Over dependence on road projects and JV relationship with Patel Engineering

Promoted by K Narasimha Reddy, KNR Construction (KNR) designs, engineers, constructs and maintains roads. The company diversified into construction of irrigation and urban water supply projects in 2005.

As part of the National Highway Authority of India’s (NHAI) national highway development NHDP) program, KNR has a seven-year relationship with Patel Engineering as a joint venture (JV) partner. The KNR-Patel JV has won 10 road construction projects including two build-operate-transfer (BOT) annuity projects as a part of NHDP Phase II. Their combined value is Rs 960 crore. Primarily focused on road projects, the company is a late entrant into irrigation and water-supply projects. It won its first irrigation project, in JV with Backbone Projects (51% stake), in 2005. Another irrigation project with a majority stake is in JV with Srilaxmi Engineering Company (49%). The JV with Patel Engineering and others facilitate KNR to move up the value chain with either higher ticket orders or complex projects or new construction verticals by acquiring the much-needed pre-qualification capabilities.

Unexecuted orders spread over 25 projects in various states were Rs 1733.83 crore end November 2007. Clients included NHAI, state government projects funded by multilateral financial institutions such as the World Bank and ADB. The order-mix is heavily skewed towards low-margin roads with about 89.3% of the orders made up of road-sector projects. Irrigation and water-supply projects account for 8.4% and urban-water-infrastructure-management projects 2.3%.

KNR has 90-acre freehold land with significant portion in adjacent districts of Hyderabad in Andhra Pradesh, about nine acres in Karnataka, and 56 cents (about half acre) near Chennai in Tamilnadu.

The IPO proceeds will be used to infuse equity in the SPVs that executes BOT projects, contribute towards unsecured loans taken for the BOT project in Andhra Pradesh, and meet capital expenses for purchase of capital equipment and working capital requirement.

Strengths

Significant successful execution track record and repeat quality orders on continuous basis from reputed clients such as NHAI.

Unexecuted order book, at Rs 1733.82 crore end November 2007, translates into about 5.4 times the operational income of the year ending March 2007 (FY 2007), providing strong revenue visibility.

Weakness

Contribution of low-margin road projects stood at about 95% of consolidated income in FY 2007 and half year ended September 2007. The share of road projects in the unexecuted order book too stood a staggering 89.3%.

About 11 of the current 25 projects that form part of the current order book were won on JV or subcontracted to it by the special purpose vehicle (SPV) or JV partner, with majority coming from JV partner Patel Engineering (PEL).

Valuation

Operational income posted a growth of 116% to Rs 324.42 crore and a 154% jump in restated profit to Rs 13.56 crore in FY 2007 The EPS on adjusted net profit works out Rs 7.3 for FY 2007. The offer price discounts FY 2007 earning by 23.3 times at the lower price band of 170 and 24.7 times at the upper price band of Rs 180. Industry peers such as JMC Projects, C&C Constructions and PBA Infrastructure quote at a PE of 23.9 times, 14.7 times, 12 times of their FY 2007 earning. MSK Projects quotes at a PE of 38.5 times FY 2007 earning.