Standing On Strong Foundations

The company which has recently bridged the gap between Bandra and Worli in Mumbai through a 4.7 km long sea link seems to be even bridging the gap between the expectations of its about 1,22,000 investors to their returns on the investments made in the company’s scrip. Till date this year, the company’s scrip has given better returns than both Sensex and BSE Midcap. HCC is up by 83 per cent since January 1, 2009 whereas in the same time period Sensex and BSE 200 have shot up by just 35 per cent and 37 per cent respectively. HCC is an 83-year-old company that claims to be focused in building ‘one of its kinds’ projects in India (including the bridge shown above) and its interest spans from infrastructure to real estate to construction. To focus on each area of the business the company has formed subsidiaries to concentrate on niche segments.

Company Business
HCC’s core area of operation is construction of projects across sectors such as power, irrigation utilities and transportation. To facilitate proper functioning and develop core competitiveness in these areas of operation the company has created five verticals viz. hydro power, nuclear power, water solutions, transportation and EPC (engineering procurement and construction) to execute related projects. Till now the company has constructed 175 road bridges having a combined length of around 46,000 kms. At the end of March 31, 2009 the total order backlog was of the value of Rs 16,400 crore, out of which a major part, up to 51 per cent, was from the power sector, followed by 31 per cent from the water sector. This order book has grown by 61 per cent on a YoY basis and is now 4.6 times its FY09 revenue compared to 3.3 times year ago.
Meanwhile, HCC Infrastructure was formed in FY08 to develop infrastructure projects in the area of transport[PAGE BREAK]

and those developed on a PPP (private public partnership) basis.As of now company has three projects under this division. One of these is the Nirmal BOT (built operate and transfer) project to build a road in Andhra Pradesh. Up to 88 per cent of the project is already complete and is likely to generate revenue from FY10. The second project undertaken by the company is that of a 4.4 km long Badarpur-Faridabad Elevated Expressway (BFTL). The financial closure of the project has been achieved and out of the total estimated cost of Rs 572 crore, the equity component is Rs 172 crore and the balance of Rs 400 crore has been financed through debt. The company’s third project is to build a 98 km highway connecting Dhule with Madhya Pradesh. This project has been awarded in consortium with John Laing of United Kingdom and Sadbhav Engineering. The financial closure of the project is yet to be achieved.  HCC’s real estate venture is led by HCC Real Estate (HREL). Till now company has only one project to its credit – that of 247 Park at Vikroli Mumbai which is to develop 1.8 million sq feet of commercial area spread over three towers. Out of the total area available, the company will occupy 0.18 million sq feet and the rest will be available for lease. The average lease rental in this area as of now is at Rs 70 per sq feet. HREL expects to generate approximately Rs 100 crore of revenue per annum from this project once the total area has been leased out. However, as of now only 50 per cent of the area has been leased. The concerned authorities to answer our query on when will the project be fully operational were not available. One of the most ambitious projects HREL has undertaken is the development of a hill city called Lavasa near Pune. This is spread over an area of 12,500 acres. The company has a plan to develop four towns in Lavasa over the next 12 years at a total cost outlay of Rs 1,40,000 crore. The first in this series is Dasve which is expected to be completely operational by end of 2010. This year (FY09), Lavasa Corporation, the company that is spearheading the project, has booked its maiden revenue to the tune of Rs 212 crore. Out of this total revenue a major chunk was due to sale of land to institutions at an average rate of around Rs 20 lakh per acre. The profit recorded from this project was Rs 123 crore. This project has been able to attract investment from various[PAGE BREAK]

financial institutions such as Axis Bank, Bank of India etc and the latest among them is Indusind Bank which has invested Rs 50 crore. According to back-of-envelope calculations (Rs 531.25 crore invested by various institutions for a 5.3125 per cent stake), the total value of the project works out to be Rs 10,000 crore. At the end of FY09 HCC holds a 64.99 per cent stake with Lavasa Corporation. The company has plan of unlocking the value by selling the shares of Lavasa Corporation to the general public any time at the end of 2010.

Financial Performance And Valuation
For FY09 the company’s sales have grown by just 7.5 per cent on a stand-alone basis and profit grew by 15.2 per cent on a YoY basis. Profit outpaced increase in sales due to an improvement of its EBIDTA margins from 11.9 per cent in FY08 to 13 per cent in FY09. This was mainly due to a reduction in commodity prices and change of project portfolio. Even during the boom years the company’s sales and profit have not moved at an astounding pace. HCC’s revenue has been growing at a compounded rate of 22 per cent in the last four years (between FY05-FY09) and its profit has grown at an even slower pace of 16 per cent.

The company has achieved this sluggish growth in its topline and bottomline despite an increase in its total assets by 44 per cent in the same time period. One of the reasons for its low utilisation of assets is its diversification into a sector such as power which is more capital intensive and calls for a longer gestation period. This has led to a lower fixed asset turnover for the company which declined from 4.5 times in FY06 to 3.18 times in FY09. A major part of its assets has grown due to an increase in its debt portion which grew at a CAGR of 53 per cent. At the end of FY09 the company carried a total debt of Rs 2,321.8 crore which translates into a debt equity ratio of 2.2 times. Out of this total debt, around Rs 450 crore is towards FCCBs which the company issued in FY06 to finance its expansion and working capital requirements. It has a conversion price of Rs 248.08 per share and is to be redeemed by 2011.

The CMP of the company’s share has to move up by more than twice before 2011 to reach its conversion price. This it has to achieve within the next 18 months. If it does not do so, the balance sheet of the company will be adversely affected. The company has two options either it can raise further debt to retire the FCCBs at future[PAGE BREAK]

date or will have to lower the conversion price, both of which will impact the balance sheet. Among the other important financial events of the company, funds were recently raised through QIP to the tune of Rs 480 crore at the rate of Rs 102 by selling 7.3 per cent of the promoters’ equity which brought down their holding to 40 per cent. The fund will be mainly used for its BOT projects and retire some of the high cost debts.

A company like HCC which has three different sources of revenue is valued on the basis of the sum of its total parts. It still derives more than 90 per cent of its revenue from its E&C (engineering and construction) business and if we value it at 16 times PE of FY10E it works out to around Rs 60 per share. If we add the value of Lavasa Corporation at Rs 6,500 crore (HCC has a 64.99 per cent share) and discount it even by 75 per cent, the value per share works out to be around Rs 64. Add to this the value of its IT Park at Vikhroli, the NPV of which is around Rs 10-15 per share. So the absolute value we arrive at is around Rs 145-150 per share. Therefore, our recommendation to investors is to hold or invest in the stock with limited exposure. One big area of cocern us FCCB.