Patel Engineering Ltd started the year with a market capitalization of Rs6,000 crore, more than three times its annual revenues, thanks to its presence in two of the market’s favourite sectors: construction and real estate.
These days, the firm has a market cap of more than Rs2,000 crore, as investors have tempered expectations from stocks in these sectors.
Macquarie Research’s report on the company dated 9 January had put a price target of Rs1,149 per share, assigning a valuation of 18 times fiscal 2009-10 earnings per share for the core engineering and construction business. The company’s real estate portfolio was valued at 1.5 times its net asset value (NAV).
A more recent report, dated 25 June, has a reduced price target of Rs484 a share, with the core business now being valued at 12 times fiscal 2010 earnings and the real estate portfolio being valued at a 40% discount to its NAV. Earnings estimates have also been lowered, but that isn’t the main reason for the drop in stock price.
In fact, the company’s recent results show that it continues to perform well, at least as far as operating profit growth goes.
Patel Engineering’s results for the June quarter show that it has been able to maintain operating margin at the same level as the March quarter, despite spiralling commodity prices.
The company reported a healthy margin of 14.1%, owing to which operating profit jumped by 70% to Rs78.6 crore over the year-ago period.
Construction and other costs, which reflect raw material expenses, fell 340 basis points as a percentage of sales over a year ago.
But, profit before tax grew at a much lower rate of 33%, as interest cost rose by 3.5 times to Rs17.6 crore. Patel Engineering had increased debt funding substantially last year to aid growth.
Compared with some of its peers, the company seems well placed to offset spiralling commodity and interest costs, thanks to its presence in the high-margin hydro power and upstream irrigation segments. Its June quarter results bear this out.
But, the stock has been done in by overexuberance in the recent past, and investors are likely to be cautious before buying into the story anytime soon.
On Tuesday, the shares closed at Rs343.45 each, down 5.4%, on the Bombay Stock Exchange.
Will earnings targets have to be lowered?
The worsening environment doesn’t seem to have dented the optimism of some brokers.
Here’s how brokerage firm Motilal Oswal Securities Ltd has revised its estimates for Sensex components over the course of six months. At the beginning of January, it had estimated the earnings growth at 20.5% in fiscal 2009 and a hefty 29% in fiscal 2010. The combined earnings per share (EPS) of the 30 Sensex companies was estimated to be Rs1,064 in fiscal 2009 and Rs1,373 the next year. EPS for fiscal 2008 was pegged at Rs883.
Three months down the road, with the markets crashing, the broker cut its estimates for Sensex companies by 5.5% for fiscal 2008 to Rs834. Part of the reason was the change in the Sensex constituents and part of it was on account of theState Bank of India rights issue. Only 3.1% of the revision was due to earnings cuts. In April, the broker estimated Rs1,002 as EPS of the Sensex firms for fiscal 2009, a 20.1% increase over the estimates for fiscal 2008.
Three months later, with no signs of a market bottom, there hasn’t been any significant revision. With the fiscal 2008 EPS of Sensex companies coming in at Rs839, Motilal Oswal has kept its fiscal 2009 estimate 20.5% higher, at Rs1,011. Fiscal 2010 estimates are now at Rs1,309, which would mean earnings growth is expected to be 29.5%. In other words, while the base is now lower, because the fiscal 2008 EPS was lower than the estimate made in January, the rates of growth are more or less intact.
The prediction seems to be that profits may rebound, despite the adverse external circumstances. As the brokerage puts it, “Despite all the concerns…our bottom-up compilation of aggregate earnings do not show any evidence of slowdown.”
The estimates for the June quarter show that for the universe of 143 stocks covered by their firm, it’s expecting a net profit growth of just 8.5% in the quarter. But its annual estimates for these 143 companies put fiscal 2009 net profit growth at 14.9%. It is true that the first quarter is a seasonally weak period, but there’s an underlying assumption that growth will pick up in later quarters. That is true of estimates by several other brokers. In spite of high inflation, a credit crunch and weakening growth, they continue to remain optimistic.
Perhaps it’s just a matter of time. A Citigroup Inc. report on Asia excluding Japan says that at the start of the year, the “consensus forecast was for EPS growth of 10.8%. As of mid-June, that had fallen to just 6.7%. Our view is that EPS growth rates have a long way to go before they bottom”.
According to the Motilal Oswal report, “Our Sensex EPS estimate for FY08 was upgraded from Rs810 in December 2006 to Rs846 in June 2007 to Rs883 in December 2007. Similarly, our Sensex EPS estimate for FY09 was revised from Rs891 in December 2006 to Rs955 in June 2007 to Rs1,064 in December 2007.”
Will the downward revisions be as rapid as the upward ones?
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