Earnings will drive construction firms' valuations: Crisil

Last Updated: Mon, Sep 05, 2011 20:00 hrs

Shares of construction companies were the toast of the stock market when the going was good. The recent past, however, has seen these counters losing flavour with investors across categories. In its latest report, Crisil Research has said earnings, and not order book, will drive the valuations of Indian construction companies.

“Though most companies have a healthy order book, valuations have taken a beating due to muted earnings growth, mainly due to execution hurdles, hardening interest rates and stretched working capital cycle,” says Crisil in a report released on Monday.

Crisil Research has coverage on ARSS Infrastructure Projects, C&C Construction Ltd, Era Infra Engineering, Marg and MBL Infrastructure. Of these, ARSS, Marg and MBL have a valuation grade of 5/5, indicating a strong upside (more than 25 per cent from current market price); C&C and Era have a valuation grade of 4/5, indicating an upside (10-25 per cent from current market price).

In the past year, construction stocks have significantly underperformed when compared to benchmark indices. While the S&P CNX Nifty of the National Stock Exchange (NSE) has lost around eight per cent, these stocks have given negative returns of 55 per cent.

While some of the above mentioned concerns may continue to plague the industry in the near term, the research entity is of the view that at current valuations, which are at historical lows, the risk-reward ratio appears favourable, given the growth potential of the sector.

Construction companies clocked an impressive growth of around 60 per cent during the period between 2004-05 and 2007-08, which fell to a paltry two per cent during from 2007-08 to 2010-11 due to weak margins and high interest costs. Crisil expects earnings pressure to continue to cloud 2011-12 due to execution hurdles and high interest, but believes all is not lost.

“The silver lining — order awards and execution issues — have started showing signs of easing in the second quarter of 2011-12 and companies have a healthy order book of 2.5x 2010-11 revenues, which provides good revenue visibility and interest rates are expected to peak in the near term,” says the report.

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