Patel Engineering Ltd’s shares have risen about 150% in less than five months, a period when the growth in its core construction business has been far from exciting.
In the October-December quarter, revenues grew just 11.8% over the September quarter, while operating profit rose just 6.4% sequentially. According to an analyst tracking the sector, the December quarter is a seasonally strong one, and hence the quarter-over-quarter growth is disappointing. Operating margin fell by about 80 basis points on a sequential basis. Worse still, the order book position rose by just 2% over the previous quarter and by less than 15% over the year-ago December quarter.
Considering that the shares now trade at over 40 times trailing earnings, the growth in both earnings and order seems hardly exciting. But note that the recent rise in the company’s valuation has more to do with the ‘unlocking’ of value of the company’s real estate investments. Enam Securities values the company’s real estate holdings at Rs591 per share, which is over 60% of the firm’s current value. Another brokerage put a value of Rs274 per share for the Patel Engineering’s real estate. Even the mean of Rs432 per share accounts for a sizeable chunk of the firm’s valuation. Besides, analysts have assigned sizeable values to the company’s independent power projects which aren’t yet contributing to earnings. Adjusted for these ‘embedded assets’, the valuation of the core business seems reasonable. But then, with both the real estate and the power projects, the markets are discounting cash flows way into the future. As of now, the company is developing just 12% of its total land holding. Unless the company announces something concrete and substantial about the development of its real estate, the recent rally in the company’s shares may be pre-mature.
ABG Shipyard Ltd’s net profits rose 61% in the December quarter to Rs71.66 crore, compared with the year-ago period, while net sales growth was 55%. Operating margins were sustained at a high 29.6% and growth in operating profits was also 55%. Both revenue and profit growth have been the highest in several quarters.
The stock has gone up more than threefold in the last one year and there are several reasons for the re-rating. Being the country’s largest private sector shipbuilder, ABG Shipyard has been a big beneficiary of the growing realization that India has a competitive advantage in the labour-intensive business of shipbuilding. Orders, including several repeat orders, have been pouring in thick and fast and, currently, the company has firm orders in hand for the next three years or so. That’s a big comfort, providing much-needed visibility in a notoriously cyclical industry. Analysts point out, however, that the current cycle is still very firm, because shipbuilders in 2008 will start to make ships whose orders had been placed back in 2006 at high prices. That’s also the reason why they remain optimistic on margins, despite concerns about higher steel prices. Moreover, given the low costs of India’s shipbuilding industry, expansion is also likely to be faster.
ABG Shipyard has moved rapidly to take advantage of these trends, lining up a string of expansion plans. The company has also acquired the Vipul shipyard, which it plans to expand. It also has plans a new shipyard at Surat for larger ships. The yard at Dahej is expected to be operational by April this year, while a yard for building rigs should be completed by the end of the year. The company is also getting into the high-margin ship repairing business, with its acquisition of Western India shipyard. Clearly, ABG Shipyard’s rapid growth is assured, in spite of the likelihood of a reduction of the shipbuilding subsidy.
At around Rs960, the stock is trading at about 17.3 times FY09 estimated earnings. The company is expected to grow earnings sharply once the expansion kicks in, but the $200 million QIP issue, which is expected to dilute earnings by 7-8%, has been the trigger for some profit-taking in the stock.
If one wanted further proof that India’s leading market indices, Sensex and Nifty, don’t accurately reflect the underlying market, they need to look no further than the advance-declines ratio on Tuesday. Over 81% of the 2,922 stocks that traded on the BSE declined, but based on the Sensex and the Nifty, the markets gained marginally. The best representative indices on Tuesday were the BSE-500 and the S&P CNX 500, which declined 0.9% and 0.7%, respectively. True, a number of stocks comprising these indices may not be considered extremely liquid, but then a good alternative to gauge market movement would be an index that includes the top 100 or 200 stocks, rather than being stuck with ones that have just 30.
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