Things to watch out for in Infrastructure cos.

It's a well known fact that India is grossly under invested in infrastructure. In a move to bolster infrastructure investments in the country and enable higher economic growth, the government plans to double infrastructure spending to US$ 1 trillion in the 12th five year plan. Around 50% of the investment is expected to come from the private sector. This presents vast opportunities for the companies engaged in construction and infrastructure development in India. There is no doubt the sector will continue to remain preferred investment bet for investors over the longer term excluding near term execution concerns. If one wants to play the India story then exposure to the construction space is inevitable. But as there are plenty of companies listed on the Indian bourses, cherry picking is a difficult task. In this article, we try to decode key aspects of the construction companies that could possibly aid investors in selective stock picking.

• Book to bill ratio: Book to bill ratio is the ratio of orders taken to invoices sent (sales) during a set period of time. A high ratio indicates a strong order backlog that should generate sales and profits in future periods while a low ratio indicates falling demand. It is one of the most important measures used to analyze the health of construction companies. Thus higher the ratio better it is.
  Book to bill ratio: Order backlog / Sales

  Book to Bill Ratio	FY06	FY07	FY08	FY09
  IVRCL Infrastructure	4.5	3.1	3.3	2.8
  Nagarjuna Construction	2.9	2.5	3.3	2.9
  Hindustan Construction	4.9	3.9	3.3	4.9

  Book to bill ratio of select construction companies
  
• Investment in subsidiaries: Over the last few years, infrastructure companies have typically increased their investments in subsidiary companies. These subsidiaries or SPVs undertake BOT projects on the parent's behalf thereby presenting a leaner holding structure. Investment in subsidiaries will not be generating incremental returns to shareholders at least in the near term as BOT projects require huge upfront construction cost (with back loaded returns spread over the concession period) and have long gestation period. This depresses initial RoE. Hence, investments have to be adjusted to give a true picture about the RoE.
  Adjusted RoE = PAT/(Net worth - Investments)

  Investments as % of Capital Employed	FY06	FY07	FY08	FY09
  IVRCL Infrastructure	24%	15%	13%	12%
  Nagarjuna Construction	6%	28%	23%	25%
  Hindustan Construction	6%	9%	10%	11%

  Investments as a proportion of capital employed of select construction companies
• Working capital cycle: Infrastructure is a working capital intensive business due to higher share of government contracts in the overall project portfolio. The projects have a high gestation period further prolonging the overall cycle. Higher working capital denotes extension of interest free loans with no incremental returns. Hence, companies that manage their working capital cycle better are preferred bets.
  Working capital Cycle: Working capital/Net sales*365

  Working capital cycle (Days)	FY06	FY07	FY08	FY09
  IVRCL Infrastructure	122	179	179	164
  Nagarjuna Construction	168	68	121	139
  Hindustan Construction	77	187	164	192

  Working capital cycle of select construction companies

• High Debt/Equity ratios: The construction companies typically have leveraged balance sheets. Majority of the debt is taken to fund working capital requirements (sharp contrast to other industries where debt is used to finance capex). This debt is of short term in nature. Construction companies also use the debt raised to finance BOT projects. (BOT projects typically have a debt/equity ratio of 2:1).
  Debt/Equity ratios of select construction companies

  D/E Ratio (Consolidated)	FY06	FY07	FY08	FY09
  IVRCL Infrastructure	1	0.5	0.6	0.7
  Nagarjuna Construction	0.2	0.8	1	1.6
  Hindustan Construction	1.4	2.2	2.9	4.6

• BOT & Real Estate Projects: Apart from a few exceptions, most of the construction companies have a large portfolio of BOT and real estate projects. Under the classic BOT project mechanism, the company typically builds, operates and then ultimately transfers the project to the contactor (government in most cases) after the expiry of the concession period. Majority of the road projects awarded by NHAI are on BOT basis. Construction companies are also engaged in development of various real estate projects. Diversification into related businesses provide significant value unlocking potential.
  List of BOT projects of select construction companies/

  Particulars	Road BOT Projects	Water BOT projects	Power BOT projects	Miscellaneous	Total
  IVRCL Infrastructure	7	2	0	1	10
  Nagarjuna Construction	5	0	3		8
  Hindustan Construction	4	0	0	0	4