Infrastructure firms’ margins may show pressure in Dec quarter

Infrastructure firms’ margins may show pressure in Dec quarter

It’s well known that the second half (H2) of a fiscal year tends to be stronger for infrastructure firms. Normally, firms in the sector book round three-fifths of annual revenues in H2 of a fiscal. A reason is because construction activity picks up after the monsoon are over. In keeping with that, on a broad basis, infrastructure firms should post comparatively better revenues in the December quarter than the September quarter.

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“We expect 3QFY11 revenue growth of 13% y-o-y against 1.3% in 2QFY11. Execution in 2QFY11 was impacted by slow progress on large projects and an extended monsoon," wrote Motilal Oswal Securities Ltd analysts in their December quarter preview. The brokerage firm has five infrastructure firms in its coverage.

While that’s good, whether infrastructure firms would be able to perform well at the net level is the key question. Unfortunately, there are some concerns on that front. Profitability of these firms is expected to be under pressure in the December quarter.

Blame higher interest costs and pressure on operating profit margins for that. Increasing interest rates have led to a rise in interest costs. Also, overall debt levels are rising due to higher working capital requirement.

Analysts expect earnings before interest, tax, depreciation and amortization margins to be under pressure due to rising commodity prices and relatively high proportion of low margin projects.

In the space, analysts expect Nagarjuna Construction Co. Ltd to perform relatively better, helped by limited order book exposure to Andhra Pradesh and diversified order book. Even as revenue growth is expected to be good for IRB Infrastructure Developers Ltd, margins are expected to fall due to higher contribution from the lower margin construction and EPC business.

“We project IVRCL Infrastructures and Projects Ltd to clock revenue growth of about 17.8% y-o-y for December 2010 quarter to Rs1,391 crore as against management guidance of Rs1,500-1,600 crore, primarily on the back of the slow-moving irrigation and road projects," wrote analysts from Angel Broking Ltd in their December quarter preview.

Infrastructure stocks have been underperformers since the beginning of this fiscal, mainly on account of slower order inflows and execution concerns. Valuations are attractive at the current levels, but higher commodity prices and rising interest rates are key concerns that investors should watch out for.