The growth rate in the construction sector seems worrisome, pointing to a dim outlook for fiscal 2012 (FY12). Even as India’s gross domestic product (GDP) growth for the first quarter was the weakest in six quarters, the construction sector was the worst performer, growing at 1.2%, against 8.2% in the March quarter and 7.7% a year ago. This was a sudden and sharp drop, because the construction segment was among the fastest growing sectors until the March quarter.
A data analysis of listed construction firms indicates that the overall performance peaked for the sector in FY08. Growth rate in aggregate net sales steadily declined (see the table) from 34.4% in FY09 to 15.8% and 6.8% in FY10 and FY11, respectively. What’s more, both operating and net profit growth also declined. In fact, for FY11, the aggregate operating profit fell 4.7% and net profit by 27.7%.
Performance deteriorated further in the June quarter. Frontline firms such as IVRCL Ltd and Hindustan Construction Co. Ltd registered a steep fall in net profit, 85% and 84%, respectively. This column had earlier given reasons for this—delays in clearances and land acquisition, cost inflation and a rising interest rate regime, all of which together choked the sector. Operating profit margins took a beating.
The only positive, however, is that the order book position, which has been the benchmark for forward valuations of a construction firm, is no longer a key concern. Despite a slowdown in order inflows in the June quarter, most construction firms have a healthy order book of about 2.5xFY11 revenue. A Crisil Research report expects construction investment to grow 13% to Rs 14.8 trillion over 2012-16, driven by roads, power and urban infrastructure segments. It also states that these investments will be on the fast track by FY14, when elections draw closer.
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The valuation focus has now shifted to profitability. Earnings and not the order book will drive valuations of companies that manage their balance sheet well through these tough quarters. They are likely to attract better valuations on the bourse.
Mint data also shows that at the aggregate level, the interest cost as a percentage of sales in FY11 at 6.7% was the highest since FY05—a key reason that has hit net profit in the last six quarters. This trend is likely to continue in the next couple of quarters even if the rate cycle peaks.
The Crisil report, therefore, adds, “We expect earnings pressure to continue in FY12 as execution hurdles, coupled with elongated working capital cycle and rising interest costs, will be a dampener.”
Graphic by Sandeep Bhatnagar/Mint
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