More pain in store for infrastructure firms

More pain in store for infrastructure firms

Rising interest costs and inflation have already played havoc on the profitability of infrastructure companies, particularly those in construction. But the September quarter performance could make things worse, barring maybe for Larsen and Toubro Ltd.

Most companies will post the lowest year-on-year (y-o-y) revenue growth in the last eight to 10 quarters—analysts’ consensus is 10-12% growth, which is about half of that registered a year earlier. IVRCL Ltd may clock flat revenue, while some others such as NCC Ltd and Simplex Infrastructures Ltd may post 10-11% revenue growth from a year before. Typically, the second quarter is a weak period for construction firms because of the slow pace of execution during monsoon. But during the quarter, rising costs have played havoc, as the sub-contractors were unable to mobilize work and funds on time.

Lower revenue growth and the overhang of high costs and interest rates that will prevail for a few more quarters could, therefore, squeeze profitability.

A report by Motilal Oswal Securities Ltd says, “While commodity prices corrected from recent peaks, we expect average prices in FY12 (year-to-date) to be higher y-o-y. The average interest cost for construction companies is now 12-12.5%." Further, while some companies intend to raise funds through the equity route, given the current state of markets and the weak balance sheets of the companies, this seems doubtful.

With margins being battered down to 1-3% at the net level, earnings per share are expected to see a decline of anywhere between 40% and 90% for most firms.

Return on equity for most companies is down to single digits and they are trading at a discount to their book value—the only factor that could inspire investment in the sector.

Besides, the quarter could see sluggish order inflows. A few such as IVRCL and NCC may reflect strong order books. The industrial segment, water and irrigation, power and railways have all been rather inactive on the orders front. And the proliferation of mid-sized firms has increased competition that may lead to lower pricing and lower profitability.

The sector is among those that have seen the highest earnings downgrades and drop in valuations. Stock prices have hit rock bottom over the last one year.

One view is that some of the battered-down stocks with credible managements could not get cheaper. But until there are signs of a turnaround in the economy, it may be prudent to steer clear of the sector.