Comparing companies across the construction space is a difficult task as apart from core construction business, the valuations are predominantly driven by embedded values. Hence, there may be wide differences in earnings multiple across companies, increasing the possibility of assuming the lower multiple business as the best bet. This could prove to be fatal as the overall business might appear cheap (lower multiple one) due to the non-performance of the embedded businesses.
Now, let us first make it clear for our readers what embedded business actually means in the construction industry parlance. Except for the core construction business, any other venture which the construction company undertakes could be deemed as an embedded business. For instance, construction companies have exposure to the real estate and asset ownership space. Asset ownership includes projects undertaken on BOT basis by the company. Sometimes these embedded values have a larger share in the overall business, thus driving valuations. Hence, those factors have to be considered while comparing construction companies.
In this article, we make an effort to compare two leading players in the construction industry: -
IVRCL Infrastructures (IVRCL) and Hindustan Construction Company (HCC). We have shortlisted a few parameters, including the embedded ones to effectively compare the two companies.
The following table displays the EBITDA margins of the two companies over the last five years:-
A cursory look at the table reveals that the EBITDA margins of HCC have been consistently higher than IVRCL. This is mainly due to higher share of hydro power projects in the order book. Hydro power projects typically command higher margins due to the technical nature of the work involved. Thus, in terms of margins HCC scores over IVRCL.
Net Working Capital Cycle
The following table displays the net working capital cycle of the two companies over the last five years:-
|Net Working Capital Cycle
The working capital cycle of HCC has been deteriorating due to higher share of hydro power projects which have long gestation period. Apart from this, the share of government projects in HCC’s overall order book has increased recently. Higher share of government projects can stretch the working capital cycle due to possible delays in payment from government. Although IVRCL has higher share of government projects when compared to HCC its working capital cycle has improved recently due to improving situation in Andhra Pradesh, where most of the finances were blocked until now. Thus, in terms of working capital management, IVRCL scores over HCC.
BOT Asset Portfolio
The following table reveals the BOT asset portfolio of the two companies:-
* 3 stretches in West Bengal are considered one
|BOT Asset Portfolio
|Asset size (Rs bn)
|No of Assets
IVRCL has a much larger BOT asset portfolio. However, in an environment where credit is hard to come by, one needs to look at the funding requirement rather than size. BOT assets typically have a D/E of 70:30. Hence, companies who are yet to tie up debt or infuse equity in BOT assets are vulnerable if the interest rate cycle moves upwards. Further, if the parent is unable to bring in the necessary equity, it will have to dilute the stake and rope in some strategic investor. However, valuations play a key role here. Right now, IVRCL is aggressively looking to raise equity in order to meet the funding requirements of the current projects in hand. Even HCC is looking out for strategic investors to dilute stake at the SPV level. Here, we believe HCC has an edge due to lower number of projects in hand.
Real Estate Exposure
Both the companies have exposure to real estate sector. Although IVRCL owns huge land reserves, it plans to sell off the land bank at appropriate price and exit from the real estate business soon. On the other hand HCC has a huge real estate component. The company plans to create a one its kind hill city in Lavasa. However, the project has been under the environment scanner off late. Thus, HCC’s real estate exposure (embedded value) faces severe execution risk as of now. In this case, we believe IVRCL has a slight edge over HCC.
Thus, comparing the two companies on the above set of parameters reveals an interesting picture. Although the core construction business for both the companies overlaps the embedded values tell a different story, making the comparison difficult.
Since embedded value typically plays a larger role in valuations one has to be careful while selecting any construction company. We typically look out for companies that do not indulge in dilution frequently, undertake sensible bidding (better RoE’s) and have better managed working capital cycle. This reduces the margin of error.