The road infrastructure sector has been the beneficiary of positive regulatory actions. With falling interest rates, reduction in the cost of debt is likely to benefit players in this capital-intensive sector. However, toll road operators may face some short-term bumps due to demonetisation and initial hiccups in the implementation of newer models for awarding road contracts, such as hybrid annuity model. Also, the National Highways Authority of India (NHAI) has been awarding majority of the projects through engineering, procurement and construction (EPC) contracts rather than the model of build, operate and transfer (BOT).

Over 5,000 km of road projects are expected to be awarded in 2016-17 , with majority of them being construction contracts.

EPC service providers with strong execution skills and strong financials are likely to gain. A good long-term bet on this theme is KNR Constructions (KNR).

The company has executed road contracts in 12 States besides three toll projects. Its order book that is growing strongly stands at over 4.5 times the 2015-16 revenue, giving good revenue visibility. KNR has a good execution track record and has received early completion bonus for delivering roads ahead of schedule. The company has been able to maintain healthy operating margins (15 per cent), thanks to strong cost control from in-house execution rather than relying on sub-contracting.

The stock has been on an uptrend since early 2014, zooming 12 times. Its current price discounts the company’s trailing 12-month earnings by about 19 times. This is slightly expensive compared to the stock’s three-year average multiple of 16 times, but still attractive considering the long-term growth potential.

It is still cheaper than that of peers such as NCC, Sadbhav Engineering and Gayatri Projects, which are either loss-making or trading at much higher multiples. Investors can buy the stock, given the company’s execution strength, large and growing order book, ability to maintain strong margins and healthy balance sheet.

Strong revenue growth

KNR’s mainstay for revenue is EPC orders for road projects. Its order book has been growing at a fast clip since 2015. It won new orders totalling ₹1,334 crore in 2016-17, taking the total outstanding orders to ₹4,579 crore as of September 2016.

This includes ₹680 crore of irrigation projects. While most of the orders are from the State and Central government in the southern states, it also has contracts from Bangladesh.

Revenue increased 74 per cent year-on-year in the first half of 2016-17 to ₹677 crore. Long-term revenue growth is likely to be robust on the back of existing orders and expected new order wins.

KNR sold two of its operational annuity-based BOT projects for ₹850 crore in November 2016. The cash will provide capital for construction, and the management has indicated that it is part of its strategy to focus on EPC business. It has two other BOT projects — one completed and the other yet to be operational.

Thanks to on-time completion, KNR was able to maintain healthy operating margin of around 15 per cent even during the downturn in 2013-14.

Stable margin

Operating marginis expected to remain stable at around 15-16 per cent in the next few years. Pre-tax profit increased 52 per cent y-o-y in the first half of 2016-17, helped by higher revenue. Fall in interest rates should aid net profit margin.

KNR’s consolidated debt as of March 2016 was about ₹737 crore and may remain at these levels. Working capital cycle is improving; it decreased steadily from 69 days in March 2015 to 40 days in September 2016.

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