real estate, NCC’s stock 160
trades at 6.7x FY12 consolidated construction EPS of Rs14. 15,000
140
10,000 120
Key risk: Higher-than-expected equity requirements arising from asset
Dec-09 M ay-10 Sep-10
development ambitions. Sensex Nag. Co nstructn.
Exhibit 1: Key financials (stand-alone)

Year to March FY08 FY09 FY10 FY11E FY12E Source: Bloomberg, Ambit Capital research
Operating Income (Rs mn) 34,729 41,514 47,778 55,971 69,901
EBITDA (Rs mn) 3,598 3,737 4,834 5,588 6,815
Adj. EPS (Rs) 7.5 6.7 7.5 8.8 10.8
RoIC (%) 16.0 12.7 12.2 12.2 12.4
RoE (%) 12.6 9.4 9.3 9.7 11.0
P/E (x) 21.6 23.0 19.3 15.7 12.7
Adj P/E (x) 12.5 14.0 12.6 10.7 8.7
(Adj for embedded value)
Company Financial Snapshot
Profit and Loss (stand-alone) Company Background

Year to March (Rs mn) FY10 FY11E FY12E
Total operating income 47,778 55,971 69,901 NCC provides construction services in India across
Operating expenses 42,944 50,383 63,085 verticals such as buildings, transportation, water &
EBIDTA 4,834 5,588 6,815 environment, electrical, irrigation, oil & gas, power,
Depreciation 525 697 835 metals and mining. The company started in 1978 and in
Interest Expense 1,322 1,522 1,873 2007 ventured into the Middle East. The buildings &
PBT 3,034 3,466 4,214 housing and water & environment segments dominate
Tax 1,204 1,206 1,433
the revenues and order book of the company (see chart
Adj. PAT 1,830 2,260 2,782
Profit and Loss Ratios
on the left). Apart from the core construction business,
the company has an infrastructure asset portfolio. NCC
EBIDTA Margin % 10.1 10.0% 9.8%
Adj Net Margin % 3.8 4.0% 4.0%
Infra Holdings, the infra projects subsidiary, has five
P/E (X) 19.3 15.7 12.7 BOT road projects and two power projects in its
EV/EBIDTA (X) 10.1 10.1 8.8 portfolio.
Dividend Yield (%) 0.94% 0.94% 1.15%
Balance Sheet (stand-alone) Cash Flow (stand-alone)

Year to March (Rs mn) FY10 FY11E FY12E Year to March (Rs mn) FY10 FY11E FY12E
Application of funds 38,013 47,124 53,517 PBT 3,034 3,466 4,214
Net Fixed Assets 5,972 6,762 7,727 Depreciation 525 697 835
Current Assets 41,083 51,560 61,319 Tax (1,302) (1,291) (1,349)
Investments 9,412 10,035 10,535 Change in Wkg Cap (3,345) (4,498) (4,512)
Sources of funds 38,013 47,124 53,517 CF from Operations 238 (201) 955
Networth 22,457 24,176 26,484 Capex (1,628) (1,486) (1,800)
Debt 15,302 22,628 26,628 Investments (2,147) (623) (500)
Current Liabilities 18,453 21,233 26,065 CF from Investing (3,763) (5,713) (713)
Deferred Tax 255 320 404 Change in Equity 3,580 0 0
Balance Sheet Ratios Debt 2,863 7,327 4,000
ROE % 9.3 9.7 11.0 Dividends (294) (389) (390)
RoIC (%) 12.2 12.2 12.4 CF from Financing 4,177 5,415 257
Net Debt/Equity (X) 0.6 0.9 0.9 Change in Cash 652 (499) 498
Equity/Total Assets (X) 0.7 0.9 1.0
P/BV (X) 1.6 1.5 1.3
Building, transportation, water & environment are the

main segments (>50% of revenues in 1HFY11) Shareholding Pattern as on 30th Sept 2010
International
Buildings &
Others, Promoters,
Business, 21% 20.2%
Housing, 25% 13.8%
Mining, 3%
Corporate
Metals, 6% Transportation Bodies, Mutual
, 7% 12.6% Funds /
Power, 2% UTI, 19.8%
Water &
Irrigation, 5% Environment,
22% FIIs, 33.7%
Electrical, 9%
Source: Ambit Capital research, Company, BSE

SWOT Analysis
Exhibit 2: SWOT Analysis
Strengths Weaknesses
 Declining working capital turnover for the last 4 years
 Fifth largest and third largest Indian construction company in (FY08:4.1x to FY11E:2.8x) due to delayed payments and poor
terms of revenues and net worth, respectively execution
 Strong and stable on cost competitiveness for the last 3 years  30% of the FY10 networth of Rs22.5 bn blocked in slow-
 Highly diversified business model: Nine verticals with only moving real estate development projects needing more equity
one segment with a dominant share (buildings, 33%) upon revival
 Negligible orders from own asset developments  Debt-equity has reached a high level of 0.88x, implying little
 Established and a fast growing presence in Middle East (22% headroom available for further debt raising if the working
of orders), a high infrastructure investment region capital cycle was to get any longer
 Relatively high gross block turnover (6.9x) as compared to  Continued delays in commencing operations in its BOT toll
the peer average (3.6x) road projects impacting the profitability of the investments
(26% of net worth)
Opportunities Threats
 Continuing and rising infrastructure creation plans of the
 Further losses in the Dubai Real Estate project post the
Government of India (GoI), XIIth 5-year plan investment of
ongoing Rs500-600mn of investments
US$1tn as against XIth 5-year plans’ investment of US$0.5tn
 Further delays in completion/commencement of operations in
 Pickup in corporate capex can lead to orders for segments
the road BOT projects
such as buildings, metals and oil & gas
 Threat of penalties given the non-generation of power from a
 Rising demand for coal is leading to increasing opportunities
potential cancellation of 1,200 MW thermal Sompeta Project
for the mining segment of the business
 Poor credit availability and rising costs of funds can impact
 The Middle East’s high infrastructure requirements can lead
the execution cycle of the projects
to much faster growth for the international business
 Rising material and labour inflation can impact margins of
 Road BOT assets can be securitised or generate cash flows to
fixed price contracts (currently ~35%) in the order book
reduce the consolidated debt-equity
Source: Ambit Capital research, Industry, Company
Key risks to our BUY stance

Whilst all the construction companies’ financials and stock price performance are
exposed to the macro risks of execution/payment delays and rising interest rates,
the key risks for NCC are the following:
Equity needs
Although NCC is relatively better placed than its peers on capital employed
turnover (2.2x) and debt-equity (0.9x) in 1HFY11, the company may need more
equity in the near term in case the working capital cycle gets further stretched
(FY11E working capital turnover of 3.0x) or if it plans to invest large amounts of
funds in the real estate or power development projects. The company has plans to
invest Rs500-600mn in its Dubai real estate project so as to restrict its liabilities on
account of default for work stoppage at the project. However, in case the company
is required to invest more in this project it will have to raise equity. Similarly, a
possible relocation of NCC’s 1,200MW power plant to a new location will need
further equity, which it will have to raise from external sources.
51% of net worth blocked in BOT and real estate

Presently 51% of Nagarjuna’s net worth is locked in roads, power and real estate
projects. Whilst the roads projects and a small power project have operations
commencement visibility, there is hardly any visibility on cash flows from the real
estate projects. Nagarjuna’s real estate projects in India and Dubai have suffered
on account of a slump in the real estate market exposing its 30% of net worth to
write-offs. Similarly, the recent issues relating to cancellation of environmental
clearances for its1,200MW thermal power plant may lead to a write-off of Rs0.6-
0.8bn, i.e. ~3.5% of net worth.

Ahead of the pack

NCC stands out at the top in our competitive mapping (based on FY10 financials)
of the top-10 construction companies; NCC was at the top in competitive mapping
based on FY09 financials as well. Relatively low FY10 standalone debt-equity
(0.7x), relatively higher gross block turnover (6.9x) and industry average working
capital turnover (3.6x) helped the company maintain its cost competitiveness when
the sector was reeling under poor execution in FY10. Further, it has maintained its
PBT margins in 1HFY11 (at 5.9%) compared with 5.9% in 1HFY10, while peers
posted declines of 20-200bps.
Competitive positioning amongst the peers
Exhibit 3: NCC is at the top on cost competitiveness Exhibit 4: NCC is at the top on cost competitiveness (the
……. entries in this table are based on the adjacent table)
Fixed Fixed
Fin
cost Interest Fin cost as Fin
Gross Gross WC exp -
as a Debt- WC cost as exp - a Debt- exp -
block block turn- as % Over-
%age equity turnover % of as % %age equity as %
turnover turnover over of all
costs (X) (X) avg of costs (X) of
(X) (X) (X) avg
total debt sales total sales
debt
costs costs
Punj Lloyd 23.0 1.5 3.6 2.5 9.1 3.7 Punj Lloyd
IVRCL 8.0 0.9 7.5 2.8 13.2 3.9
IVRCL
Nagarjuna 8.2 0.7 6.9 3.0 10.8 3.6
HCC 23.4 1.7 2.1 1.8 11.6 6.2 Nagarjuna
Simplex 8.3 1.3 3.7 3.7 7.7 2.6
HCC
Gammon 6.3 0.9 3.3 3.6 9.9 4.5
Soma 16.3 2.6 2.1 2.6 10.8 9.0 Simplex
CCCL 12.4 0.6 11.3 3.5 12.2 1.6 Gammon
Patel 9.9 1.2 4.6 1.2 9.0 6.2
Soma
Sadbhav 7.4 1.1 4.2 4.1 6.0 3.0
Madhucon 10.9 1.6 2.9 43.9 8.6 1.4 CCCL
Average 12.2 1.3 4.7 6.6 9.9 4.2
Patel .
Source: Company, Industry, Ambit Capital research
Note (a) We include depn. in fixed costs and also total costs Sadbhav
(b) We exclude FCCBs for interest cost calculation
(c) We include mobilisation advance in working capital and exclude Madhucon
it from debt ; (d) We include bank charges in financial expenses
Note: - strong - relatively strong - average - relatively
weak
NCC stood its ground in FY10

Improvement on three parameters (out of the five that we use to assess for cost
competitiveness) helped NCC maintain its leadership amongst peers, in FY10.
However, we highlight that the company has also maintained its PBT margins (at
5.9%) in 1HFY11 compared with 5.9% in 1HFY10 in spite of working capital
turnover further deteriorating in 1HFY11. We believe NCC’s clients, segmental
and geographical diversification help it maintain its competitiveness.

Exhibit 5: Cost structure movement for NCC over the years (based on annual reports)
Cost competitiveness FY08 FY09 FY10 FY10 vs. FY09 Comments
parameters
Fixed cost as a %age 9.0% 9.4% 8.2% Improvement Stable overheads and depreciation over FY09-FY10
total costs
Debt-equity (X) 0.57 0.74 0.68 Improvement Improvement on account of equity raising in FY10
Gross block turnover (X) 6.0 6.5 6.9 Improvement Marginally improved execution, controlled capex and
higher machinery lease
WC turnover (X) 4.1 3.4 3.0 Deterioration Payment delays and high retention money led to
deterioration
Interest cost as % of avg 10.7% 11.9% 10.8% Improvement Increased usage of low cost commercial paper route led
debt to lower interest costs
Financial expenses as % 2.8% 3.5% 3.6% Stable Lower interest cost borrowings through commercial
of sales paper balanced the deteriorating working capital
turnover

Higher quality and lower risk orders

We expect NCC’s order book execution over the next 12 months to be better than
in 1HFY11E (up 11% YoY) due to a diversified order book, not only regionwise
(India, 78% and international, 22%) but also segmentwise (largest segment
buildings/housing: 33%). Furthermore, negligible dependence (~1%) upon captive
orders also limits the scope for disappointments on account of inability to raise
equity and mobilize orders from captive projects. We expect a 22% YoY increase in
2HFY11E standalone revenues (guidance 30%) leading to 17% YoY increase in
FY11 revenues. Except the water and environment segment (14% order book), we
find relatively buoyant activity in other segments of the company.
Diversified order book
Exhibit 6: NCC: Order book diversification is high Exhibit 7: NCC: International business gaining traction
(Rs bn) International (Rs bn) International
180 180
Mining Mining
150 Metals 150 Metals
120 Power 120 Power
Oil & Gas Oil & Gas

90 90
Irrigation Irrigation
60 60
Electrical Electrical
30 Water & Environment 30 Water & Environment
Transportation 0 Transportation
0
FY07 FY08 FY09 FY10 Buildings & Housing FY07 FY08 FY09 FY10 Buildings & Housing
Low level of captive order book

Given the near completion date of most of the road projects and the hydel power
project, we do not find any meaningful contribution in NCC’s order book from
captive assets. Ambiguity around the real estate project in Dubai has led to a
cancellation in orders from that front.
Exhibit 8: Relatively low captive orders for NCC

Balance
Equity invested % of NCC
Length (kms)/ Project cost equity Target Status/completion
as of 30 Sep 10 equity
Capacity (MW) (Rs mn) required COD stage
(Rs mn) invested
(Rs mn)
Western UP Tollway 78.75 6,690 795 100% 0 Nov-10 Toll collection to start
OB Infra 62.8 5,848 940 100% 0 Nov-10 Toll collection to start
Toll collection to start
Pondicherry Trivandrum 36 3,150 330 100% 0 Apr-11
from Apr-11
Himachal Sorang 100 7,552 933 59% 655 Mar-12 59%

Key assumptions & estimates

Exhibit 9: Assumptions for construction business (All units in Rs mn unless specified)
Key assumptions FY10 FY11E FY12E Comments for key assumptions up to FY12
Closing order book 153,700 188,616 232,955
We expect order inflows to improve in FY12 led by buildings, power
Order addition – India 74,306 85,832 107,459
and water & environment sectors
Established presence and rising infrastructure activity in Middle East to
Order addition – intl. 14,704 18,086 23,512
drive orders
Order book: revenues
1.6 1.7 1.7
(stand-alone)
Revenues - standalone 47,778 55,971 69,901
Growth 15% 17% 25% Execution improvement in FY12 with the pickup in order flows
Order book: revenues
3.2 2.8 2.7
(international)
Revenues – intl. 11,016 13,770 16,731
Growth 98% 25% 22% Short duration orders to drive growth
EBITDA 4,834 5,588 6,815
Near-term inflationary and interest rate challenges to keep EBITDA
EBITDA margin 10.1% 10.0% 9.8%
margins under check
Total financial charges Higher interest rates and debt borrowings to push financial expenses
1,322 1,522 1,873
(net) high
Average working capital Continuing payment delays to limit any near-term improvement in
3.0 2.8 2.8
turnover working capital turnover
Gross block turnover 6.9 6.7 7.0 Marginal improvement on account of a pickup in execution
Capex to remain high due to increased investments in high technology
Capex (1,628) (1,486) (1,800)
equipment to drive productivity
Ambit versus consensus

Whilst our revenue and EBITDA estimates are mostly in-line with the consensus,
our net earnings and EPS estimates for FY11 and FY12 are 4% and 5%,
respectively lower than consensus on account of higher depreciation and interest
charges. Our depreciation assumption is higher than consensus on account of our
higher capex assumptions. We expect capex of Rs1.5bn in FY11 followed by
Rs1.8bn in FY12. Our interest charges are also higher than the consensus on
account of higher debt levels due to our assumption of limited improvement in
working capital turnover and cash flows.
Exhibit 10: Ambit versus consensus

Consensus Ambit Divergence
Revenue (Rs mn)
2011 57,558 55,971 -3%
2012 70,812 69,901 -1%
EBITDA (Rs mn)
2011 5,774 5,588 -3%
2012 7,133 6,815 -4%
EPS (adjusted) (Rs)
2011 9.2 8.8 -4%
2012 11.4 10.8 -5%
Source: Bloomberg, Ambit Capital research

Valuation: SOTP-based
We expect standalone operations to turn FCF positive in FY13 on account of a
marginal improvement in working capital and gross block turnover and stable PBT
margins. Our SOTP-based valuation is Rs165/share (DCF-based value of
Rs98/share for the Indian construction business, Rs23 for international construction
business and Rs46 for the assets). Adjusting for BOT assets/real estate, NCC’s
stock trades at 6.7x FY12 consolidated construction EPS of Rs14.
Exhibit 11: SOTP-based valuation of Rs165/share

Effective
Investment Value/share
Business Method Multiple (x) value
(Rs mn) (Rs)
(Rs mn)
Construction business -
DCF NA 9x FY12* 24,992 98
Standalone
Construction business -
P/E NA 7.2x FY12** 6,013 23
International
BOT assets and real estate
(equity and loans and
advances excl Rs600 mn P/B 11,925 0.94x*** 11,249 44
likely write-off in the
Sompeta Power project )
Total 42,254 165
Note: * Implied multiple based on our DCF valuation; **20% discount to the Indian construction
business; *** implied multiple post using different multiples for various modes of investments
Construction business – Rs121/share

We value the Indian construction business using cash flows and value the
international construction business on a 20% discount to the Indian construction
business.
Indian construction – Rs98/share

We value NCC’s Indian construction business at Rs98/share using DCF-based
valuation. We use a WACC of 13.5% (CoE of 15%, cost of debt of 10%, target
debt/equity of 0.70x) and a terminal growth rate of 5%. Underpenetration of
infrastructure in India, rising corporate capex and new business opportunities like
mining will keep growth for a player such as NCC high. We moderate our growth
assumptions beyond FY14 and model revenue growth of 8-16% p.a except in one
year (20% growth in FY16E). Our Rs98/share valuation for Indian construction
business implies a valuation of 11x and 9x FY11 and FY12 earnings, respectively.

Exhibit 12: DCF valuation for the core Indian construction Exhibit 13: Terminal value is the main component of
business the Indian construction business valuation
PV of the forecasting period up to FY20 (Rs mn) 10,651

(Rs bn)
3 20%
2 16% Terminal value (Rs mn) 33,815
1 12%
0 8%
Enterprise value (Rs mn) 44,466
-1 4%
-2 0%
Less: net debt at Sep-10 (Rs mn) 19,443
2HFY11
FY12
FY13
FY14
FY15
FY16
FY17
FY18
FY19
FY20
Implied equity value (Rs mn) 25,023
PV of FCFF WACC (RHS)
RoCE (RHS) Implied equity value (Rs per share) 98
Source: Ambit Capital research, Company, Industry Source: Ambit Capital research, Company, Industry
International construction– Rs23/share

NCC’s international construction business of has been growing at a much faster
pace (161% revenue CAGR over FY08-10), given the lower incidences of execution
delays in the Middle East and the low base. Rising crude price has kept the
infrastructure build-up activity in the Middle Eastern region high and stable.
We value NCC’s international construction business at Rs23/share using a 20%
discount to NCC’s implied target valuation multiple of 9x FY12 earnings. Lack of
detailed financials of the international business restricts usage of DCF-based
valuation for this business. Our discount is supported by the fact that NCC is a
marginal/smaller player and relatively less competitive than the global and local
majors operating in the Middle East. The Middle East construction companies such
as Orascom Construction (Egypt) trade at a P/E of 13.6x and 10.4x in CY11 and
CY12 earnings, respectively.
Embedded value – Rs44/share

We value the BOT and the real estate portfolio at Rs44/share using a P/B
methodology. Whilst we would have preferred a detailed asset-by-asset valuation,
given the lack of complete details and the stalled nature of most of the real estate
projects, we use the P/B multiple.
Infrastructure assets (BOT) portfolio – Rs24/share

We value the direct investments in 5 road projects and one power project at 1.2x
book value or equity invested. We do not value the investments of Rs600 mn in its
Sompeta power project currently facing construction and environmental clearance
issues. We highlight that some of the BOT assets of NCC are yet to commence
operations and are dependent on JV partners for timely commencement of
operations and thereby increase NCC’s risk profile. Further, a couple of assets
despite being nearly complete are facing operational commencement issues,
restricting our hopes of any meaningful creation from these investments. Asset
development companies such as GVK and IRB are trading at 1.9x-3.5x FY10 book.
Considering that NCC’s road and power assets have another 3-15 months to go
before these get operational, we value them at a discount to the listed peers with
operational assets. We value the relatively minor loans and advances to these BOT
assets at a discount to their outstanding value, given the high likelihood of delays
in repayments and high interest rate being charged on such advances. The key risk
to the value emanating from these assets is delay/cancellation and increased
equity requirements.

Real estate investments – Rs20/share

We value the equity investments in the real estate ventures under NCC Urban
Infrastructure (Rs1.2bn) at 0.9x equity invested and equity investments in other real
estate ventures (Rs786mn) at 0.75x equity invested (as these are currently on
hold). Apart from Rs1.9bn of equity investments in real estate ventures, NCC has
invested another Rs4.7bn into its real estate ventures through loans, debentures
and preference shares, which we again value at 0.75x equity invested given the
increasing risk to these investments from delays.
Cross cycle valuation

NCC’s current one-year forward PE (without adjusting for embedded value) is at
39% discount to its average PE of 21x for the past five years (exhibit 12) and at a
75% discount to its peak one-year forward multiple of 53x (December 2007).
Whilst the valuations have corrected significantly in the last few months, NCC’s
stock is not trading at any levels close to its lowest of 5.1x one-year forward
multiples as in March 2009.
Whilst we do not see the stock heading towards close to its average multiple of
21x one-year forward earnings, we also do not expect any material deterioration
in the multiples unless the company’s investments in infrastructure assets and real
estate are materially written off. Pick-up in execution and stable–to-improving cash
flows (less negative FCF) will drive valuations and stock price performance.
Exhibit 14: NCC trades at a significant discount to its Exhibit 15: NCC trades at a significant discount to its
historical P/E multiples historical P/B multiples
(Rs) (Rs)
400 400
Average P/B
350 Average PE 30x 350
3x
300 25x 300
2.5x
250 20x 250
2x
200 200
15x 1.5x
150 150
100 10x 100 1x
50 5x 50 0.5x
0 0
Apr-05
Apr-06
Apr-07
Apr-08
Apr-09
Apr-10
Apr-05
Apr-06
Apr-07
Apr-08
Apr-09
Apr-10

Exhibit 16: Balance sheet (stand-alone)

x
Year to March (Rs mn) FY08 FY09 FY10 FY11E FY12E
Shareholders' equity 458 458 513 513 513

Reserves & surpluses 15,209 16,398 21,943 23,663 25,971
Total net worth 15,724 16,856 22,457 24,176 26,484
Debt 8,938 12,439 15,302 22,628 26,628
Deferred tax liability 167 188 255 320 404
Total Sources of funds 24,829 29,482 38,013 47,124 53,517
Net block 5,197 4,592 5,538 6,328 7,293
CWIP 143 281 434 434 434
Investments 5,648 7,402 9,412 10,035 10,535
Cash & equivalents 2,330 1,345 1,997 1,498 1,996
Debtors 8,677 10,260 12,995 16,101 19,151
Inventory 5,493 7,495 7,539 8,972 11,062
Loans & advances 13,725 14,484 18,520 24,957 29,078
Other current assets 61 30 32 32 32
Total current assets 30,286 33,615 41,083 51,560 61,319
Current liabilities 15,564 15,541 17,497 20,275 25,023
Provisions 880 867 957 958 1,041
Total current liabilities 16,444 16,408 18,453 21,233 26,065
Net current assets 13,842 17,206 22,629 30,327 35,254
Total Application of funds 24,829 29,482 38,013 47,124 53,517
Exhibit 17: Income statement (stand-alone)

Operating income 34,729 41,514 47,778 55,971 69,901
% growth 21 20 15 17 25
Operating expenditure 31,132 37,777 42,944 50,383 63,085
EBITDA 3,598 3,737 4,834 5,588 6,815
% growth 33 4 29 16 22
Depreciation 482 533 525 697 835
EBIT 3,116 3,204 4,309 4,891 5,981
Interest expenditure 719 964 1,322 1,522 1,873
Non-operating income 56 42 48 97 107
Adjusted PBT 2,452 2,282 3,034 3,466 4,214
Tax 811 743 1,204 1,206 1,433
Adjusted PAT/net profit 1,641 1,539 1,830 2,260 2,782
% growth 27 -6 19 23 23
Extraordinaries - - 496 - -
Reported PAT/net profit 1,619 1,539 2,326 2,110 2,782

Exhibit 18: Cashflow statement (stand-alone)

EBIT 3,116 3,204 4,309 4,891 5,981
Depreciation 482 533 525 697 835
Others 16 7 (493) (97) (107)
Tax (1,121) (1,319) (1,302) (1,291) (1,349)
(Incr) / decr in net working
(3,041) (3,955) (3,345) (4,498) (4,512)
capital
Cash flow from operations (492) (1,488) 238 (201) 955
Capex (1,588) (75) (1,628) (1,486) (1,800)
(Incr) / decr in investments (32) (1,107) (2,147) (623) (500)
Loans to subsidiaries &
(1,627) (819) (1,305) (3,700) -
associates
Others (1,642) 919 1,317 97 1,587
Cash flow from investments (4,890) (1,082) (3,763) (5,713) (713)
Net borrowings 2,569 3,501 2,863 7,327 4,000
Issuance of equity 4,049 0 3,580 - -
Interest paid (1,112) (1,567) (1,972) (1,522) (3,353)
Dividend paid (228) (348) (294) (389) (390)
Cash flow from financing 5,277 1,586 4,177 5,415 257
Net change in cash (104) (985) 652 (499) 498
Closing cash balance 2,330 1,345 1,997 1,498 1,996
Free cash flow (2,080) (1,563) (1,389) (1,688) (845)
Exhibit 19: Ratio analysis (stand-alone)

Year to March (%) FY08 FY09 FY10 FY11E FY12E
EBITDA margin (%) 10.4 9.0 10.1 10.0 9.8
EBIT margin (%) 9.0 7.7 9.0 8.7 8.6
Net profit margin (%) 4.7 3.7 3.8 4.0 4.0
Dividend payout ratio (%) 17.3 16.4 17.4 14.8 14.6
Net debt: equity (x) 0.4 0.7 0.6 0.9 0.9
Working capital turnover (x) 4.1 3.4 3.0 2.8 2.8
Gross block turnover (x) 6.0 6.5 6.9 6.7 7.0
RoCE (%) 15.7 12.5 12.1 12.1 12.3
RoIC (%) 16.0 12.7 12.2 12.2 12.4
RoE (%) 12.6 9.4 9.3 9.7 11.0
Exhibit 20: Valuation parameters (stand-alone)

EPS (Rs) 7.51 6.72 7.48 8.81 10.84
Diluted EPS (Rs) 7.50 6.72 7.48 8.81 10.84
Book value per share (Rs) 72 74 92 94 103
Dividend per share (Rs) 1.30 1.10 1.30 1.30 1.58
P/E (x) 21.6 23.0 19.3 15.7 12.7
P/BV (x) 2.3 2.1 1.6 1.5 1.3
EV/EBITDA (x) 11.7 12.4 10.1 10.1 8.8
EV/EBIT (x) 13.5 14.5 11.3 11.6 10.0
EV/Sales (x) 1.2 1.1 1.0 1.0 0.9

Construction December 16, 2010
IVRCL Infrastructure
Bloomberg: IVRC IN Equity
Reuters: IVRC.BO SELL RE-INITIATING COVERAGE
Testing times Analyst contacts

Nitin Bhasin
IVRCL’s equity requirement of Rs19bn for mobilizing the recently bid Tel: +91 22 3043 3241
IVRAH road projects (constitutes 23% of IVRCL’s order book) is making nitinbhasin@ambitcapital.com
an equity dilution/raising at the subsidiary level inevitable. Execution Chhavi Agarwal
disappointments vis-à-vis aggressive guidance is expected to continue Tel: +91 22 3043 3203
in the near term leading to further declines in PBT margins. We chhaviagarwal@ambitcapital.com
downgrade IVRCL to SELL from BUY whilst noting that recent stock
price decline limits shareholders’ downside from the current levels. Recommendation
IVRCL stock is down 20% over the last three months (in line with the sector) CMP: Rs126
due to execution delays, worsening working capital turnover and rising equity
Target Price: Rs109
needs. Despite relatively poor share price returns over last five years, IVRCL’s
stock is one of the most hyped in the sector given its industry leading revenue Previous TP: R190
growth rate over FY05-09 (CAGR 47%) and dominance in the promising Downside (%): (13)
water-related segments. Whilst we believe that its long-term growth can be EPS (FY11E): Rs6.6
better than its recent performance, the stock price may see further (albeit Change from previous (%): (30)
modest) declines before investor returns can be generated. Variance from consensus (%): (21)
Nearly 40% of the order book facing execution challenges

Stock Information
Whilst IVRCL has one of the largest order books in the sector and a high book-
Mkt cap: Rs34bn/US$748mn
to-bill ratio (4.5x), nearly 40% of the Rs240bn order book is facing execution
issues (Rs40bn of irrigation orders and Rs55bn of captive orders). We believe 52-wk H/L: Rs198/110
such slow moving orders make the situation worse for IVRCL at a time when 3Mavg. daily trade value.:Rs330mn/US$7mn
the industry is facing slow execution across other sectors. We expect 2HFY11E
revenues to grow 19% YoY, implying a 13% YoY growth for FY11. Beta: 1.7x
BSE Sensex: 19,648
Equity raising: Important and difficult
Nifty: 5,892
IVRCL was one of the first construction companies to raise equity in the early
years of the noughties followed by a couple of equity raisings at the parent Stock Performance (%)
and the subsidiary levels (total equity raisings of Rs10bn over FY04-08).
However, over the last few quarters, the company has been facing the lack of 1M 3M 12M YTD
capital given the rising debt-equity and the rising need of equity for mobilizing Absolute -7.1 -20.2 -27.3 -28.2
the recently bagged infrastructure assets. Lack of capital has led to regular Rel. to Sensex -3.9 -20.9 -43.8 -40.7
delays in booking construction revenues from captive contracts.
Performance (%)
Valuations, reflecting cash and earnings concerns rather than orders
25,000 250
We do not expect stand-alone operations to turn FCF positive up to FY14 on
20,000 200
account of poor working capital and gross block turnover, despite marginal
improvements in PBT margins. Our SOTP-based valuation is Rs109/share 15,000 150
(Rs59/share for the construction business, Rs9 for HDO and Rs41 for IVRAH). 10,000 100
Adjusting for subsidiaries’ valuations, IVRCL stock trades at 9.1x FY12 Dec-09 M ay-10 Sep-10
construction EPS of Rs8.4. Poor cashflow profile and likely dilution of Sensex IVRCL Infrastruc
subsidiaries at distressed valuations can lead to further declines in multiples. Source: Bloomberg, Ambit Capital research
Exhibit 1: Key financials
Year to March FY08 FY09 FY10 FY11E FY12E
Operating Income 36,606 48,819 53,093 59,890 72,125
EBITDA 3,614 4,218 5,312 5,435 6,924
EPS (Rs) 15.8 16.9 7.9 6.6 8.4
ROIC (%) 16.2% 14.5% 12.3% 10.9% 11.8%
ROE (%) 14.4% 13.2% 11.5% 9.2% 10.7%
P/E(x) 15.9 14.8 15.9 18.8 14.8
Adj P/E(X) Adj for embedded value 4.8 4.5 9.6 11.5 9.1
Company Financial Snapshot
Profit and Loss (stand-alone) Company Background

(Rs mn) FY10 FY11E FY12E
Net sales 53,093 59,890 72,125 IVRCL provides construction services for the water,
Optg. Exp(Adj for OI.) 47,781 54,455 65,201 irrigation, roads, railways, civil structures, power
EBIDTA 5,312 5,435 6,924 transmission and distribution sectors. The company was
Depreciation 543 749 863 started in 1987 mainly with irrigation projects and has,
Interest Expense 1,637 2,133 2,772 over the last decade, expanded into other segments.
PBT 3,288 2,678 3,421 IVRCL acquired Hindustan Dorr Oliver (HDO) in 2005
Tax 2,586 893 1,163
for Rs539mn in order to increase its water-based
Adj. PAT 2,111 1,786 2,258
Profit and Loss Ratios
strengths as HDO provides it with technology for EPC
and design work for urban and industrial water-based
EBIDTA Margin % 10.0% 9.1% 9.6%
Adj Net Margin % 4.0% 3.0% 3.1%
projects amongst other things. Apart from the mainstay
P/E (X) 15.9 18.8 14.8 construction business, the company is also involved in
EV/EBIDTA (X) 9.0 9.9 8.3 developing its own toll roads, a water desalination plant
Dividend Yield (%) 0.6% 0.5% 0.6% and in developing real estate.
Balance Sheet (stand-alone) Cash Flow (stand-alone)

(Rsmn) FY10 FY11E FY12E (Rsmn) FY10 FY11E FY12E
Application of funds 34,790 42,954 48,055 PBT 3,288 2,678 3,421
Net Fixed Assets 6,017 7,449 8,786 Depreciation 543 749 863
Current Assets 47,005 56,147 65,527 Tax (1,293) (869) (1,094)
Investments 6,138 6,138 6,138 Change in Wkg Cap (2,480) (3,008) (4,978)
Sources of funds 34,790 42,954 48,055 CF from Operations 1,796 1,558 852
Networth 18,532 20,153 22,185 Capex (1,209) (2,180) (2,200)
Debt 16,133 22,666 25,666 Investments 0 0 0
Current Liabilities 24,369 26,781 32,396 CF from Investing (1,278) (5,055) (553)
Deferred Tax 125 135 203 Change in Equity 0 0 0
Balance Sheet Ratios Debt 1,149 6,533 3,000
ROE % 11.5 9.2 10.7 Dividends (215) (250) (179)
ROIC (%) 12.3 10.9 11.8 CF from Financing 81 4,150 (966)
Net Dept/Equity 0.8 1.5 2.2 Change in Cash 599 653 (667)
Equity/Total Assets 0.9 1.6 2.3
P/BV (X) 1.8 1.7 1.5
Water /Irrigation is the main business segment

(Revenues break-up as on 1HFY11) Shareholding pattern as on 30 Sept 2010
Power
transmission, Promoters,
Others,
5% 10%
13%
Mutual
Body Funds, 8%
Buildings, 31% Corporates,
Water/Irrigation 12%
, 51%
Transportation,
13% FII, 58%
Source: Ambit Capital research, Company,BSE

SWOT Analysis
Exhibit 2: SWOT Analysis
Strengths Weaknesses
 Third largest Indian construction company in terms of
revenues and the fifth largest in terms of net worth,  Declining gross block turnover for last 4 years (FY07:11X to
respectively FY10E: 7.5x) due to poor execution and declining revenues
 Leading player in the water and irrigation segment (45% of  IVRAH subsidiary’s investments in real estate projects remain
FY10 revenues) with nearly 4-5% market share in this highly stalled whilst the BOT road projects are facing cost overruns
unorganised segment  Debt-equity has reached a high of 1.2x, implying little
 Chennai desalination provides it with the prequalifications to headroom available for further debt raising
participate in other potential desalination opportunities in  Continued delays in commencing construction in the recently
the country won road BOT projects
 Established and leading presence in high water and infra  Largest business segment of irrigation saddled with slow-
spend states such as Andhra, Maharashtra and Rajasthan moving Rs40bn worth of orders from the home state, Andhra
 Subsidiary, HDO, provides technology and fabrication Pradesh
capabilities not available with many players except L&T  Low promoter shareholding (9.7%) leaves little room for
 One of the fastest growing companies over the last five years equity raising at the company level
(CAGR of 29% in revenues over FY06-10)
Opportunities Threats
 Further delays in commencement of construction of the
 Continuing and rising infrastructure creation plans of the recently bagged road BOT projects
Government of India (GoI), XIIth 5-year plan investment of
US$1tn as against XIth 5-year plan’ investment of US$0.5tn  Cancellations and payment delays from slow-moving
irrigation orders in Andhra Pradesh
 Pick-up in corporate capex can lead to orders for segments
such as buildings and oil & gas  Lack of sufficient equity capital may lead to sale of existing
investments at low valuations
 Exploring fast growing Middle Eastern markets with recent
order wins of Rs19bn  Recent entry into Middle East for orders could impact margins
due to entry pricing and unknown external issues
 Road BOT assets can be securitised or generate cash flows to
reduce the consolidated debt-equity  Poor credit availability and rising costs of funds can impact
the execution cycle of the projects
Source: Ambit Capital research, Industry, Company
Key risks to SELL stance on IVRCL

Whilst we note for all construction companies, the financials and stock price
performance is exposed to the macro risks of execution/payment delays and rising
interest rates, for IVRCL, the key risks are the following:
Equity raising at the subsidiary level

Given that it is difficult for IVRCL to raise money at the company level (low
promoter holding of 9.7%), IVRCL may look to dilute its investments in either of its
subsidiaries (HDO or IVRAH) and infuse money into IVRAH for mobilizing the
recently won projects. Since the valuations of IVRAH are currently at a material
discount to the book, it seems likely that IVRCL will sell its stake in HDO. If IVRCL
is able to raise money and infuse it into IVRAH, it could improve the
execution cycle of the captive orders, which constitute 23% of the order
book.
Material improvement of the execution cycle

Any meaningful improvement in the slow moving order book of the irrigation
segment (17% of order book) especially in the Andhra Pradesh region and captive
orders can accelerate the execution cycle and thus lead to higher-than-expected
revenue growth. Well funded captive orders can improve working capital turnover
impacting our low working capital turnover assumptions.

Nearly 40% of the order book facing

execution challenges
Whilst IVRCL has one of the largest order books in the sector and a high book-to-
bill ratio (4.5x), nearly 40% of the Rs240bn order book is facing execution issues
(Rs40bn of irrigation orders and Rs55bn of captive orders). We believe such slow
moving orders make the situation worse for IVRCL at a time when the industry is
facing slow execution across other sectors. We expect 2HFY11E revenues to just
grow 19% YoY, implying a 13% YoY growth for FY11.
Irrigation order book of Rs40bn is slow moving

The irrigation segment forms 17% of the current order book and the Andhra
Pradesh (AP) region constitutes 63% of the irrigation segment order book.
Execution of irrigation orders (primarily from AP) has been slow for nearly five
quarters now because of multiple issues in the state (such as death of the chief
minister in a helicopter crash, floods, lack of funds, potential division of the state
into two etc.). Given these political and economic challenges, we do not expect this
segment to start contributing materially towards revenue growth in FY11.
Exhibit 3: Water (including irrigation) forms a large Exhibit 4: Water (including irrigation) has been
part of the order book witnessing slow execution
100% 5% 6%
8% 6% 100% 13%
6% 13%
5% 26% 13% 12% 17% 14%
5% 16% 17% 21% 5%
80% 8% 8% 2%
23% 21% 80% 2%
18% 4% 5%
20% 20% 33%
11% 31% 30% 34%
60% 60% 41%
41%
40% 40%
67% 66% 64% 58% 59% 60% 54%
47% 47% 50%
20% 20% 40%
33%
0% 0%
1Q FY10 2Q FY10 3Q FY10 4Q FY10 1Q FY11 2Q FY11
1Q FY10 2Q FY10 3Q FY10 4Q FY10 1Q FY11 2Q FY11
Water/Irrigation Buildings Power Transportation Water/Irrigation Buildings Power Transportation
Captive order book (23% of total book) is also slow moving

Whilst captive orders (primarily roads segment) are supposed to be better orders
given that the client is a related party, for IVRCL such orders have systematically
faced execution delays, which have now become a vital concern as captive orders
now account for nearly one-fourths the total orders. Whilst external regulatory and
procedural issues continue to impact execution progress, we believe that the lack
of availability of equity capital and delays in financial closure are other critical
reasons for such delays. Management has revised downward its FY11 revenue
guidance from existing captive projects to Rs750mn in 2QFY11 from Rs1,000mn in
1QFY11. We believe that until sufficient equity capital is arranged, captive orders
will continue to be slow moving.

Exhibit 5: Captive order primarily for roads waiting for equity

IVRCL’s Total project Date of IVRAH
Projects Segment Status
stake cost (Rsmn) award equity share
Baramati-Phaltan Roads 75 3,820 Nov-09 525 Financial closure achieved
Indore-Gujarat border project Roads 100 15,240 Mar-10 3,810 Financial closure achieved
Chengapalli-Walayar project Roads 100 11,250 Feb-10 4,250 Financial closure achieved
Goa Karnataka Roads 100 31,000 Jun-10 7,170 Concession agreement to be signed
Karanji-Wani-Ghuggus-Chandrapur Roads 100 7,500 1,295 Concession agreement to be signed
Oil and
IOCL –Tankages 37.5 30,000 2,250 Financial closure achieved
Gas
Sion-Panvel project Roads 51 15,000 1,530 Concession agreement to be signed
Total 113,810 19,424
Primary data suggests that the company will miss guidance
We have highlighted earlier in our industry section (see page 10) that multiple
stakeholders in the construction industry are pointing towards subdued execution
pick-up versus the sanguine picture painted by most of the listed companies. Even
the unlisted players are guiding towards YoY growth rates of 10-15% in 2HFY11
as against listed players’ guidance of 25-35%. Given these challenges and IVRCL’s
slow moving captive and irrigation orders, we expect IVRCL to once again miss its
aggressive guidance of Rs65-67.5bn in revenues for FY11, implying Rs43.1-
45.6bn revenues in 2HFY11 or 35-36% YoY growth.
Exhibit 6: Ambitious revenue guidance for 2HFY11 feeding into consensus estimates for IVRCL
2HFY11 Ambit 2HFY11 2HFY11
1HFY10 2HFY10 1HFY11
estimates Consensus Management
(Rsmn) (Rsmn) (Rsmn)
(Rsmn) estimates (Rsmn) guidance(Rsmn)
Revenues 23,040 31,883 21,814 38,076 41,222 43,186
Share of annual revenues (%) 42 58 36 64 66 66
YoY growth (%) 12 12 -5 19 29 35
QoQ growth (%) -19 38 -32 75 89 98
EBITDA 2,141 3,172 1,961 3,474 3,982 4,376
EBITDA margin (%) 9.3 9.9 9.0 9.1 9.7 9.8
PBT margin (%) 5.4 6.4 3.4 5.1 6.5
Source: Company, Ambit Capital research, Note: Consensus data is as on Dec14, 2010

Equity raising: Difficult and urgent

IVRCL was one of the first construction companies to raise equity in the early part
of the noughties followed with a couple of equity raisings at the parent and the
subsidiary levels. The firm’s total equity raisings over FY04-08 amount to Rs10bn.
However, over the last few quarters the company has been facing the lack of
capital given the rising debt-equity ratio and given its rising need for equity to
mobilize the recently bagged infrastructure assets. The lack of capital has led to
regular delays in booking construction revenues from captive contracts.
Large equity requirements of infrastructure development ambitions

IVRCL, through its subsidiary, IVRAH, owns 11 BOT assets and a large real estate
land bank in multiple cities. Over the last 15 months, IVRAH has taken up seven
infrastructure BOT projects and requires equity investment of Rs19bn over the next
3-4 years. Whilst IVRAH is debt free (has loans in SPVs and has loans from IVRCL),
it is short of equity for mobilizing the construction work required for most of these
projects.
Exhibit 7: Equity requirements for IVRCL’s BOT projects
Total project Debt/Grant Equity IVRAH Expected project

Projects Segment Stake cost (Rsmn) (Rsmn) (Rsmn) equity share completion date
Baramati-Phaltan Roads 75 3,820 3,120 700 525 12-Sep
Indore-Gujarat Border project Roads 100 15,240 11,430 3,810 3,810 13-Apr
Chengapalli-Walayar project Roads 100 11,250 7,000 4,250 4,250 13-Apr
Goa-Karnataka Roads 100 31,000 23,830 7,170 7,170
Karanji-Wani-Ghuggus- Roads 100 7,500 6,205 1,295 1,295
Oil and
IOCL –Tankages Gas 37.5 30,000 11,400 2,250 2,250
Sion-Panvel project Roads 51 15,000 12,000 3,000 1,530
Total 113,810 91,355 22,475 19,424
Limited ability of the parent to infuse equity

In the past, IVRCL has funded its infrastructure and real estate development
ambitions through either equity investments from the parent or loans and
advances from the parent (32% and 18% of IVRCL’s net worth is invested in
subsidiaries as equity investment and loans & advances, respectively). However,
given the rising debt-equity level (1.2x at end-1HFY11) of the listed entity, it is
highly unlikely that IVRCL can infuse any more equity via raising debt given the
non-existent free cash flows in the core construction business. In 1HFY11 IVRCL
invested Rs3bn into the subsidiaries and plans to invest another Rs3bn in 2HFY11.
Exhibit 8: Lack of cash flows led to borrowings funding the asset development
ambitions
(Rsbn)
20
15
10
5
0
-5
-10
FY07 FY08 FY09 FY10
Free Cash Flows Investment in subsidaries Loans and Advances to subsidaries Debt

Project level equity raising could be difficult

In the past, IVRCL was able to raise money for the BOT assets based on the
promising future performance of the BOT assets. However, the company’s BOT
performance has been unsatisfactory on account of project delays, cost overruns
and traffic numbers (exhibit 9 ). Given this poor past experience of the existing
operational BOT assets, IVRCL may find it difficult to attract investment for the new
BOT projects.
Exhibit 9: IVRAH BOT projects have seen time as well cost overruns of 44% and 24% respectively
Cost
Cost at
Cost at project Project Original Actual Cost overruns
Delay Delays project
Project details announcement announcement Completion completion overruns as % of
(months) (%) completion
(Rs mn) month month month (Rs mn) original
(Rs mn)
cost
Kumarapalayam
– Chengapalli 4,366 Jan-06 Jan-09 Sep-09 8 22.% 4,500 134 3%
BOT
Chennai Water
Desalination 4,500 Aug-05 Aug-08 Jul-10 24 67% 6,000 1,500 33%
Project
Jalandhar –
3,806 Oct-05 Jan-09 May-10 16 41% 5,700 1,894 50%
Amritsar BOT
Salem –
Kumarapalayam 5,500 Jan-06 Jan-09 Jun-10 18 50% 6,340 840 15%
BOT
Total 18,172 44% 22,540 4,368 24%

Cost structure under pressure

Competitive positioning amongst peers is middling
In spite of being among the best construction companies on prequalification
parameters, IVRCL is an average player on the cost structure parameters (based on
FY10 financials). In particular, it has the highest average cost of debt among peers
(13.2%) and lower than industry average working capital turnover (2.8x).
Moreover, things have worsened in 1HFY11, as the stand-alone debt:equity has
increased to 1.2x (an all-time high for the firm) owing to the poor working capital
turnover. Higher debt and rising interest rates will limit any improvement in the
PBT margin based on operating leverage; we expect only 30bps decline on YoY
basis and 160bps improvement on HOH basis, respectively.
Exhibit 10: IVRCL is a relatively middling business in Exhibit 11: IVRCL is a relatively middling business in
terms of cost competitiveness terms of cost competitiveness
Fixed Fixed
Interest Fin Fin
cost as Gross cost as Fin
Debt- WC cost as exp - Gross WC exp -
a %age block a Debt- exp -
equity turnover % of as % block turn- as % Over-
costs turnover %age equity as %
(X) (X) avg of turnover over of all
total (X) costs (X) of
debt sales (X) (X) avg
costs total sales
debt
Punj Lloyd costs
23.0 1.5 3.6 2.5 9.1 3.7
IVRCL 8.0 0.9 7.5 2.8 13.2 3.9 Punj Lloyd
Nagarjuna 8.2 0.7 6.9 3.0 10.8 3.6 IVRCL
HCC 23.4 1.7 2.1 1.8 11.6 6.2
Simplex Nagarjuna
8.3 1.3 3.7 3.7 7.7 2.6
Gammon 6.3 0.9 3.3 3.6 9.9 4.5 HCC
Soma 16.3 2.6 2.1 2.6 10.8 9.0
Simplex
CCCL 12.4 0.6 11.3 3.5 12.2 1.6
Patel Engg. 9.9 1.2 4.6 1.2 9.0 6.2 Gammon
Sadbhav 7.4 1.1 4.2 4.1 6.0 3.0 Soma
Madhucon 10.9 1.6 2.9 43.9 8.6 1.4
Average CCCL
12.2 1.3 4.7 6.6 9.9 4.2
Source: Company, Industry, Ambit Capital research Patel .
We include depn. in fixed costs and also total costs
exclude FCCBs for interest cost calculation Sadbhav
(c) We include mobilisation advance in working capital and exclude
it from debt ; (d) We include bank charges in financial expenses Madhucon

Note: - strong - relatively strong - average - relatively
weak
IVRCL lost ground in FY10

IVRCL’s disappointing financial performance on the key cost competitiveness
parameters has led its loss of the leading position amongst the top-10 players
(exhibit 12 ). The only saving grace for IVRCL in FY10 was an improvement in the
average cost of debt (debt cost movements were favourable for the entire industry
due to falling interest rates). Going forward, we do not expect FY11 to be any
better. In fact, poor execution is likely to: (a) impact fixed costs absorption, (b) lead
to lower working capital and gross block turnover, and (c) higher debt-equity.

Exhibit 12: Cost structure movement over the years (based on annual reports)
Cost competitiveness
parameters FY08 FY09 FY10 FY10 vs. FY09 Comments
Fixed cost as a %age Deterioration

11.4 7.3 8.0 Administrative overheads increased in FY10 over FY09
total costs
Debt-equity (x) Deterioration Requirement of funds for subsidiaries and working
0.66 0.77 0.87
capital.
Gross block turnover (x) 10.9 9.0 7.5 Deterioration High capex expenditure and poor execution
WC turnover (x) 2.9 2.9 2.8 Deterioration Payment delays and poor execution
Interest cost as % of avg Declining short-term interest rates in FY10 resulted in a
12.4 13.7 13.2 Improvement
debt (%) 50bps improvement in average debt cost.
Financial expenses - as Decline in financial expenses because of reduced costs is
3.0 4.0 3.9 Stable
% of sales balanced by a decline in revenues

Key assumptions
Exhibit 13: Assumptions for stand-alone business unless otherwise indicated (all units in Rs mn unless specified)
Key assumptions FY10 FY11E FY12E Comments for key assumptions up to FY12
Closing order book 168,865 211,351 260,232 .
We expect stand-alone order inflows at a CAGR of 19% over FY10-12
Order addition 85,134 102,093 121,005
driven by high orders in the transportation and building segment.
We expect execution to remain slow mainly in the irrigation segment,

Revenues 53,093 59,890 72,125 which has pulled down the revenue estimates for FY11, despite high
order inflow. We expect execution to materially improve only in 2HFY12.
Growth (%) 9 13 20
EBITDA 5,312 5,435 6,924
Increase in construction expenses and employee costs is likely to keep
EBITDA margin (%) 10.0 9.1 9.6 EBITDA margins under pressure in FY11.We expect margins to improve
by 50bps in FY12.
Total financial charges Given the increasing inflationary pressures we expect average debt cost
1,637 2,133 2,772
(net) to increase by 50bps in FY11 and another 25 bps in FY12
Average Working capital Payment delays and slow execution will keep working capital turnover
2.8 2.8 2.8
turnover stable.
Gross block turnover 7.5 7.0 6.7 Execution pick-up to be balanced by increase in gross block.
Capex to remain high due to increased investments in high technology
Capex (1,209) (2,180) (2,200)
equipment to drive productivity
Ambit versus consensus

We expect 19% revenue growth in 2HFY11 compared to consensus’ estimate of
32% in 2HFY11 (revenues declined by 5% in 1HFY11), given the slow moving
captive order book and irrigation order book (40% of total order book).
We expect revenue growth to pick up in FY12 but at a slower pace (our estimate is
20% growth v/s 23% for consensus).
Where consensus expects a stable–to-strong EBITDA margin of 9.5%, we believe a
lower level of execution and rising interest rates will not lead to any improvement
in EBITDA margin despite higher execution. However, our divergence with
consensus widens at the PBT level given our assumptions of higher interest rates,
higher debt due to no improvement in working capital turnover and rising capex
requirements. We expect a PBT margin of 5.1% in 2HFY11 (consensus: 5.5%) and
4.7% in FY12 (consensus: 5.6%). We expect IVRCL to incur capex of Rs2.2bn each
in FY11 and FY12, resulting in higher depreciation expenses.
Exhibit 14: Ambit versus consensus

Consensus Ambit Divergence
Revenue (Rsmn)
2011 62,746 59,890 -5%
2012 77,363 72,125 -7%
EBITDA (Rsmn)
2011 5,943 5,435 -9%
2012 7,417 6,924 -7%
EPS (adjusted) (Rs)
2011 8.3 6.6 -21%
2012 10.7 8.4 -22%
Source: Bloomberg, Ambit Capital research

Valuation – SOTP-based
Our SOTP-based valuation is Rs109/share (DCF-based value of Rs59/share for the
core construction business plus R50/share for the subsidiaries).
Exhibit 15: SOTP-based valuation of Rs109/share

Effective
Value Value/share
Business Method Multiple (x) value
(Rs mn) (Rs)
(Rs mn)
Construction business DCF 15,790 7.2X FY12* 15,790 59
Subsidiaries 18,140 13,356 50
Hindustan Dorr Oliver Mcap 4,511 2,391 9
IVRC Assets and Holdings Mcap 13,628 10,965 41
Total 29,146 109
Note: * Implied multiple based on our DCF valuation
Construction business – Rs59/share

We value IVRCL’s construction business at Rs59/share using DCF-based valuation.
We use a WACC of 13.5% (CoE of 15%, cost of debt of 10%, target debt/equity of
0.65x) and a terminal growth rate of 5%. Whilst some improvement in execution
and rising construction business opportunities will drive revenues and free cash
flows from FY14E, we find that the current high level of debt and near-term poor
working capital and gross block turnover will not lead to any free cash generation.
We maintain low revenue growth assumptions beyond FY13, owing to the rising
scale of the business and increasing competition; we model revenue growth of 7-
15% beyond FY13 except in one year (20% growth in FY17E). Our Rs59/share
valuation for the construction business implies a valuation of 8.9x and 7x FY11
and FY12 earnings respectively.
Exhibit 16: DCF valuation Exhibit 17: Terminal value is the main component
(Rs bn)
2.5 16% PV of the forecasting period up to FY20 (Rs mn) 8,133
1.5
12%
0.5 Terminal value (Rs mn) 29,430
8%
-0.5 Enterprise value (Rs mn) 37,562
-1.5 4%
Less: net debt at Sep-10 (Rs mn) 21,733
-2.5 0%
Implied equity value (Rs mn) 15,790
FY11 E
FY12E
FY13E
FY14E
FY15E
FY16E
FY17E
FY18E
FY19E
FY20E
2H
Implied equity value (Rs per share) 59

PV of FCFF WACC (RHS) ROCE (post tax) (RHS)
Source: Ambit Capital research, Company, Industry Source: Ambit Capital research, Company, Industry
Embedded value – Rs50/share

IVRCL owns 53% of Hindustan Dorr Oliver (HDO) and 80% of IVRCL Assets and
Holdings (IVRAH). We value investments in both these entities at the market
capitalization (adjusted for ownership).
HDO – Rs9 per share

HDO gives IVRCL an edge in the engineering and construction sector due to its
technology and manufacturing edge for multiple industries. HDO is one of the few
companies in the country capable of fabricating high value engineered products

like mining hoists, pressure vessels and heat exchangers. Whilst we believe that
HDO can grow at a faster pace than the parent (yet maintain profitability) and
grow its market capitalization, we find that the growth will require equity dilution
leading to limited upside for the parent company.
IVRAH – Rs41/share
In FY10, IVRCL transferred its BOT holdings to IVR Prime leading to the merger of
real estate and infrastructure asset development business and formation of IVRAH.
Given the slump in the real estate market, the company has been posting losses in
the real estate business and is looking to liquidate certain land bank inventory.
From hereon, it will focus on asset development (roads, desalination, tankages,
power etc.). We value IVRCL’s investments in IVRAH using market cap leading to a
valuation of Rs13bn; this implies a P/B multiple of 0.6x.
Why should embedded values be at such a discount to book value?

Given that we do not have complete traffic and operational details for most of the
BOT assets held by the construction companies, we are valuing the investments in
these entities at 1-1.5x P/B depending upon the stage of completion, disclosures
and delays/cost overruns.
We find that IVRCL was one of the first and the largest BOT aspirants in the early
part of the decade leading to winning three road projects and a ’one of a kind’
desalination project. Despite its touted capabilities, we find that the company’s
BOT ownership experience has been unsatisfactory on account of delays (16-24
months), cost overruns (3-50%) (exhibit 18) and poor traffic numbers. In our recent
discussions with financiers and rating agencies (which have rated IVRCL’s road
assets) we were informed that most of the road projects have traffic numbers far
below estimates.
Exhibit 18: IVRAH BOT projects have seen time as well cost overruns of 44% and 24% respectively
Cost
Cost at
Cost at project Project Original Actual Cost overruns
Delay Delays project
Project details announcement announcement Completion completion overruns as % of
(months) (%) completion
(Rs mn) month month month (Rs mn) original
(Rs mn)
cost
Kumarapalayam –
Chengapalli 4,366 Jan-06 Jan-09 Sep-09 8 22.% 4,500 134 3%
BOT
Chennai Water
Desalination 4,500 Aug-05 Aug-08 Jul-10 24 67% 6,000 1,500 33%
Project
Jalandhar –
3,806 Oct-05 Jan-09 May-10 16 41% 5,700 1,894 50%
Amritsar BOT
Salem –
Kumarapalayam 5,500 Jan-06 Jan-09 Jun-10 18 50% 6,340 840 15%
BOT
Total 18,172 44% 22,540 4,368 24%
Source: Company, Industry, , Ambit Capital research
Given this poor track record, we are valuing IVRAH on a market cap-based
valuation rather than on P/B multiples. Our market cap based valuation implies
0.6x the FY10 net worth of Rs23bn. Such a low P/B multiple implies that the
market believes that either the inventories (i.e. real estate) or the
investments/gross block (BOT assets) will have to go through write-downs or will
incur losses. Nearly 32% of the net worth is on account of share premium from the
equity issuances of IVRAH of Rs10bn in FY07, post which the company has nearly
stalled its original real estate development business.

Cross cycle valuation

IVRCL is trading at a one-year forward PE (without adjusting for embedded value)
of 13.5x (consensus estimates) which is in line with its average PE of 14x for the
past five years (exhibit 19), However, it is trading at a discount of 48% to its peak
PE of 26x (December 2009).
We believe that this company’s earnings multiple will decline from hereon as
financial performance (read earnings and cashflows) will be poor in the near-term
given the large captive slow moving orders (cash flows, poor performance of
embedded investments) and industrywide challenges. Whilst we expect earnings
multiples to come down, we do not expect valuations to get to the lows of 3.2x as
in October 2008.
Exhibit 19: IVRCL trades in line with its historical five Exhibit 20: IVRCL trades in line with its historical five
year P/E multiples year P/B multiples
450 (Rs) 350 (Rs) Average P/B

Average PE
400
300 3.5x
350 3x
30x 250
300 2.5x
250 25x 200
2x
200 20x
150
1.5x
150 15x
100 1x
100 10x
50 5x 50
0 0
Apr-05
Apr-06
Apr-07
Apr-08
Apr-09
Apr-10
Apr-05
Apr-06
Apr-07
Apr-08
Apr-09
Apr-10

Exhibit 21: Balance sheet

Shareholders' equity 271 267 534 534 534
Reserves & surpluses 15,789 17,839 17,998 19,619 21,651
Total networth 16060 18106 18532 20153 22185
Minority Interest 5,788 10,185 12,688 28,324 46,960
Preference share capital 4,891 3,795 3,445 3,445 3,445
Debt 10,678 13,980 16,133 22,666 25,666
Deferred tax liability 103 117 125 135 203
Total sources of funds

26,841 32,203 34,790 42,954 48,055
Net block 3,192 5,207 5,664 7,096 8,433
CWIP 541 196 353 353 353
Investments 3,409 3,892 6,138 6,138 6,138
Cash & equivalents 1,771 1,009 1,643 2,296 1,629
Debtors 6,585 11,430 19,445 22,643 26,676
Inventory 1,943 2,093 2,447 2,984 3,930
Loans & advances 7,781 9,319 6,606 9,913 11,436
Other current assets 10,747 14,284 16,864 18,312 21,855
Total current assets 28,827 38,135 47,005 56,147 65,527
Current liabilities 8,780 14,787 23,924 26,407 31,975
Provisions 347 440 445 374 421
Total current liabilities 9,127 15,226 24,369 26,781 32,396
Net current assets
19,699 22,909 22,635 29,367 33,130
Total application of funds
26,841 32,203 34,790 42,954 48,055
Exhibit 22: Income statement

Operating income 36,606 48,819 53,093 59,890 72,125
% growth 59% 33% 9% 13% 20%
Operating expenditure 32,992 44,601 47,781 54,455 65,201
EBITDA 3,614 4,218 5,312 5,435 6,924
% growth 56% 17% 26% 2% 27%
Depreciation 328 473 543 749 863
EBIT 3,286 3,745 4,769 4,687 6,061
Interest expenditure 478 1,306 1,637 2,133 2,772
Non-operating income 45 299 155 125 131
Adjusted PBT 2,853 2,738 3,288 2,678 3,421
Tax 749 478 2,586 893 1,163
Adjusted PAT/ Net profit 2,105 2,260 2,111 1,786 2,258
% growth 49% 7% -7% -15% 26%
Reported PAT / Net profit
2,105 2,260 702 1,786 2,258

Exhibit 23: Cash flow statement

EBIT 3,286 3,745 4,769 4,687 6,061
Depreciation 328 473 543 749 863
Others 555 1,154 1,739 2,008 2,640
Tax (1,229) (1,018) (1,293) (869) (1,094)
(Incr) / decr in net working
(6,283) (2,878) (2,480) (3,008) (4,978)
capital
Cash flow from operations (3,776) 468 1,796 1,558 852
Capex (1,638) (2,188) (1,209) (2,180) (2,200)
Other income (expenditure) 315 (176) (69) (2,875) 1,647
Cash flow from investments (1,323) (2,364) (1,278) (5,055) (553)
Net borrowings 5,930 1,221 1,149 6,533 3,000
Issuance of equity 1 0 - - -
Interest paid (1,093) (1,899) (1,904) (2,133) (3,787)
Dividend paid (151) (189) (215) (250) (179)
Cash flow from financing 4,634 1,133 81 4,150 (966)
Net change in cash (467) (763) 599 653 (667)
Closing cash balance 1,771 1,009 1,545 2,296 1,629
Free cash flow (5,403) (1,685) 601 (622) (1,348)
Exhibit 24: Ratio analysis

Year to March (%) FY08 FY09 FY10 FY11E FY12E
EBITDA margin (%) 9.9% 8.6% 10.0% 9.1% 9.6%
EBIT margin (%) 9.0% 7.7% 9.0% 7.8% 8.4%
Net profit margin (%) 5.7% 4.6% 4.0% 3.0% 3.1%
Dividend payout ratio (%) 8.7% 8.3% 10.0% 8.5% 8.5%
Net debt: equity (x) 0.6 0.7 0.8 1.5 2.2
Working capital turnover (x) 2.9 2.9 2.8 2.8 2.8
Gross block turnover (x) 10.9 9.0 7.5 7.0 6.7
RoCE (%) 16.2% 14.5% 12.3% 10.9% 11.8%
RoIC (%) 16.2% 14.5% 12.3% 10.9% 11.8%
RoE (%) 14.4% 13.2% 11.5% 9.2% 10.7%
Exhibit 25: Valuation parameter

EPS (Rs) 16.1 16.9 7.9 6.7 8.5
Diluted EPS (Rs) 15.8 16.9 7.9 6.6 8.4
Book value per share (Rs) 120 136 69 75 82
Dividend per share (Rs) 1.40 1.40 0.79 0.57 0.72
P/E (x) 15.9 14.8 15.9 18.8 14.8
P/BV (x) 2.1 1.9 1.8 1.7 1.5
EV/EBITDA (x) 11.7 11.0 9.0 9.9 8.3
EV/EBIT (x) 12.9 12.4 10.1 11.5 9.5
EV/Sales (x) 1.2 1.0 0.9 0.9 0.8

Technical View (3 months view)
IVRCL Infra and Nagarjuna Construction: Downside looks limited
Exhibit 26: IVRCL Weekly chart
Source: MetaStock
 • Both IVRCL and Nagrajuna had a sharp fall in recent weeks.

 • Both are trading below their 200DMA but are above 10DMA and on the
daily chart both are witnessing bullish moving average crossover with 10DMA
cutting 20DMA from below signalling downside is limited.
 • Even the weekly RSI of both the stocks are nearing the Oversold zone.
 • Every time the RSI touches the Oversold line, the stock has witnessed a
sustainable rally.
 • Therefore we recommend Buying both the stocks with IVRCL targeting Rs144
and Nagarjuna targeting Rs155.
Exhibit 27: Nagarjuna Construction Weekly chart
Ashish Shroff
Technical Analyst
Tel.: +91-22-3043 3209
ashishshroff@ambitcapital.com
Source: MetaStock

Derivative View
Exhibit 28: Nagarjuna Constructions – OI chart
OI Pric e( F&O)
200 12,000,000
180 10,000,000
8,000,000
160
OI 6,000,000
140
4,000,000
120
2,000,000
100 0
2-Nov-10
16-Nov-10
19-Apr-10
3-May-10
17-May-10
31-May-10
9-Aug-10
23-Aug-10
1-Dec -10
15-Dec -10
14-Jun-10
28-Jun-10
12-J ul-10
26-J ul-10
6-Sep-10
21-Sep-10
5-Oc t-10
19-Oc t-10
Date
Source: Ambit Capital research
The stock had seen a good amount of shorting activity in late October to early
November. However, since then the open interest positions have been reducing
down indicating declining commitment to the short side at these price levels. This
is in line with its peer IVRCL Infra.
We think this is positive for the stock and the stock is likely to do well over the next
few weeks. We, however, think that 140 is a stiff resistance and hence longs
should be initiated only on a break above 140 for a medium term target of 160 on
the stock.
Exhibit 29: IVRCL – OI chart
OI Pric e( F&O)
200 12,000,000
180 10,000,000
8,000,000
160
6,000,000
OI
140
4,000,000
120
2,000,000
100 0
2-Nov-10
16-Nov-10
19-Apr-10
3-May-10
17-May-10
31-May-10
9-Aug-10
23-Aug-10
1-Dec -10
15-Dec -10
14-J un-10
28-J un-10
12-J ul-10
26-J ul-10
6-Sep-10
21-Sep-10
19-Oc t-10
5-Oc t-10
Gaurav Mehta
Derivatives Analyst Date
Tel.: +91-22-3043 3255
gauravmehta@ambitcapital.com Source: Ambit Capital research

Institutional Equities Team

Saurabh Mukherjea Managing Director - Institutional Equities – (022) 30433174 saurabhmukherjea@ambitcapital.com
Research
Analysts Industry Sectors Desk-Phone E-mail

Amit Ahire Telecom / Media & Entertainment (022) 30433202 amitahire@ambitcapital.com
Ankur Rudra IT/Education Services (022) 30433211 ankurrudra@ambitcapital.com
Ashish Shroff Technical Analysis (022) 30433209/3221 ashishshroff@ambitcapital.com
Ashvin Shetty Consumer (022) 30433285 ashvinshetty@ambitcapital.com
Bhargav Buddhadev Power/Capital Goods (022) 30433252 bhargavbuddhadev@ambitcapital.com
Chandrani De Metals & Mining (022) 30433210 chandranide@ambitcapital.com
Chhavi Agarwal Infrastructure (022) 30433203 chhaviagarwal@ambitcapital.com
Gaurav Mehta Derivatives Research (022) 30433255 gauravmehta@ambitcapital.com
Krishnan ASV Banking (022) 30433205 vkrishnan@ambitcapital.com
Nitin Bhasin Infrastructure (022) 30433241 nitinbhasin@ambitcapital.com
Pankaj Agarwal NBFCs (022) 30433206 pankajagarwal@ambitcapital.com
Parikshit Kandpal Construction / Real estate (022) 30433201 parikshitkandpal@ambitcapital.com
Poonam Saney BFSI (022) 30433216 poonamsaney@ambitcapital.com
Puneet Bambha Power/Capital Goods (022) 30433259 puneetbambha@ambitcapital.com
Rajesh Kumar Ravi Cement (022) 30433274 rajeshravi@ambitcapital.com
Ritika Mankar Economy (022) 30433175 ritikamankar@ambitcapital.com
Ritu Modi Metals & Mining (022) 30433292 ritumodi@ambitcapital.com
Subhashini Gurumurty IT/Education Services (022) 30433264 subhashinig@ambitcapital.com
Vijay Chugh Consumer (incl FMCG, Retail, Automobiles) (022) 30433054 vijaychugh@ambitcapital.com
Sales
Name Designation Desk-Phone E-mail

Alok Doshi Manager Sales (022) 30433229 alokdoshi@ambitcapital.com
Deepak Sawhney VP - Ins Equity (022) 30433295 deepaksawhney@ambitcapital.com
Dharmen Shah VP - Ins Equity (022) 30433289 dharmenshah@ambitcapital.com
Dipti Mehta Senior Manager Equities (022) 30433053 diptimehta@ambitcapital.com
Sarojini Ramachandran Director, Sales +44 (0) 20 7614 8374 sarojini@panmure.com

Explanation of Investment Rating
Investment Rating Expected return

(over 12-month period from date of initial rating)
Buy >15%
Hold 5% to 15%
Sell <5%
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December 16, 2010

Future Growth ≠ Future Cash Analyst contacts

Valuation: Superficially cheap

An unappreciated fact: Poor returns............................................... 3

Poor returns, a function of the industry behavior.......................... 4

The construction opportunity is huge .............................................. 9

So are construction stocks set to fly?............................................. 10

Valuations: Superficially attractive ............................................... 15

Nagarjuna Construction ................................................................ 21

Ambit Capital Pvt Ltd 2

An unappreciated fact: Poor returns

Ambit Capital Pvt Ltd 3

Poor returns, a function of the

High competitive intensity

Exhibit 2: Porter’s analysis of Indian construction industry

Competitive intensity Bargaining power of buyers

Bargaining power of suppliers

Fragmented nature of the construction

Continuing shortage of skilled manpower

Barriers to entry Threat of substitution

Rising scale of projects is increasing the

Improving Unchanged Deteriorating

Source: Ambit Capital research, Industry

Ambit Capital Pvt Ltd 4

Persistent inability to generate cashflow

Misallocation of cash and equity raisings

Ambit Capital Pvt Ltd 5

Cash parked in unclassified loans and advances

The transitory competitive positioning of the players

Exhibit 9: Key competitive assessment metrics

Ambit Capital Pvt Ltd 6

Assessing current competitive positioning

Exhibit 10: Competitive assessment of the mid-size Indian construction companies

Gammon 45 144 20 19 40% Power

Soma(a) 25 151 NA 8 31% Transport

Patel 24 105 22 15 29% Power

Sadbhav 13 78 18 5 37% Transport

Madhucon 14 46 9 6 44% Transport

Source: Company, Ambit Capital research, Industry, Bloomberg,

Note : - Strong; - Relatively Strong; - Average; - Relatively weak.

Shift in competitive standing

Exhibit 11: Nagarjuna remains the strongest player

Source: Company, Ambit Capital research, Industry

Note: - Strong; - Relatively Strong; - Average; Relatively weak.

Contentious accounting policies

Ambit Capital Pvt Ltd 8

The construction opportunity is huge

GFCF as a share of GDP % (LHS)

Can the construction industry deliver?

6,000 12% (Rsbn)

Ambit Capital Pvt Ltd 9

So are construction stocks set to fly?

Cash generation could be far away

 Management teams of unlisted construction companies seem to be less

 Banks/financial institutions highlight that lending to the infrastructure

Capex requirements could also increase

 Labour inefficiency and poor availability of the right kind of labour,

Payment/execution delays and higher capex to exacerbate the

Ambit Capital Pvt Ltd 10

Source: Company, Ambit Capital research, Industry, Bloomberg.

Furthermore, the use by the construction companies of sub-contracting and leasing

Ambit Capital Pvt Ltd 11