Patel Engineering Ltd. - RESULTS

Results for the quarter ended March’07 were in line with our expectations. Net sales increased by 35.1% to Rs 4910.2 million. EBIDTA for the quarter increased by 49.2% to Rs 608.1 million while EBITDA margins increased YoY by 120 bps to 12.4% majorly on account of change in project mix on a YoY basis. Cost of construction as a percentage of sales declined by 330 bps to 79.3%. However, general & administrative expenses increased by 81.3% to Rs 408.6 million which as a percentage of net sales increased YoY by 210 bps to 8.3%. Other income declined by 30.6% to Rs 23.1 million.
Interest cost for the quarter declined by 9.7% to Rs 92.8 million due to repayment of debt from the IPO proceeds. Depreciation cost was up by 41.3% to Rs 108.1 million. Tax incidence (current+ deffered) increased YoY by 14.7% to Rs 39.7 million, which as a percentage of PBT increased by 300 bps to 13%. This resulted in 53% increase in Profit after tax to Rs 358.2million.

FY07 records healthy growth

FY07 results were in line with our estimation. Net sales for FY07 increased by 30.2% to Rs 13309.7 million while EBITDA margins increased by 60 bps to 13.5%. Interest cost for the period is down by 26% to Rs 193.2 million on account of repayment of debt to the tune of Rs 792.8 million from the IPO proceeds. Depreciation increased by 21.4% to Rs 378 million on increased capex during the period. Tax provisions increased by 119.8% to Rs 144.7 million. PAT for the full year period increased by 51.2% to Rs 1108.7 million.

Order book

The order book of the company as on 31st Mar’07 stands at Rs 50 billion (3.8xFY07 Revenues). Average ticket order size of the company is Rs 2-2.2 bn with an average execution period of about 4 years.The order book of the company grew in excess of Rs 2000 crores (higher than revenues). The company further expects a growth of 40% to 60% in its order book for the next 2 years. The company expects a higher contribution from hydro power projects thereby improving its margins. Going forward, Patel Engineering is moving into Independent Power Producer (IPP) & real estate sectors.

Foray into Independent Power Production

Patel Engineering Ltd. Has entered into an MOU with the Government of Gujarat for 1200 MW Thermal Power Project at Bhavnagar involving a total investment of Rs 50 bn. The project is to be implemented in 3 phases of 400 MW each (400MWx3). The company proposes to take up a strategic partner for Electro Mechanical Works. PEL expects to funds its own equity contribution through internal accruals.

The details of the Project are as follows:

The company is also looking for IPP projects in the Hydro Power segment. Patel Engineering’s foray into IPP’s would result in its going up the value chain thereby increasing the shareholders’ value in the long term.

A wholly owned subsidiary to be formed for Real Estate Business

• The company plans to form wholly owned subsidiary Patel Realities India Ltd. (PRIL) for its real estate ventures.

• The company has a total land bank of 507 acres spread across Mumbai (92 acres), Bangalore (32 acres), Chennai (29 acres) & Hyderabad (354 acres) which it plans to monitise. This would result in significant increase in shareholders’ value. The land bank has been acquired since the 1950’s &
thus the cost of land acquisition is insignificant. At the current market prices we have estimated the land bank at Rs 151 per share.

• The company plans to develop commercial complex, residential complex, IT parks, Corporate Offices, Malls etc. The first phase of development would cover Mumbai (750000 sq.ft of commercial development) & Bangalore (3-5 mn sq ft for development of IT Park & residential complex). First phase is expected to commence in FY08 & revenues there from are expected in FY09-FY10. The second phase would cover Hyderabad & Chennai.

• The company does not intend to raise funds for its real estate subsidiary going forward which according to us is positive for the stock.

Tax at MAT Rate

PEL has continued to provide tax rate at the MAT levels as it claims to be a developer & has filed litigation for the reversal of the order. Total Outflow from FY2000-FY2007 would entail to Rs 270 million. However, taking a conservative estimate we have provided for a cash outflow of Rs 270 million in FY08 & also provided for taxation levels at 33% for future years.

Business Outlook

Increased thrust on infrastructure development especially on transportation, irrigation, water projects and power with Patel Engineering’s impressive track record of executing hydro and irrigation projects gives it a competitive advantage. Further, the company plans to increase the share of hydro projects in its order book and also enter the power generation space and real estate business. We estimate a 28% CAGR increase in net revenues between FY07-09E to Rs 21755.3 million and an increase in EBITDA margins by 50 bps in FY08 & FY09 to 14%. We estimate a PAT of Rs 1224.7 million in FY08E & Rs 1536.4 million in FY09E translating into an EPS of Rs 20.5 & Rs 25.7 respectively.

Valuation

At the current price of Rs 406, the stock quotes at P/E of 20x FY08E and 16xFY09E. We believe the stock to be a good long-term investment in the construction space. We value the business of the company on Sum of the parts method. Looking at the robust business model of the company and good growth prospects in the construction sector we have our target price to Rs. 513 on SOTP method. At current market price of Rs. 406 the PEL stock is trading at a PE multiple of 20x & 16x on FY08E & FY09E earnings. We recommend a BUY with an increased target price at Rs. 513