NCC: 3QFY12 Results-Despite dismal performance, asset ambitions remain high

NCC:

3QFY12 Results-Despite dismal performance, asset ambitions remain high (NJCC IN, mcap US$318mn, TP `42, SELL, 32% downside)

Analyst: Nitin Bhasin, nitinbhasin@ambitcapital.com, Tel: +91 22 3043 3241 Analyst: Chhavi Agarwal, chhaviagarwal@ambitcapital.com, Tel: +91 22 3043 3203 Our view of the results: In 3QFY12, NCC reported poorer-than-expected performance on all parameters: Standalone revenues declined 5% YoY and were 10% below our expectations, EBITDA margin of 6.1% was down 341bps YoY and 285bps below our expectations and the company reported net losses of `95mn v/s net profit of `404mn in 3QFY11 and our net profit estimate of R228mn for 3QFY12. Net losses would have been higher, if the company had not provided for a low effective tax rate of ~20% (in 2QFY12 also NCC reported a low tax rate of 19%, however, NCC had never posted such a low effective taxation rate in the last 5 years). NCC 's EBITDA margin of 6.1% is the lowest ever reported in the last 5-6 years and the management highlighted that such a sharp decline in EBITDA margin was due to: (a) time and cost overruns in a few large infrastructure projects; (b) revenue decline on a YoY basis (due to low order booking in last 12 months and execution delays in the existing projects) resulting in under-absorption of fixed overheads; and (c) additional provisioning of `150mn for doubtful debts leading to 57% YoY increase in other expense. Low EBITDA margin coupled with a sharp increase in interest expenses (58% YoY) on account of an increase in debt levels and interest rates (~300bps YoY), resulted in losses to the PBT. However, the interest costs declined (2% lower) on a sequential basis and was 6% lower than our estimates, as the company reduced its debt to `24bn in 3QFY12 compared to `26bn in 2QFY12 (debt equity of 1.0x at December 2011 v/s 1.1x at September 2011). The decline in debt was due to financial jugglery by the NCC, as it replaced working capital debt from the advances (`7bn) that NCC received from its Power asset subsidiary NCC Infra, which achieved financial closure and awarded the project of `52bn to NCC. The order book at the end of December 2011 was `220bn (`165bn at end of March 2011), which represents a book-to-bill (TTM) ratio of 4.3x. Whilst including the captive power project, order flow in 3QFY12 is `68bn, excluding it, the order flow in 3QFY12 is only `17bn (40% YoY decline). For 9MFY12, NCC has only received orders worth `47bn from external clients compared with `58bn received in 9MFY11 (17% YoY decline). Where do we go from here? We have been continuously highlighting that NCCs low order booking and execution slippages will lead to low revenue growth for FY12E, and EBITDA margin will remain under pressure due to increasing raw material/subcontractor expenses and under-absorption of fixed overheads. Therefore, for FY12E, we had modelled YoY revenue growth of only 5% and EBITDA margin of 9.3%. However, in 9MFY12, the performance has been below our expectations, as the revenues have declined 3% YoY and company has posted an EBITDA margin of a mere 8.1%. We believe that in 4QFY12 as well, NCC shall post revenue decline/muted growth and an EBITDA margin of ~8%. We will have to lower our FY12E revenue estimates by another 5%-8% and our EBITDA estimates by 15%-16%. However, we will have to increase our interest expenses estimates by ~10% on account of a decrease in debt levels. All the above changes will lead to 12%-13% decline in our core construction business FY12E EPS of `3.7. For FY13E we presently maintain our estimates for revenue growth at 14% and for EBITDA margin at 9%. Valuation and recommendation: Whilst NCCs stock price has rallied in the last one month, we expect that the decline in interest rates will not materially improve the business performance of NCC, as it will continue to remain capital starved for growth and PBT margins will remain low due to high debt:equity. Our SOTP-based valuation is `60/share (`42/share for the core construction business (Indian and international) and `18/share for the embedded value). NCCs stock (ex-embedded value) is trading at 8x FY13 EPS of `4.7 for the construction business (Indian and international business). We maintain our SELL recommendation as the value of the core construction business (`42/share) remains lower than the CMP. Moreover, we believe the embedded value (`18/share) could see further erosion on account of: (a) continuing poor performance of most of the operational BOT assets (roads mainly, as visible from the current results); and (b) inevitable equity dilution needs at the subsidiary levels. Considering the losses in most of the operational BOT assets and non linkage/PPA for NCCs power asset under construction, we fail to see any meaningful value even closer to the equity invested in NCC Infra.

Ambit Capital Pvt Ltd

7 February 2012, Page 1

NCC: 3QFY12 Results-Despite dismal performance, asset ambitions remain high

Other key takeaways from the conference call:

Subsidiaries continue to post poor performance: On a consolidated basis, in 3QFY12, NCC has posted revenues of `15bn (4% YoY decline) and PBT losses of `148mn (v/s PBT profit of `816mn in 3QFY11). Whilst the revenues of subsidiaries (consolidated less standalone) grew by 5% YoY, the company reported a loss of `31mn in PBT as against a profit of `130mn in 3QFY11. Lower profitability of the BOT assets (housed under NCC infra and standalone SPVs) due to lower-than-expected traffic growth and high interest expenses was the main reason for the decline in the PBT margin of the subsidiaries. In the international business, Nagarjuna International Muscat reported revenue of `1.8bn and a PBT margin of only 3% and Nagarjuna Contracting Company reported a low turnover of `130mn and PBT of only `1mn. Lower-than-expected traffic growth in the operational road BOT projects: Management highlighted that in its recently started Pondicherry-Trivandrum road project, the average toll collection is `0.5mn/day, which is lower than the management expectations of `0.8mn/day. Similarly, in the Bangalore Elevated Tollway project (which started tolling ~18 months ago) average toll collection is `2.2mn/day, which is lower than management expectations of `2.5mn/day. In an earlier media article it was highlighted that NCC plans to raise funds either by listing or by selling a part of its equity stake in the BOT subsidiary NCC Infra. The article also mentioned that NCC has assigned a value of `25bn for its subsidiary, NCC Infra. We believe that given the continuous poor performance of its existing operational BOT road projects, it will be difficult for NCC to attract investors to its BOT project portfolio at such premium valuations. Order flow momentum remains weak due to lack of availability of funds at the clients end. Management highlighted that some clients are facing delays in achieving financial closure for their project and therefore, not awarding the EPC contract to the construction companies. Further, even if the developers have awarded the EPC contract to any construction company for which financial closure has not been achieved, the construction companies have not started any works, as they have not received the mobilization advances. NCC has also received few projects for which financial closure has not been achieved and the company has not received mobilization advances, therefore, NCC has not included those orders in its current order book. Though the management maintains FY12E order flow guidance, it reduces the FY12E revenue growth and EBITDA margin guidance: Management maintains its order flow guidance of `140bn (including the captive power order of `52bn) but reduces its FY12E standalone revenue guidance to `52bn from `56bn and its EBITDA margin guidance to 8.5%.from ~9.5%. However, given that NCC has only booked orders worth `99bn (71% of its guidance) in 9MFY12 and given the poor order flow momentum, we believe that order flow guidance of `140bn is highly optimistic. Similarly, revenues have declined by 3% YoY in 9MFY12, NCC will have to post revenue growth of ~17% in order to meet its guidance, which we believe is challenging in the current environment. Absence of PPA agreement in the Nelcast power project raises concerns: Management had earlier highlighted that the PPA agreement with the Karnataka state Government for supply of 400mW of power was cancelled and the company is looking at signing new PPA agreements with various other state Governments. Until date, NCC does not have any PPA agreement. As per the terms of the financial closure agreement, NCC is required to sign a PPA agreement for at least 990mW (70% of the power capacity of the Nelcast power plant) within one year of achieving financial closure (i.e November 2012). We have been highlighting for a year now that this power project has no potential to generate meaningful returns given the lack of funds with both the promoter, no coal linkage and lastly, no PPA.

Ambit Capital Pvt Ltd

7 February 2012, Page 2

NCC: 3QFY12 Results-Despite dismal performance, asset ambitions remain high

Exhibit 1: NCC's 3QFY12 quarterly financials (` mn unless specified)

Source: Company filings, Ambit Capital research

Ambit Capital Pvt Ltd

7 February 2012, Page 3

NCC: 3QFY12 Results-Despite dismal performance, asset ambitions remain high

Institutional Equities Team

Saurabh Mukherjea, CFA Research Analysts Aadesh Mehta Anand Mour Ankur Rudra, CFA Ashvin Shetty Bhargav Buddhadev Chandrani De, CFA Chhavi Agarwal Dayanand Mittal Gaurav Mehta Hardik Shah Krishnan ASV Nitin Bhasin Pankaj Agarwal, CFA Parita Ashar Puneet Bambha Rakshit Ranjan, CFA Ritika Mankar Mukherjee Ritu Modi Shariq Merchant Sales Name Deepak Sawhney Dharmen Shah Dipti Mehta Pramod Gubbi, CFA Sarojini Ramachandran Production Sajid Merchant Kausalya Vijapurkar Praveen Mascarenhas Production Editor Database (022) 30433247 (022) 30433284 (022) 30433251 sajidmerchant@ambitcapital.com kausalyavijapurkar@ambitcapital.com praveenmascarenhas@ambitcapital.com Regions India / Asia India / Asia India / Europe India / Asia UK Desk-Phone (022) 30433295 (022) 30433289 (022) 30433053 (022) 30433228 +44 (0) 20 7614 8374 E-mail deepaksawhney@ambitcapital.com dharmenshah@ambitcapital.com diptimehta@ambitcapital.com pramodgubbi@ambitcapital.com sarojini@panmure.com Industry Sectors Banking / NBFCs FMCG Technology / Telecom / Education Automobile Power / Capital Goods Metals & Mining Construction / Infrastructure Oil & Gas Derivatives Research Technology / Education Services Banking Construction / Infrastructure / Cement NBFCs Metals & Mining / Media / Telecom Power / Capital Goods Mid-Cap Economy Cement Consumer Desk-Phone (022) 30433239 (022) 30433169 (022) 30433211 (022) 30433285 (022) 30433252 (022) 30433210 (022) 30433203 (022) 30433202 (022) 30433255 (022) 30433291 (022) 30433205 (022) 30433241 (022) 30433206 (022) 30433223 (022) 30433259 (022) 30433201 (022) 30433175 (022) 30433292 (022) 30433246 E-mail aadeshmehta@ambitcapital.com anandmour@ambitcapital.com ankurrudra@ambitcapital.com ashvinshetty@ambitcapital.com bhargavbuddhadev@ambitcapital.com chandranide@ambitcapital.com chhaviagarwal@ambitcapital.com dayanandmittal@ambitcapital.com gauravmehta@ambitcapital.com hardikshah@ambitcapital.com vkrishnan@ambitcapital.com nitinbhasin@ambitcapital.com pankajagarwal@ambitcapital.com paritaashar@ambitcapital.com puneetbambha@ambitcapital.com rakshitranjan@ambitcapital.com ritikamankar@ambitcapital.com ritumodi@ambitcapital.com shariqmerchant@ambitcapital.com Head of Equities (022) 30433174 saurabhmukherjea@ambitcapital.com

Ambit Capital Pvt Ltd

7 February 2012, Page 4

NCC: 3QFY12 Results-Despite dismal performance, asset ambitions remain high

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