NBCC: Troubled projects a pain in the neck; put on your guard

Image result for NBCC: Troubled projects a pain in the neck; put on your guardOnce considered as a company with “great growth”, NBCC has come off 66 percent to Rs 48.5 per share, from its peak of Rs 145 in November 2017.

While a general erosion in faith in construction stocks has taken a toll, its own issues pertaining to local agitation about redevelopment of government colonies in Delhi and delays in construction of real estate projects hit the stock hard.

Moreover, the government has proposed NBCC to acquire assets of the Amrapali group, Unitech and others like Jaypee Infratech’s prestigious Yamuna Expressway to salvage these assets in the interest of customers and bankers.

However, given the size of these projects, complications and a possible stress on its balance sheet and profitability, this is an additional component of uncertainty.

Stressed assets cast their shadow 

Last year, NBCC acquired two government-owned loss-making construction companies at the cost of Rs 500 crore. These companies have also been facing other headwinds such as delays in execution of projects at hand and employee issues.

NBCC recently deferred its decision to acquire the Jaypee Infratech assets on the ground of differences among bankers and homebuyers and with itself. Through various means, the infrastructure player had proposed to settle claims worth of Rs 23,723 crore of financial creditors. Considering the size of the project and the amount involved, this would have certainly put pressure on its balance sheet, which is today flush with cash and the least working capital requirements.

While Jaypee Infratech is off its radar now, NBCC is in the news for taking over the unfinished projects of the Amrapali group and possibly for Unity Group’s incomplete real estate projects. These are again fairly large projects.

Amrapali has some 12 unfinished projects and it is estimated that close to Rs 8,500 crore would be required to complete the same. In this case, it is expected that the court receiver would raise money through various means and NBCC would work on these projects with 8 percent profit margin. While NBCC is cautious that it does not take any liability and terms are suitably decided to make economic profit, the market would take this with a pinch of salt as the company is a government agency.

The market’s apprehensions primarily stem from the fact that most private players have stayed away from bidding for these assets, considering the complicated deal structures, unfavourable terms, possible delays in execution, working capital requirements and the amount of money they would require to infuse.

The other important point is these are stressed assets and they will require a huge amount of resources and attention which could possibly cast their shadow on its core business activities that are profit making and generating good cash flows.

Some of these project-related issues are already visible and wreaked havoc in the past. Its recent experience in redeveloping government colonies in Delhi is one example for which its growth has suffered.

Shrinking growth expectations

It is sitting on a huge order book of close to Rs 80,000 crore or 11 times its annual revenue. Backed by this, investors had very high expectations and the market was counting on earnings growth in excess of 35 percent.

However, expectations have dropped drastically. During 2018-21, the consensus are factoring in an earnings growth of 18 percent. What led to this caution is the expected delays, which are already visible. In Q4 FY19, the company’s main segment PMC business grew at 3.6 percent while the EPC business recorded a sharp 65.1 percent decline on a year-on-year basis. Bulk of this is related to the delays in the Delhi redevelopment projects.

How should investors deal with it?

To sum it up, NBCC has one of the best business models in the construction and engineering space. It is an asset light business with no debt, does not require much working capital and generates strong return on invested capital. That apart, it also enjoys strong competitive advantage and revenue visibility because of the robust order book.

However, the issues that are discussed above are overshadowing its business prospects and this could continue as long as NBCC is roped in to bail out ailing real estate projects. The implication of NBCC taking over troubled projects is difficult to assess and not well understood. Investors are staring at a dilemma and it’s difficult to assess how exactly future profitability and balance sheet would look like.

When in doubt, stay out. That’s the choice many investors have already made. They need to be cautious and consider both sides of the coin before taking an investment call.

For those who can take the risks, thankfully the valuations are on their side. Purely from the valuation point of view, the stock that used to trade at 50 times 1-year forward earnings has fallen to 16 currently. So, these risks are already reflected in the price. If incrementally there are no bad news or any adverse developments, it makes immense investment sense. The rider is it should maintain an earnings growth of 15-18 percent at 16 times P/E.

However, if NBCC is wrongfully used for bailing out the moribund real estate projects, then serious investors would continue to avoid the stock for long despite the fundamental moats of the business.