NBCC: Will performance justify rich valuation?
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Public sector unit NBCC (India) Ltd’s offer for sale made a strong beginning on Thursday, with about 1.5 times subscription by institutional investors for 72 million shares. On Friday, retail investors will get an opportunity to lap up the balance 18 million shares, thereby completing the 15% equity divestment by the firm.
What catches attention is that the floor price of Rs246.50 per share discounts the fiscal year 2018’s estimated earnings per share by around 30 times.
Justifying the rich valuation is the firm’s business model, which is unique in many ways.
Firstly, the revenue stream is mainly from project management consultancy contracts for government projects. So, with the commitment to boost infrastructure, NBCC’s prospects are bright with a vast canvas of orders coming its way through the planned smart cities, railways, affordable housing, and redevelopment of urban infrastructure and maintenance.
This is already visible from the firm’s burgeoning order book of Rs70,000 crore (FY16) that the Street estimates will touch Rs80,000 crore by FY17—almost 12 times its annual revenue!
This is not all. Being largely a consulting firm, NBCC is debt-free as it operates on customer advances and gets the job done by contracting companies. Further, its efficiency is mirrored in the robust double-digit growth in revenue over the last couple of years. Return on equity, therefore, is gratifying for the investor.
But there are downsides too. NBCC operates on wafer-thin operating margin, which has been erratic over the last two years. Despite the huge order book, the revenue ramp -up hinges on efficient outsourcing. Also, infrastructure and mainly redevelopment projects run the risk of clearances, which could upset the apple cart of stable revenue. If this happens, profitability will dip from already thin levels.
In fact, NBCC’s June quarter performance missed the Street’s forecast, with operating margin on business income contracting to 2.1%. In its note, Reliance Securities Ltd cut its earnings estimate by 7% and 2% for FY17 and FY18, respectively, to factor in low revenue booking and margin moderation.
That said, the positives outweigh the uncertainties. Any change in the bullish sentiment of a 20-25% growth in earnings over the next two years will depend on the FY17 full-year performance.