Company
Brief
Madhucon Projects Ltd (MPL) (NSE: MADHUCON, INR 49.25) is an integrated
construction, Infrastructure development and management company headquartered
in Hyderabad, India. The Company has its presence in multiple sectors of
construction and infrastructure projects such as Transportation, Irrigation,
Water resources infrastructures, railways, Engineering, Procurement &
Construction (EPC), Turnkey projects, and smart city projects in India. A majority
of the development projects are based on Public-Private Partnerships (PPP), operated
by Special Purpose Vehicles (SPVs). The company reports its revenue through
three operating divisions: Power Generation, (78% of FY15 operating revenue) Construction
& Civil Engineering (12%) and Toll Collections (10%).
Power generation business has an operational 600MW
(2 X 300MW) plant at Thamminapatnam and Mommidi villages, in Nellore district,
in the state of Andhra Pradesh. The company is in a process of expanding the capacity
to 1920 MW by 2020. Construction & Civil Engineering business includes EPC business
and road construction business. The key projects under implementation under EPC
business are Nagapattinam - Thanjavur Section of NH-67 and Patna–Koliwar
Section of NH-30. Apart from EPC works, the company also has 1760 kms of Toll
& Annuity projects under progress. In addition, the company is also
developing various irrigation projects (amounting to INR 2072 crores) in the
state of Andhra Pradesh, Gujarat, Maharashtra, Madhya Pradesh, Uttar Pradesh
and Telangana.
Industry
Context
Indian economy is expected to grow at 7.5% during
2017, following a stupendous 7.6% growth in 2016. The expected interest rate
cut this year will provide a fillip to private sector infrastructure spending.
Considering the enhanced focus on this sector by the Indian Government,
policymakers project USD 1 trillion investments in infrastructure sector in
12th five year plan (2012-17) with 100,000 kms of national highway by the end
of 2017.
Power
Economic growth of a country is driven by energy,
which powers nation’s industries, vehicles, homes and offices. For growth to be
sustainable, energy must be both, resources efficient and environmentally-safe.
The utility electricity sector in India had an installed capacity of
303 GW as of 31 May 2016, Renewable Power plants constituted 28%
of total installed capacity and Non-Renewable Power Plants constituted the remaining
72%. The gross electricity generated by utilities is 1,106 TWh (66
TWh by captive power plants) during 2014–15 fiscal. However, the current
power infrastructure in India is not capable of providing sufficient and reliable
power supply and more than one third of the country's population continues to
live without power. Many reforms have been made for a reliable and cost
effective supply of electricity in the country. On May 2016, the Government of India
gave its approval for allowing flexibility in utilization of domestic coal for
reducing the cost of power generation. Having a huge reserve of coal, it
is logical to have more coal based thermal power plants in the country. In
addition, the huge gap between demand and supply uncovers a number of possibilities
and opportunities for growth in power generation business.
Road
construction
The infrastructure and construction sector remained
stressed in FY15 and struggled to deal with structural issues and macro
economic factors. Issues such as delays in land acquisition, delays in
approvals, delays in payments, delays in settlement of claims, long working
capital cycle etc., affected the progress of the projects and the companies.
However, many initiatives taken by the Government such as formation of dispute
resolution committees, faster clearances, easing financial norms and increased
ordering under new viable models have created a robust financial and regulatory
environment
Engineering,
Procurement and Construction (EPC)
EPC is a popular model being adopted globally in
many projects like road construction, roof-top solar projects, etc. Due to
deterioration in the financial health of developers and limited capital
availability, appetite for the BOT projects has reduced substantially. NHAI has
taken cognizance of the same and started awarding higher number of projects through
the EPC route. For FY17e, of the target of 10,000kms has been set for NHAI, ~50%
are expected to be awarded through the EPC segment as against ~3,000kms awarded
through EPC in FY16.
Irrigation
The increased allocation of funds for irrigation
projects in Budget 2016-17 shows central governments’ focus on irrigation. The
Central government budget this year highlighted a plan to fast track 89
projects which have been stranded, with INR170bn in FY17 and INR865bn over the
next five years is expected to be spent on these projects. Moreover, states
like Telangana (the company’s focus region) are also looking to aggressively spend
on improving irrigation in the state. Telangana irrigation outlay stands at
INR250bn (a 3 fold increase over FY16RE outlay of INR85bn) for FY17e.
Increasing focus on irrigation is expected to create large opportunities for
the EPC players.
Investment
Positives
Power
generation business is a cash cow
Implemented in two phases, Madhucon power business
operates through two units (300MW X 2 units), which are currently fully operational.
For Phase-I (2x 150 MW) of the Plant, the coal supply has been tied-up from
Indonesia. 70 % of the Plant capacity has been tied-up on long term Power tolling
basis with PTC India Ltd while the balance capacity is planned for sale vie a merchant
route. Similarly for Phase-II (2x 150 MW), 50% of the capacity is tied-up with
PTC India Ltd. on Power tolling basis and the balance capacity is exposed to
short term market. Furthermore, the company is currently developing a 1320 MW thermal Power
Plant in its Phase-III 2X660 MW, expected to be completed by the end of 2017.
Madhucon’s power business generated an EBITDA of INR
603 crores for FY14-15 (EBITDA margin of 38.8%). In addition, first unit of phase
III is expected to start its operation within two years, increasing the
production capacity of power plant by around 660 MW. The increase in capacity
will result in a two -fold growth in revenue as well as EBITDA of the Power
business. The cash generated from the Power business has hitherto been supporting
the company’s loss making road construction business. We believe, the growth in
the Power business in 2018 and beyond would be a key value creator over the
longer term.
Focus
on fast growing EPC and Irrigation projects
Stringent funding requirements set by banks made Madhucon
turn its focus back to the EPC business. This focus on low capital intensive
cash contracting business along with efforts to divest stake in BOT projects
and improving working capital situation would help the company reduce leverage
levels. Madhucon has won two new EPC orders from NHAI, Nagapattinam - Thanjavur
Section of NH-67 in the state of Tamil Nadu for an estimated value INR 397 crore
and Patna–Koliwar Section of NH-30 for a total length of 33.250 kms in the
state of Bihar for an estimated value of INR 598 crore. In addition, various irrigation
projects amounting to INR 2072 crore are under progress in the State of Andhra
Pradesh, Gujarat, Maharashtra, Madhya Pradesh, Uttar Pradesh and Telangana.
On the other hand, company is trying to divest most
of its’ existing BOT projects as it struggles with
liquidity crunch and has a highly leveraged balance sheets. The company has returned
many highways and expressways projects to NHAI (Barasat-Krishnagar Expressways
Limited and Rajauli-Bakhtiyarpur Expressways Limited) by issuing letters of
termination. Madhucon has also sold its
Madhucon Agra-Jaipur Expressways to Cube Highways and Infrastructure for INR
248 crores. Currently, the company is executing only one BOT project i.e.
Ranchi Expressways Ltd. as the company couldn’t exit it due to some obligations.
Key Catalysts
Debt
Reduction and lower interest rates will ease liquidity and improve credit
rating
Madhucon has default credit ratings ([ICRA] D)
primarily due to significant delays in debt servicing owing to stretched
liquidity profile of the company. Poor operational performance of BOT portfolio
has adversely affected the financial profile at the consolidated level as
reflected in cash losses over last few years, highly leveraged balance sheet,
negative net worth and poor coverage indicators. Company has a debt of around
INR 5700 crores on its balance sheet and divesting some of the BOT projects
will help company in reducing its debt burden. With lower cash burn in the
roads business, the company will utilize bulk of its free cash flow from Power
business in overall debt reduction.
Another option to generate cash would be divesting a
part of its power business or an IPO carve-out of its power generation
business. Currently, power business is generating most of the revenue from the
fully operational Phase I and Phase II plants, which has a combined capacity of
600MW. Company plans to commission first unit of Phase III by the end of 2017,
which will have a capacity of 660 MW. Moreover with a new Central
Bank Governor stepping in from September 2016, there is higher likelihood of
more rate cuts which would be a silver lining for debt laden companies like
Madhucon (1% reduction in borrowing costs can lead to savings of INR 60 crore
(almost equal to FY16 net profit).
In
addition, new project wins and positive news flow will boost the stock in the
short run while improved transparency in reporting and increased control
measures will help the company re-rate the stock over long term.
Major
Risks
Delays in construction continues to be a concern that
occurs from factors
outside the control of the project sponsors, such as land acquisition, regulatory
approvals, inflation, and litigation etc., which can delay the timely
completion of the project and increase in cost of project. This can result in additional
funding, additional cost of fund etc. Further the Indian industry, in general,
the construction sector, in particular, is suffering from high interest costs.
To stimulate much needed growth in the real economy, RBI and the commercial
banks have to further cut their interest rates. Furthermore, lack of lack of disclosure and transparency remains a major
risk. The company has not declared detailed result for FY15-16 and its quarter
results also contain bare minimum information about its business progress. The
investors do not see much clarity about the projects and progress of the
company which typically weighs on their investment decision.
Valuation
We value Madhucon Projects Limited (MPL) using
EV/EBITDA based SOTP methodology and arrive at a consolidated intrinsic value
of INR75.00 per share which implies a 2017e EV/EBITDA multiple of 6.5x. Our
valuation factors in a decent growth in Civil engineering segment due to EPC
and irrigation projects.
Bulk
of the company’s value is derived from the power business. We have assumed
conservative multiples by applying a discount of about 18% to its Power
generation peers. By applying an EBITDA multiple of 6.7x to the power
generation business, we arrive at an EV of INR 4,883 crores. Note that we have
not considered the expected expansion in Power generation business. Many of the
power deals in power generation sector have been valued at approx. 6-7 crore
per MW. In the year 2014, Adani power bought
Avantha Power’s 600 MW thermal power project Korba West Co. Ltd. for an
enterprise value of INR 4,200 crores, which values it at approximately INR 7
crore per MW. Another deal between JSW and JSPL was valued at 6.5 crore per MW
in which JSW will buy 1000MW unit of JSPL for INR6500 crore. Considering a
setup cost of INR 5 crores/MW for Madhucon existing plant’s setup cost comes to
INR 3000 crores and the whole setup of 1920MW will cost around INR 9600 crores,
which shows that the company (principally the power segment) is grossly
undervalued.
Below table shows the sensitivity of the company’s fair value with power Business’ 2017 EBITDA multiple and 2017 EBITDA margin.
