Vascon Engineers IPO Analysis

Investors can avoid the initial public offer of Vascon Engineers, a provider of EPC services, for now. Despite a good track record in construction, premium valuations, dependence on related parties for a bulk of the future contract revenues and long gestation of its real-estate projects support our recommendation. At the offer price band of Rs 165-185, the stock is likely to trade at 32-35 times its consolidated annualised earnings for FY-10 on a post-issue equity base. The valuation does appear steep, irrespective of whether it is compared with pure construction contract plays or stocks of established realty companies.

Scaling up of real-estate revenues, winning of significant contracts from external clients or a steep correction in the stock price linked to broader markets can be reasons to take a re-look at this recommendation.

The company and offer

Vascon Engineers provides Engineering Procurement and Construction (EPC) services and is also into real-estate development mostly through the joint development model. Consolidated revenues for FY-09 stood at Rs 519 crore. The company plans to raise Rs 180-200 crore for construction activities.

asset-light model

Following the footsteps of Godrej Properties, Vascon Engineers seeks to showcase an asset-light model in real-estate through joint developments. It also seeks to integrate its construction skills with real-estate development activity. Sales — from third-party construction contracts — from its own real-estate projects and from development of property would be the three main revenue streams.

From deriving a majority of contract revenues from external clients, the company's order backlog is now tilted in favour of real-estate projects developed by itself/related entities. Of its order backlog of Rs 3,227 crore, 37.6 per cent or Rs 1,215 crore are contracts awarded by external customers, while the rest — Rs 2,012 crore —worth of EPC contracts is for its own real-estate development.

This leads to the risk of deriving a chunk of revenues from related entities whether in the form of joint ventures, partnerships or associates; receivables too would be due from such sources.

It may be worth recollecting that DLF's sale transactions with associate company, DLF Assets, was not too well-received by the market and this factor, in fact, hurt the valuation.

Excessive dependence on internal source(s) for revenue — from the point of view of maintaining an arms-length transaction as well as timely conversion of debtors to cash — does pose a risk. Currently, about 18 per cent of Vascon's total debtors are due from related parties.

This said, Vascon's revenue decline during the realty downturn of FY-09 (at 15 per cent) was lesser than its real-estate peers, primarily because of growth in EPC revenue. However, its current EPC order backlog may not offer sufficient hedge, given the dependence on own projects.

Long drawn

Vascon's projects also appear long-term in nature. For instance, only one-fifth of the EPC projects (external and own projects together) of Rs 3,227 crore are slated for completion over 2010/11. Similarly, of the 55 million square ft. of real-estate projects planned/being developed, less than 10 per cent are due for completion over the next three years ending FY-13. Earnings growth in the near term may, therefore, not keep pace with the valuations sought now.

Further, unlike the Mumbai commercial market, where prices have seen a quick revival, Tier-II cities such as Pune, where the company's commercial projects are concentrated, have not seen any clear demand pick-up as yet. Over the long term though, residential projects, a chunk of it in Pune, dominate the portfolio.

Financials

Vascon's revenue expanded at a robust 54 per cent compounded annually over three years leading to FY-09, while earnings grew by 35 per cent over this period.

This growth, however, predominantly came from pure construction contracts. Going forward, revenues could be lumpy, given the higher dependence on real estate.

The offer is open from January 27-29.

via BL