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HCC: Dismal performance continues

Aug 1, 2012

Hindustan Construction Company (HCC) announced its results for the quarter ended June 2012. During 1QFY13, net sales declined by 8% YoY. At the net level, the company reported a loss of Rs 310 m. Here is our analysis of the results.

Performance summary
  • Standalone revenues decline by 8% YoY during 1QFY13 seemingly on the back of slower execution and a slowdown in order-inflows.
  • Operating profits declined by 51% YoY during the quarter due to higher construction expenses and cost of materials (as a percentage of sales).
  • The company reported a net loss of Rs 310 m during the quarter.
  • Order book at the end of the quarter stood at Rs 150.2 bn (Rs 153.4 bn at the end of 4QFY12). The company is believed to be L1 in orders worth Rs 34.3 bn (Rs 17.1 bn in 4QFY12).

Standalone financial snapshot
(Rs m) 1QFY12 1QFY13 Change
Income from operations 10,579 9,694 -8.4%
Expenditure 9,168 9,004 -1.8%
Operating profit (EBDITA) 1,411 691 -51.0%
Operating profit margin (%) 13.3% 7.1%  
Other income 185 251 35.8%
Interest 1,147 1,282 11.8%
Depreciation 392 405 3.3%
Exchange gain/ (loss) 5 209 4080.0%
Exceptional items - 95  
Profit before tax 61 (442)  
Tax 33 (132)  
Profit after tax/(loss) 29 (310)  
Net profit margin (%) 0.3% -3.2%  
No. of shares (m) 606.5 606.6  
Basic & diluted earnings per share (Rs)    0.0  
P/E ratio (x) *   NM  
* On a trailing 12-months basis

What has driven performance in 1QFY13?
  • HCC's revenues declined by 8.4% YoY during 1QFY13. Lower revenues are seemingly on the back of the execution issues being faced by the company, coupled with the slowdown in order booking over time. At the end of the quarter, the company's order book backlog stood at Rs 150.2 bn as compared to Rs 181.3 bn at the end of FY11 i.e. March 2011. The company has seen a substantial slowdown in the hydro power sector which forms around 38% of the total order book, over the last year. HCC's management attributed the current dull environment to the overall slowdown in addition to the delays in decision making as well as delays in awarding environment clearances by government.

  • HCC's operating performance continued to be under pressure during 1QFY13 as operating profits more than halved during the quarter. Expenses decreased at a slower pace as compared to the decline in revenues. While the company was able to keep its employee and other expenses under control, its variable costs - construction and cost of materials consumed - increased significantly (as a percentage of sales). During the preceding quarter, the company had reported margins at similar levels and had attributed the lumpy nature of the business as the reason for the same.

  • HCC reported a loss of Rs 310 m during the quarter. Apart from a poor operating performance higher interest outgo led the company's profits to dip in to the red territory at the PBT level itself. Interest costs increase by 12% YoY.

What to expect?
The dullness surrounding the infrastructure sector in general and HCC in particular has been going on for a while now. We expect HCC to continue to go through tough times in the near future as well. This is on account of various reasons with the primary one being the profitability of the standalone core engineering and construction business. We believe so, because of the long term declining trend in the order book. If this continues, the only way the company will be able to report flat/ grow revenues is by executing orders at a faster pace. Given the lower backlog, that may be a possibility. But for the same to happen in the future, the execution rate needs to be improved substantially, which we believe is a difficult task. The management however expects to clock a revenue growth of 5% to 10% during the current year.

Also, HCC's management seems to be relying heavily on developments which are out of its control (such as reforms and government actions and policies) in order to improve the business performance. While the company is doing its best to cut costs, the fact of the matter is that there is only a limited amount that the company can do. In a recent interview, the company's management had stated that it is targeting margins in the range of 10-11% for the full year. A reason for expecting the same was lower other expenses, namely - employee costs and other expenses. In absolute terms, the company has done well to keep costs under control. As compared to an average employee expense of Rs 1,045 m during each quarter in the past four years, employee expenses during the quarter ended June 2012 stood at Rs 945 m. As for other expenses - the same stood at Rs 218 m during 1QFY13 as compared to an average of Rs 380 m during the same period.

However, it must be noted that focus remains on the above-mentioned variable expenses given that they form about 80% of the total operating expenses. The fixed price contracts, long gestation periods, cost overruns, volatile input costs are amongst the many others reasons that make the operating margin very volatile and in the process, very uncertain. Also a lot depends on the increasing competition and ergo, order inflow.

The overall slowdown has also stretched the company cash requirements way beyond comfortable levels. This has anyways been the case for the high debt on its books for HCC. The interest costs are literally eating away into the profits, and we expect the same to continue for a while. While the company is looking at lowering its debt position by selling of some assets, there is a lot of uncertainty surrounding the same. The recently approval of the corporate debt restructuring (CDR) package (for debt of Rs 32 bn) will however provide HCC with some breathing space in terms of extended principle repayment period and lower interest costs.

While value can be found in other business of the company particularly - HCC Real Estate (including Lavasa - which is itself surrounded by a great deal of uncertainty and controversy) and HCC Concessions - we cannot help but expect the dismal performance of the standalone business to overshadow all positives in the stock.

Keeping all the above reasons and assumptions in mind, we believe investors would do well to sell the stock at current levels and look for better opportunities.

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