Shares of mid-sized construction company Sadbhav Engineering Ltd have been trending downward since April. This was very likely due to the increase in debt on its books in the last six months, and the lull due to demonetisation and implementation of the goods and services tax (GST), which led to a slowdown in execution until the March quarter.
But the situation has improved since then. The company staged a comeback in performance in the June quarter. Importantly, through the last two quarters, order flows have been robust. June quarter order inflows at Rs1,755 crore have taken the order book up to Rs8,377 crore—a comfortable 2.5 times its annual revenue. A key plus point is that Sadbhav Engineering has been getting a large share of road projects tendered under the new hybrid annuity model (HAM) too.
In fact, HAM projects now contribute 15% to revenue. Mobilization advances from these projects improved working capital for the company and reduced debt on its books too. Net debt during the June quarter therefore fell to Rs1,450 crore from Rs1,800 crore in the preceding quarter.
In the quarters ahead, Sadbhav Engineering’s debt is likely to drop further, which will ease its interest burden too. This is good news for investors. At present, what sticks out like a sore thumb in otherwise attractive financial results is the 87% jump in interest costs. This is perhaps one reason why the stock lost steam after the results were announced.
High interest cost is the bane of most construction and realty firms. Working capital management is important to ensure revenue translates into strong profits. A report by HDFC Securities Ltd adds that debt is likely to come down further in the latter part of fiscal year 2018 (FY18), when irrigation and Metro projects are completed and fresh mobilization advance comes in through the HAM projects.
This apart, another positive is that the share of roads in orders and revenue is increasing—a healthy trend as they are more reliable in timelines compared to the orders from mining and irrigation, which are erratic. Within roads, the higher share of engineering, procurement and construction orders at 65% of revenue in the June quarter compared to 55% a year back, should improve profit margins too.
Sadbhav Engineering also scores in timely execution of projects. June quarter net revenue rose by 17% to Rs944.5 crore year-on-year. This brought in benefits of operating leverage. Raw material cost as a percentage of sales dropped by 330 basis points from a year ago, while other cost tapered too. Operating profit rose by 23% year-on-year to Rs1,068 crore. Margins improved too, albeit slightly.
Although the stock has not reacted to a good June quarter performance, higher revenue from HAM projects should sustain earnings recovery. Also, fresh orders normally trigger upward movement in stock prices of infrastructure firms. In this context, analysts forecast an 18-20% growth in Sadbhav Engineering’s order flows until FY19, which would largely come from roads.