June 14, 2006

SREI Infrastructure - A must buy

The reason for my posting some companies in my blogs is just to re-inforce myself if I was right in making a purchase of shares. After this crash, it makes sense for an investor to be a critic and understand if staying with the company makes sense. The recent fall in the share market has given tremendous opportunities for investors to look at his portfolio and make adjustments to them. Surely, the crash would have left most of us wounded with huge losses, but I believe this crash giving an ideal entry to companies that one missed in the previous rally. The rally gave hints of companies that have the potential to be better than the others, but have fallen as there no buyers and speculators have left them in the lurch. Ideal long term investors need to grab them and have the next round of gains.

I enjoy infrastructure based companies as it is not heavily dependent on outside economies. Most of these companies undertake projects for the development of our country. The only risk being whether such investments will yield the desired returns. Peter Lynch did well in the 80s investing in companies that focused on infrastructure. If I recall correctly, he did a 5 bagger in most of these companies. His reason was extremely simple. These companies do a big service to give the country the next level of growth. However, these companies will stop showing growth after the country has become a developed one simply because consumption can be easily monitored. You are not going to spend more on electricity just because you have more money. You probably will travel more-but the facilities that you need from the road, ports or in airports will become predictable and further investments into these areas would only enhance comfort marginally. Well, we are a long way off. We hardly have continuous power, decent roads to travel, excessively used airports created by the low fare airlines. So creating the opportunity for all companies in this sector to grow and grow much faster. I do not know if they would grow at a pace greater than the other sectors, but I am atleast confident on the government's commitment to improve basic necessities that is much needed for us. Hence this post and possibly more on these type of companies.

The main problem that I encountered in this sector is the investment that one needs to make. Companies that are in IT, Entertainment etc rely heavily on manpower. Unlike infrastructure, where companies consume massive capital, these sectors hardly have such requirement. Any deal with proper pricing can ensure reasonable amount of safety for the return of capital. Infrastructure based companies run a risk on this. They consume capital and you do not know if they will make money. The projects have a huge gestation period and have leveraged balance sheets. Small changes in interest rates is sufficient to make the project infeasible after a few years. I am bullish on the country and hence I believe that I am making the right sense of investing in these companies.

I shall be posting my views on a series of infrastructure based companies in the next few posts of mine, if I have sufficient time at my disposal. My objective is to try and make sense in the policies of these companies.

SREI Infrastructure could probably be one such company that falls in this segment. The company gave up its highs of around Rs. 80 from around a month back to the lows of Rs. 30 today. That is one mammoth fall for a company that is doing pretty well. A company with a slightly different objective. They are into lending and only to infrastructure based companies. I read their annual report, and a truly interesting one. Very colorful (the company is in a purple patch), loads of explanation of the core activities of the company, extensive information on the industry (it probably took half of the report, which is a good one). Currently trading at a PE of 7. Imagine. Why are people not investing then? The company at its peak was trading at about PE of 18. Capital and infrastructure based companies were literally murdered in this crash. Probably that is why it is trading at such levels.

Company is primarily involved in these segments
  • Equipment financing
  • Equipment leasing
  • Infrastructure Project financing
  • Projects that are based on renewable resources (extremely small but amplified in the report)
Company has some diversification, of which some looks unnecessary in
  • Capital Markets-generated marginal revenues, not making operating profits mainly due to increase in debtors
  • Forex Services-generated about 2 lakhs of profits, not generating operating profits
  • Insurance-loss making division and again not making operating profits and is moving into securitisation and asset reconstruction. Has created a new company that has a general license to market all insurance in one window. Company seems to have made some heavy initial investment not in assets, as the only asset they have is a computer. Sustainability in this seems to have some attractiveness as there is some synergies in business, especially in the non-life insurance sector.
  • Venture capital-looks promising but details of this company is a bit sketchy. The company is investing in infrastructure based companies in the SME segment. The profitability that the company has shown is impressive. The salary in the P/L gives an indication that there are not more than a few individuals, and that too in the lower rungs of the company
  • Retail Financial Services-made some huge investments in infrastructure, but the segment is highly competitive with banks being the market leaders. It is difficult for the company to position itself unless some clear differentiation can be created by the company.
Investment Positives

  • Paison Ki Nilami-reverse Auction - a concept of reverse auctioning on determining interest rates.
  • Direct bulk purchase of equipments from companies like Tata, Ingresoll Rand and ensuring their availability to its clients at cheaper prices. This fends off competition especially from the banking sector as their cost of borrowing is significantly lower. However, they would not purchase assets for lending them as leases. This activity has to be done by these companies.
  • Listed on the LSE-can be more transparent in its accounts
  • Its presence across the finance vertical, its expertise in consultancy, its reach
  • Good dividend yield at current levels. At 15% dividend declared last year, the yield is about 4-4.5%. We have seen the upside on this stock a few weeks back.
  • The company has done well in terms of customising its receipts with the cash flows of its client and has done well on the NPA front. Its capital adequacy ratio is well above the prescribed limit of 12%.
  • The company uses securitisation of its assets, buys from ARC's (can get at a decent price) to ensure lower costs are maintained.
  • The sales growth in its key areas are well above 30% and with more infrastructure based projects in pipeline and a capital starved country, the company should be able to maintain these growth levels for a certain period of time.
Investment Negatives
  • Heavily dependent on the condition of the economy and the pace at which government will announce its projects
  • Road projects are sometimes not viable investments. Any hardening of the interest rates can affect the project
  • Raising money for projects- Rating of the company is not attractive. It is at AA-, which is a comfortable 200 bps from a bank. This benefit will affect the company as competition from banks is bound to get fierce.
  • The other segments that the company is concentrating will give poor returns
  • The company has a corpus of only 2200 crores
  • There is a constant hint in the annual report that the company is not able to deliver its equipments on time due to non-availability. It seems to have mitigated thru bulk purchases.
  • Interest Coverage ratio of less than 2 is a big risk in a rising interest rate scenario. The company's debt equity ratio is frightening given the fact that the company seems to borrow quite extensively (close to 6) and the borrowing mix is heavily tilted towards term loans from banks and financial institutions
Overall, the company has shown promise and the report that I spent reading for more than 3 hours was well spent. I truly believe the price of this stock to bounce back and show better appreciation in the years to come. More updates shall be posted when required.

No comments: