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Pre earnings analysis - Construction pack

Jul 8, 2010

First quarter results for this fiscal are just around the corner. We hereby present a short write up on how this quarter should pan out for the construction universe companies as a whole. Due to the general economic slowdown, construction companies had seen their growth rates topple down during the past couple of years. However, 4Q FY10 came as a positive surprise. At Rs 922.9 bn, the construction sector registered the highest ever order backlog recorded in any quarter till date.

Following is the list of order back log and growth rates for the construction companies over the past few quarters.

Quarter ended Order Book (Rs bn) Q-o-Q growth
4Q FY08 553.0 57%
1Q FY09 467.0 -16%
2Q FY09 605.8 30%
3Q FY09 438.6 -28%
4Q FY09 441.5 1%
1Q FY10 337.2 -24%
2Q FY10 747.7 122%
3Q FY10 432.2 -42%
4Q FY10 922.9 114%
Source: Business Standard

A look at the above table suggests that the concerns persisting with respect to order backlog have started easing off. Although the trend suggests a quarter of negative growth followed by a positive one it should be noted that the last quarter's order back log is at a historical high. Further, we believe the party is not over as yet. With government taking steps in the right direction one can expect to see a lot of action especially in the road and power sector in the upcoming quarters.

First quarter is traditionally the weakest quarter for the companies as construction activity literally comes to a standstill during monsoons. As a result, we do not expect a lot of fireworks in 1Q FY11. However, it should be noted that on a y-o-y basis, majority of companies should report revenue growth in high double digits due to low base effect coupled with strong order inflow recorded in the last quarter.

Margins are likely to witness a marginal improvement of 20-30 bps in this quarter as steel and crude oil prices have remained soft due to weak global demand. Even cement prices have remained southbound due to commissioning of large capacities. However, interest cost is likely to increase with government raising rates recently to control inflation. But the entire impact is likely to be visible in the next quarter as rate increase came into the effect at the end of 1Q FY11.

We believe FY11 could be one of the best years for the construction universe if the companies manage to execute the projects as perceived. Favorable business environment may lead management to revise their guidance on the upside.

Considering the recent developments we believe that the construction pack is ripe for re-rating. The construction stocks have already outperformed the broader markets in the recent past. However, given the strong order book position and long term positive outlook, we believe there are quite a few opportunities in the construction space for a medium to long-term investor even after the recent run up.

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