Small is beautiful

It’s a study in contrast, if one were to look at infrastructure stocks. Of the 198 listed infrastructure companies, the behemoths continue to be out of favour, while the Street seems to be taking fancy to small- and mid-sized companies. 

Vibhor Singhal, who tracks the sector at PhillipCapital, says, “The market is no longer rewarding companies with a huge order-book unless they have a strong balance sheet. This is also why small- and mid-cap companies with good balance sheets are bagging fresh orders as the bigger players, due to their weak low cash flow, are staying away from fresh bids.”

Leading infra names such as GMR Infra, GVK, JP Associates, Gammon India, Lanco Infra, Punj Lloyd, and Reliance Infra have, on an average, eroded 44% of their market cap over the past three years. This is against the 500% return generated by small- and mid-cap companies such as Sadbhav Engineering, NCC, ITD Cementation, Gayatri Projects, KNR Construction, J Kumar Infra, and IRB Infra. Even on a YTD basis, with average negative 2% share price return, the smaller companies have significantly outperformed the larger ones who on an average lost 37% in this period.

One big reason for the big shift is the continued indebtedness of the larger peers. In fact, given that many of the bigger players are having a negative net worth, they are not even able to service debt. To put it in perspective, on an average the larger peers have an interest coverage ratio of 0.3x against 2.67x for small- and mid-size companies.

Construction is a working capital-intensive business. Even the most efficient players such as J Kumar, NCC and KNR Construction have got a working capital ratio of 150-200 days, which means they need funding for that long to execute projects. Main developers are finding it difficult to raise fresh debt because of a highly leveraged balance sheet. 

That apart, the bigger companies are also facing challenges in building up equity as a large part of the cash generated from the business goes into making payment of interest and installment of loans. In FY16, JP Associates' income before interest at ₹4,708 crore was not even enough to cover interest cost of ₹7,618 crore. After paying the financers, it actually reported a negative cash flow. This is where the mid-sized players are benefitting. 

Once a domain of larger players, several of Mumbai Metro projects were won by J Kumar Infraprojects and NCC. J Kumar, with an order-book of close to ₹10,000 crore, has an order book to bill ratio of 7x, the highest in the industry. Last year in FY16, the company made a cash profit of ₹150 crore, indicating that the company has enough leeway in terms of managing its growth. NCC, too, saw a 133% jump in its order inflows led by lower competition and reduction in leverage from 1.42x debt to equity in FY14 to 1x in FY16.

"NCC is one of the few construction companies to have managed a successful turnaround in its balance sheet. Post that, its order inflows have started to improve which sets it up for a pick-up in revenues from FY18 onwards. Valuations post correction are very attractive at 11.5x for 40% earnings CAGR over the FY16-18 period," mentions Inderjeet Singh Bhatia, who tracks the company at Macquarie Capital 

KNR Construction, which has a market cap of ₹2,178 crore, has a debt to equity of less than 0.1x and interest coverage ratio of 11x. Given its light balance sheet and strong execution, it has grabbed more orders. To put it in perspective, the company is sitting on an order book to sales of close to 4x, ensuring strong earnings visibility. 

Despite asset sales, most larger players are still stuck with humongous debt. “This is a vicious cycle and most of these large players will be stuck for at least another two to three years. They will have to cut debt substantially and raise equity to reach a point where they can grab new business,” feels Singhal.

In other words, for now, the mid- and small-sized infra firms will continue to rule the roost.