Prospects of Infra Companies with Strong Orderbook 

Dear Viewers

Have you ever been to an auction event.

I often wonder how a tangible product gets valued so differently by different people.

In fact, it's even more irrational to see the battle of bids, when the same bidder is willing to pay 4x of the original bid he made.

An auction scene is one of the most likely places to see a full range of human emotions on display... pride, excitement, FOMO, overconfidence, herd mentality, and more.

Now you can say that value is in the eyes of beholder.

Certainly, you can't capture in numbers the emotional or prestigious value of Picasso's work or of a rare, signed photo of Mahatma Gandhi.

But what when matters get practical?

For instance, consider an oil company bidding in oil lease auctions.

No sentimental value there. The quantity and the value of the oil are going to be the same for all the bidding participants.

Let's say the real value of the oil in the block is Rs 1 trillion. The bids for this asset start from Rs 500 bn and go upto Rs 2 trillion.

Obviously, the highest bidder wins the lease.

But would it be a real win, considering that the winner paid a price that was double the value he got?

This is the phenomenon of the winner's curse.

The term 'winner's curse' was first addressed in 1950, by engineers of an oil field.

They claimed that year after year, the oil companies were marred by low returns on account of oil lease auctions.

A few decades ago, technology was not so advanced to estimate the potential value of an offshore oil field.

Recently, there was this news that ONGC had cut peak KG basin crude estimate by 40%. I guess the technology is still not advanced.

The contracts are often won by the highest bidder, only to find out that the oil is not worth that much.

It would not be an exaggeration to call it a gamble and a game of probabilities.

But we don't need to go that far in history to understand the implications of a winner's curse.

As India's infra and capex cycle is in a full upswing, this curse could come true for quite a few infra players.

You see, with a strong government capex, it has been raining orders for companies in the manufacturing, construction and infra ecosystem.

Railway, defence, green energy stocks have witnessed a sharp runup as such in the last one year.

Most of these are tender based contracts, marked by intense competition. The winner is often the one who charges the least to get a project done, and is called the L1 bidder.

In other words, of all the bidding participants that are qualified, the winner is the one who is willing to work on the minimum profit margins.

Sometimes, these contracts are on a fixed price basis. Also, they tend to be multiyear contracts.

This means that in case of cost escalations or delays in execution, the winner could also end up incurring losses on the project.

Just as location is the keyword in real estate, it is all about efficient execution for infra companies.

However, many a market participants ignore this basic fact.

Every order win is rewarded with an upper circuit or rating expansion, without enough stress on the company's abilities - and that include ability to execute, to earn decent margins and returns, and to manage finances and cash flows.

Orderbook to marketcap, unfortunately has become the metric to value an infra/construction/manufacturing/EPC company, seducing many inexperienced investors.

The stocks of companies like HPL Electric, Oriental Rail Infra, Om Infra, Texmaco Rail & Engg, and many others have witnessed a 3-4x rise in the last one year. And even at high valuations, they are witnessing investors' interest.

Despite a sharp rise in revenue, their returns ratios on equity and on capital employed leave a lot to be desired, and are poorer than what one may fetch in fixed deposits.

I'm not suggesting a view on the stocks of these companies. This is just a sample of what's happening in many companies at present.

And do note that this is the case at a time when infra theme is doing well. The numbers are likely to look a lot worse in a down cycle.

Let's not forget the lessons from history. In the last capex cycle, IVRCL enjoyed an orderbook to revenue ratio of over 3 times. While it did push the stock price too far, it wasn't for too long. Its fall was sharper and swifter than its rise.

In every capex cycle, there will be companies that will create wealth and become stronger, while others will shrink due to reckless bidding and poor execution.

So next time you get excited about an order win for the company, do pause to reflect on what that might mean for financials and business sustainability.

The managements may be doomed to the winner's curse, but you don't have to end up with buyer's remorse.

With this, I have come to the end of this video. I hope it will help you avoid potential IVRCLs in this capex cycle.

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Thank you for watching. Goodbye.