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HCC: Working capital concern looms large
May 2, 2011

Hindustan Construction Company (HCC) has announced fourth quarter results of financial year 2010-2011 (4QFY11). The company has reported 10.8% YoY growth in sales. However, net profits declined by 47.4% YoY during the quarter. Here is our analysis of the results.

Performance summary
  • Top line registered a growth of 10.8% YoY during 4QFY11.
  • Operating profits increase 35.1% YoY in 4QFY11 due to healthy top-line growth and modest rise in operating expenses.
  • Net profits decline 47.4% YoY in 4QFY11 due to increase in interest expenses, depreciation and tax outgo during the quarter.
  • The company paid a dividend of Rs 0.4 during the quarter.

Standalone financial snapshot
(Rs m) 4QFY10 4QFY11 Change FY10 FY11 Change
Income from operations  10,850 12,021 10.8% 36,292 40,907 12.7%
Expenditure  9,620 10,359 7.7% 32,013 35,534 11.0%
Operating profit (EBDITA) 1,230 1,662 35.1% 4,279 5,373 25.6%
Operating profit margin (%) 11.3% 13.8%   11.8% 13.1%  
Other income 42 134 220.6% 130 170 30.5%
Interest 443 903 103.8% 2052 2,899 41.3%
Depreciation 201 440 118.4% 1139 1,527 34.0%
Profit before tax 628 454 -27.7% 1,218 1,117 -8.3%
Tax 198 228 15.0% 404 407 0.7%
Profit after tax/(loss) 430 226 -47.4% 814 710 -12.8%
Net profit margin (%) 4.0% 1.9%   2.2% 1.7%  
No. of shares (m)         606.6  
Basic earnings per share (Rs)          1.17  
P/E ratio (x) *         29.9  
* On trailing 12 month basis

What has driven performance in 4QFY11?
  • HCC's top line increased 10.8% YoY during 4QFY11; owing to an improvement in execution across key projects namely the Kishanganga project and NH-34 road build operate transfer (BOT) project.

  • Operating margins increased to 13.8% in 4QFY11 due to decline in overall expenditure as a percentage of revenues. Construction expenses as a percentage of revenues declined to 43.8% in 4QFY11 from 48.0% in 4QFY10. Improvement in execution led to expansion in margins.

  • The net profits of the company declined 47.4% YoY due to increase in interest and tax expenses. Interest expenses increased due to stretched working capital cycle. Tax rates increased as the entire effect of additional provisioning for the full year due to reinforcement of a new tax law was evident in 4QFY11.

What to expect?
Management categorically stated that the overall macro environment will take some time to improve. Environmental issues/land acquisition delays and ongoing state elections will impact the new project award activity in the near future. However, the situation is likely to improve in 2HFY12. The company has also renewed its focus on working capital reduction as rising debt is risking the profitability growth. However, as claims management is an arbitrary (lengthy) process we do not foresee any immediate improvement in the working capital cycle. Further, rising commodity prices are not helping either. In 4QFY11 improved execution cushioned margins. However, if the commodity prices continue to rise margins could be at risk (over the next six months) as first half is a seasonally weak period for construction companies.

As far as the BOT business is concerned, HCC has invested Rs 6.5 bn in all the BOT assets till now and has plans to invest Rs 4 bn over the next year. With respect to Lavasa, the situation remains status quo. The company has already filed a petition in order to get the fresh clearance for 2,000 hectares and the matter is in court as of now.

Despite concerns pertaining to the core construction business in general and Lavasa in particular we believe that the stock offers reasonable margin of safety for investors at current levels. As a result we maintain our view on the stock.

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