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HCC: The tax axe - Views on News from Equitymaster
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HCC: The tax axe
Apr 28, 2007

Performance Summary
Hindustan Construction Company (HCC) has announced mixed results for the fourth quarter and year ended March 2007. While the topline for the quarter grew by a modest 8% YoY, the company reported a net loss. The dismal performance at the net profit level was mainly on account of the one time adjustment made by the company in the wake of the withdrawal of tax benefits under Section 80 IA. Operating margins during the same period witnessed a contraction of 10 basis points (on a YoY basis) to stand at 8.7%.

Financial snapshot - Standalone numbers
Particulars (Rs m) 4QFY06 4QFY07 Change FY06 FY07 Change
Net Sales 7,681 8,277 7.8% 19,870 23,576 18.7%
Expenditure 7,006 7,555 7.8% 18,041 21,424 18.7%
Operating Profit (EBIDTA) 675 722 7.0% 1,829 2,153 17.7%
EBITDA margin (%) 8.8% 8.7%   9.2% 9.1%  
Other income 8 125 1457.2% 61 199 223.6%
Interest 85 212 149.3% 414 620 49.7%
Depreciation 147 244 66.0% 524 797 51.9%
Profit before tax 451 392 -13.2% 952 935 -1.8%
Extraordinary income/(expense) - - - 400 - -
Tax 25 604 2310.4% 135 811 502.6%
Profit after tax 426 (212) - 1,217 124 -89.8%
Profit from integrated JVs 12 154 1185.8% 31 244 689.0%
Net profit 438 (58)   1,248 368 -70.5%
Net profit margin (%) 5.7% -0.7%   6.3% 1.6%  
No. of Shares (m)         256.2  
Diluted earnings per share (Rs)         1.4  
Price to earnings ratio (x)         68.3  

What is the company’s business?
Established in 1926 by Walchand Hirachand Group, HCC is one of the largest and oldest private sector construction companies in India. The company has been involved in the construction of diverse projects ranging from power dams, highways and bridges to marine structures, water supply, factories and waste treatment plant. Apart from the domestic presence, HCC has executed several projects overseas in countries like Iraq, Nepal and Tanzania. Towards this, the company has entered into a number of technical collaborations as well as joint ventures with overseas players, bringing the latest technical know-how into the execution of its projects.

What has driven performance in FY07?
HCC has reported an 8%YoY and 19%YoY growth in topline for 4QFY07 and FY07 respectively. As per the management, this lackluster performance in sales was mainly on account of the heavy mobilisation undertaken by the company for its power related projects. Power projects continue to dominate the company’s order book, accounting for 48% of the same. HCC expects these projects to start contributing to revenues from this fiscal. As on 31st March 2007, the company’s order backlog stood at Rs 93 bn, about 4 times its FY07 sales.

Order book composition (%)
Segments FY04 FY05 FY06 FY07
Power 23 14 38 48
Transportation 38 38 43 40
Water supply & Irrigation 25 37 15 8
Others 14 12 4 3
Source: Company

Operating margins remain stable: HCC’s operating margins for the quarter stood at 8.7%, compared to 8.8% in 4QFY06. Construction expenses and material consumed, together, as a percentage of sales, declined from 83.3% in 4QFY06 to 79.5% in 4QFY07. However, given the acute talent crunch faced by the industry, staff cost as a percentage of sales increased to 7.4% in 4QFY07 (4.9% in 4QFY06). It should however be noted that the operating margins for the company would actually be higher (at around 12%), as expenses include the losses written off the by company from the Bandra-Worli sea project (to the tune of Rs 710 m in FY07).

Cost breakup
as a % of sales 4QFY06 4QFY07 FY06 FY07
Construction expenses 37.3% 48.4% 37.1% 46.5%
Materials consumed 45.9% 31.2% 43.4% 31.4%
Staff cost 4.9% 7.4% 6.6% 8.9%
Other expenditure 3.0% 4.3% 3.6% 4.1%

Withdrawal of tax benefits roils bottomline: The withdrawal of tax benefits (with retrospective effect since 2001) under Section 80IA has been a big negative for the construction companies. HCC has provided a tax provision of Rs 604 m for the quarter, which includes Rs 425 m of tax liability for prior periods. Due to this one time adjustment relating to taxes, the company reported a loss to the tune of Rs 58 m in 4QFY07, compared to a profit of Rs 438 m in the year ago period. As mentioned earlier, the company made significant capital investments (Rs 3.8 bn) during the year, especially towards the mobilisation of power projects. As a result, depreciation and interest expense registered a significant jump on a YoY basis. The other income for the quarter, however, increased from Rs 8 m in 4QFY06 to Rs 125 m in 4QFY07. This was mainly on account of the foreign exchange gains booked by the company in relation to the FCCBs.

HCC's real estate portfolio
Project Acres Msqft.
Lavasa (Pune) 12,500 150
Vikhroli West (Corporate Park) 11 2
Residentail project in Mumbai 10 1
Vikhroli East 15 1
Township In MMR* 200 6
Township in new Mumbai 250 3
SEZ/Township in Nashik 1,000 20
Township in Pune 300 6
Total 14,286 189
Source: Company
*Mumbai Metropolitan Region

What to expect?
At the current market price of Rs 99, the stock is trading times at 31.7 times its FY07 earnings (adjusted for the one time tax write off pertaining to earlier years). After a year of lackluster performance, HCC expects to register better financial performance going forward, primarily driven by its power division. The company also expects its real estate projects to start contributing from FY09 onwards. Besides, the company is also looking at bidding for BOT (build-operate-transfer) projects (both in the transport as well as the power space). HCC has been awarded an annuity road project (its solitary BOT project) of 30 Kms stretch in Andhra Pradesh with a project cost of Rs 2.7 bn. The company had recently raised Rs 10 bn through GDR and FCCB issue. The company expects to do a capex of around Rs 2 bn in FY08, which includes investments in its real estate projects.

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