Company Overview
VA
Tech Wabag (Wabag), a INR 32 billion (USD 480 million) pure-play water treatment
company is an Indian multinational player operating in the business of water
and waste water treatment solutions both in India and other emerging markets (Asia,
Africa, Middle East and Central & Eastern European countries). The company
provides a complete range of water and waste water treatment solutions, with
product offerings spread across municipal drinking water, municipal sewage,
industrial water, industrial effluents, desalination and recycle. It is a
technology driven company with more than 100 patents with R&D centers
located in India, Austria and Switzerland. It has a strong track record having executed
more than 2300 projects executed over the last three decades.
Industry Context
Water Treatment: In the Indian context, the
treatment of water has a strong business potential. A rapidly growing
population demanding more water per capita (140 liters per capita per day)
along with inadequate conservation & rain water harvesting has resulted in
severe water shortage; a major cause for concern for the government and local municipalities
across the country. Water being a scarce resource, conservation and
preservation has been an area of focus for public and private sector
enterprises across the globe. Governments across regions are also laying
special emphasis in this direction and hence business traction is expected to
improve further in the years ahead.
Sewage Treatment: Sewage treatment is currently has
not been handled efficiently, however it’s now one of the top priorities for
the Government in pursuit of its ‘Swacch Bharat campaign’. India is likely to spending
large sums on sewage treatment, irrigation and water recycling in the
forthcoming years. Central Pollution Control Board (CPCB) has reassessed sewage
generation and treatment capacity for Urban Population of India for the year
2015. As per CPCB, Sewage generation is estimated to be ~62000 MLD and sewage
treatment capacity developed so far is only 23277 MLD (approx 38% of demand) from
816 STPs. Cities and towns do not have adequate system for sewage collection
and treatment; thus the entire waste water either falls into rivers/ lakes or remains
inundated on land, causing potential risk of ground water contamination.
Furthermore,
additional opportunity is expected to come under way by way of AMRUT project (earlier
known as JNNURM) from various municipal corporations and state governments,
Smart cities program and Namami Ganga project (It’s a hybrid-annuity based PPP
model with a INR 250 billion allocation
to be committed in next 2-3 years).
These
factors ensure a strong business opportunity for the VA Tech Wabag. VA Tech
Wabag competes against global payers such as SIIC Environment Holdings Ltd, China
Everbright Water Ltd., ELL Environmental Holdings Ltd, Sino Thai Engineering
and Construction PCL and Politeknik Metal Sanayi Ve Ticaret AS in its target
market and against Indian companies such as Eco Recycling Ltd, Ion Exchange
India Ltd.
Investment
Positives
1. Improved Order
book position: With
an improved order book position of INR79.5 billion (USD 1.2 billion), Wabag
provides investors with revenue visibility for the next 2-3 years (INR 24.4
billion in FY15). Despite a challenging environment, Wabag has won orders of INR50
billion in FY16 (a beat versus company’s earlier guidance of INR35-37 billion).
The beat was primarily driven by two large orders worth INR13 billion announced
in March 2016 - the INR6 billion ((USD90 million) order for a water reclamation
plant at Chennai and an INR7.3 billion (USD108 million) integrated water supply
scheme for Polgahawela, Sri Lanka. The order book has been growing at a faster
pace, although the company is now focusing on high value orders coupled with
higher margin profile.
2. Asset light
model: Wabag is
a technology driven company and has an asset light business model, as it outsources
bulk of its non-core activities such as capital intensive construction
business, to external vendors. The company is currently reaping the benefits of
amounts spent on in-house R&D activities and patents developed by the
overseas subsidiary over the years.
3. Geographic and
Customer diversity:
VA Tech Wabag’s products and services are offered to a wide range of customers
spread across different industries and geographies. This cushions the company against
any long term adverse impact on its business performance as revenue is
diversified across customers and geographies. On the flip side, presence in
multiple countries exposes the company to operational and Government risks. VA Tech
Wabag has taken many steps towards consolidation of sites and to mitigate the
risks. The company has created a team specifically to ensure project closure
and collections (with delineated closure-related incentives). Moreover, the
company has set minimum contract size standards for various segments (for instance,
INR500 million for Indian municipal contracts and half the amount for international
projects).
Reasons for the recent
stock underperformance
Wabag
has declined 55% from INR943 on 18th March 2015 to an intermediate
low of INR421 on 1st March 2016. The reasons for this fall are lower
margins, euro depreciation versus INR (11% decline in FY16) and excess cash
which depressed the company’s return ratios.
· The
company's FY16 margins were impacted by low margin overseas projects (low-margin
Turkey STP O&M contract for INR3 billion (6% revenue contribution in 9M
FY16)) and higher provisioning (INR300 million provisions for Al Gubrah’s
projects).
· Wabag
has a significant amount of cash, almost INR2.1 billion (as of Sept. 2016) of
cash. The company hasn’t been able to put this cash in use for acquisitions and
hence this has depressed the return ratios.
Catalysts
Strong inflow growth
along with steady project execution to result in robust revenue growth trajectory
Wabag’s
order inflow is likely to be driven by domestic orders in FY17, with projects
like Namami Gange, Atal Mission for Rejuvenation and Urban Transformation
(AMRUT) and finalization of large municipal water and desalination projects across
Mumbai and Chennai. This along with order wins in FY16 should result in an
acceleration in topline growth in FY17 and FY18. Growth will be led by
execution of large orders such as Petronas project, AMAS, Bahrain, Istanbul
O&M and Dangote etc. Notwithstanding benign crude oil prices, projects in
which Wabag operates have not been impacted.
Margin expansion on
cards, cash conversion to improve
Wabag
has traditionally struggled with margins in a few large projects (Turkey STP
O&M, APGENCO contracts). Going forward, margins would steadily improve due
to better EBITDA mix projects, higher revenue recognition of key projects, rising
revenue share from O&M along with focused efforts on site closures and
collections. In the last few years, profits growth has lagged revenue growth.
This is likely to reverse with expected margin expansion, operating leverage from
normalized depreciation, which should result in higher PAT growth. Margin
and cash conversion
will be boosted
by growing share of Petronas project revenues and
focused efforts on site closures and collections.
Key Risks
FX risks
VA
Tech Wabag operates in international markets and hence is exposed to currency movements,
however is naturally hedged to some extent as most of the costs are also
incurred in local currency of the respective foreign country. Based on its
target markets, it is faces FX risk from euro depreciation
Geopolitical risks
– Ability to execute projects in tough geographies
VA
Tech Wabag operates in different countries and hence any geopolitical
instability in a country of operation (e.g. Nigeria, Turkey etc) or surrounding
countries might impact its business and repatriation of funds could be a
challenge.
Valuations can re-rate
Wabag
has traded in the P/E band of 20-30x and P/B of 2-3x till FY14. However, in
FY15, stock rerated on account of the Indian government’s thrust on water
conservation and initiatives undertaken to improve the quality of water, and reached
P/E of 50x. However due to global pressures and volatility in financial markets
coupled with some delays in the execution of few projects, the stock has
corrected substantially in FY16. We believe that this correction should be used
to accumulate the stock as it provides substantial upside from current levels over
a 2-3 years time frame. At current CMP of INR570 as on 23rd May, the
stock trades at 25.2x 2017 consensus EPS/18.9x 2018 consensus EPS. The
valuations are much below as compared to its historical valuations. Moreover
WABAG deserves a premium valuation due to scarcity of listed large cap
pure-play water treatment comps. We believe improving margins and cash conversion
metrics, would lead to a potential re-rating of the stock.
Disclaimer
Investment
ideas issued by Maxim Research Pvt. Ltd, does not constitute a recommendation
for any investor to purchase or sell any particular security. Any investor
should determine whether a particular security is suitable based on the
investor’s objectives, financial situation needs, and tax status. The investors
should take note of the fact that stocks in Emerging markets like India tend to
be more volatile and impact costs tend to be higher as compared to the
developed markets. Maxim Research Pvt Ltd., its employees and affiliates may
maintain positions and buy and sell the securities or options of the issuers
mentioned herein (Safe to assume vested interest - long position on the stock).
This is not a complete Research Document. All materials are subject to change
without notice. Information is obtained from sources believed to be reliable,
but its accuracy and completeness are not guaranteed.
All
Standard Disclaimers apply
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