Analysis: PNC Infratech Ltd

Modified: 28-Aug-21

The current section of the “Analysis” series covers PNC Infratech Ltd, an India infrastructure developer focusing on the roads/highways sector, airport runways, water distribution, power transmission etc. In the roads sector, the company acts as an engineering, procurement & construction (EPC) player as well as develops projects based on build, operate & transfer (BOT) as well as under the hybrid annuity model (HAM).

“Analysis” series is an attempt to share with all the readers, our inputs to the company analysis submitted by readers on the “Ask Your Queries” section of our website.

To benefit the maximum from this article, an investor should focus on the process of analysis instead of looking for good or bad aspects of the company. She should learn the interpretation of different types of data and transactions and pay attention to the parts of annual reports etc. used to get the information. This will help her in improving her stock analysis skills.

PNC Infratech Ltd Research Report by Reader

Dear Dr Malik,

Many thanks for your tutorials and your guidance in analysing various companies. I have attempted to analyse one such company namely PNC Infratech Ltd. I request you to check my analysis and let me know what further I should have looked into.

Regards

Meghana Moghe

Detailed analysis of PNC Infratech Ltd:

The revenue growth trends indicate that the company has grown at over 19%, 25% and 35% CAGR for 10, 5 and 3 years, which is extremely healthy. However, there has been a de-growth of 6% in the past 12 months. This may be because of the nationwide lockdown due to which execution of projects were delayed. There is considerable variance in the year on year (YOY) growth, which is 3% in the year 2013 and 48% in the year 2020. This could be because of the cyclicality of the Infrastructure business.

The operating profit margin (OPM) of PNC Infratech Ltd, however, has remained constant at around 25% over the past 4 years including the trailing 12 months period. The net profit after tax (PAT) growth also indicates a rising trend from 26% (10 years) to 67% for the 3 years. This, however, has de-grown a -21% in the trailing 12 months.

The net profit margin (NPM), which was 10% in the year 2018 and 2020 and 9% in the year 2019 have reduced to 8% in the last 12 months. In other words, though there has been a considerable dip in the revenue, the NPM has been maintained indicating an increased efficiency by cutting costs. The maintenance of OPM at 25% is also indicative that the company has some pricing power.

During the period 2011-2020, PNC Infratech Ltd had an operating cash flow of Rs 2,260 Cr and spent Rs 3,416 Cr on capital expenditure (capex) resulting in a negative free cash flow of Rs 1,156 Crores. Moreover, PNC Infratech Ltd paid interest to the tune of Rs 1,876 Crores and earned other income of Rs 343 Crore. The company further gave a dividend of Rs 76 Crores and has a debt of Rs 3,411 Crores indicating that the business is a capital-intensive business.

This is also evident from the fact that the self-sustainable growth rate (SSGR) of PNC Infratech Ltd is 2% whereas the company has grown at very high growth rates for which they had to incur heavy debt.

Despite this debt, the company’s net fixed asset turnover (NFAT) is a very healthy 34% indicating high efficiency in asset utilization. The trade receivable days and inventory has been brought down considerably, indicating improvement in working capital, which could be the reason for higher NFAT.

During the period 2011-2020, PNC Infratech Ltd had retained earnings of Rs 1,766 Crores and the market capitalization of the company has increased to Rs. 6,059 cr indicating a value add of Rs 3.43. Though it is more than the recommendations of Warren Buffett i.e. more than one rupee, it is still low. It indicates that the retained earnings have been deployed in assets, which have still not started generating commensurate returns.

There has been an increase of debt from Rs 104 Crores to Rs 3,515 Crores and dilution of equity from Rs 415 Cr to Rs 2,554 Crores. Despite dilution, the debt to equity ratio is not so healthy 1.4 and considerably higher than its peers in the construction industry such as KNR Constructions Ltd or H.G. Infra Engineering Ltd.

As regards the CFO, the PNC Infratech Ltd.’s operating cash flow was Rs 2,260 cr vis-a-vis its 10-year PAT, which is Rs 1,842 Crores indicating that the company has been able to convert its profit to cash. This could be also due to higher depreciation and interest outgo, which are non-cash expenses (around Rs 660 Crores in the 10 years) and deducted while calculating PAT but not included in the cash flow. The CFO to PAT ratio is 95% for the year ended 31.3.20.

While going through the CARE rating’s report dated 17.11.20, the ratings assigned to their long-term debt is AA (stable) and short term is A1+ (positive).

Sufficient management integrity: nothing adverse noted on google search.

Recording revenue too soon: does not seem to be the case as the CFO of PNC Infratech Ltd each year has been consistently above PAT.

Calculation of Intrinsic Value by discounted cash flow (DCF):

Taking the free cash flow (FCF) growth at 19% for the first 5 years and 10% for the next 5 and terminal growth rate at 3% and the discount rate at 10%, the intrinsic value of PNC Infratech Ltd is in a band of Rs. 61-74.

Conclusion

Though PNC Infratech Ltd appears to be a well-run-fundamentally-strong infra company with good growth prospects, the stock is presently overvalued. Further, the sector itself is subject to cyclicality.

Regards,

Meghana Moghe

Dr Vijay Malik’s Response

Dear Meghana,

Thanks for sharing the analysis of PNC Infratech Ltd with us! We appreciate the time & effort put in by you in the analysis.

As highlighted by us in the articles on KNR Constructions Ltd and MBL Infrastructure Ltd, the analysis of an infrastructure/EPC player (Engineering, Procurement and Construction) is different from other companies. It is because of the following factors that we need to keep in mind whenever we interpret the financial results of any infrastructure/EPC player:

  • An EPC contractor’s business is nothing but an accumulation of all its projects under execution. Unless each of these projects is assessed individually, it is difficult to understand the complete business position of the EPC contractor. However, many times, from the information in the annual reports, we find it difficult to assess whether these projects have achieved important milestones like land acquisition, govt. approvals etc. Similarly, it is difficult to assess the cost estimates shared by companies in the publically available information whether these are the real ones or there have been escalations, which the companies may not have disclosed.
  • The revenue of the EPC players is derived from the cost incurred by them as these companies use the percentage of completion method (POCM) for revenue recognition. The reported revenue may not have a linkage to the actual cash that an EPC player might or might not receive. Many times, using the percentage of completion method (POCM), EPC companies show even that part of the project work in revenue whose bills are not yet sent to the customers, which is called “Unbilled Revenue”. Frequently, there are disputes between the stage of the project claimed by the EPC player and the Govt Departments/project allottee who have to release the payments. From the publically available information, it is difficult to assess how the situations are on this front.
  • The infrastructure/EPC players usually have many subsidiaries and joint ventures. To assess the overall financial position of the company, the financials of each of the subsidiaries and the joint venture has to be assimilated into the main company. This consolidation exercise provides many areas of accounting manipulations, which always raises an alarm in the assessment.

Therefore, whenever an investor studies any infrastructure/EPC player, then she should keep the above-mentioned points in her mind and remind herself that despite best efforts, her analysis may turn out to be erroneous or incomplete.

While analysing PNC Infratech Ltd, an investor would notice that on June 30, 2021, the company had 19 subsidiaries and 4 joint ventures (JV) (source: Q1-FY2022 presentation, page 20).

We believe that while analysing any company, an investor should always look at the company as a whole and focus on financials, which represent the business picture of the entire company including its subsidiaries, joint ventures etc. Consolidated financials of any company, whenever they are present, provide such a picture.

Further advised reading: Standalone vs Consolidated Financials: A Complete Guide

Therefore, in this analysis of PNC Infratech Ltd, we have studied the consolidated financial performance of the company.

With this background, let us analyse the financial performance of the company.

PNC Infratech Ltd Financials FY2012 FY2021

Financial and Business Analysis of PNC Infratech Ltd:

While analyzing the financials of PNC Infratech Ltd, an investor notices that the sales of the company have grown at a pace of about 18% year on year from ₹1,273 cr in FY2012 to ₹5,788 cr in FY2021. Further, the sales of the company have increased to ₹6,157 cr in the 12-months ended June 30, 2021, i.e. during July 2020-June 2021. The revenue growth of the company over the last 10-years has been consistent except FY2017 when the sales had declined by more than 20% to ₹2,252 cr from ₹2,837 cr in FY2016.

While looking at the profitability of the company, an investor notices that the operating profit margin (OPM) of the company improved from 12% in FY2012 to 24% in the 12-months ended June 2021. The OPM of the company had increased to 32% in FY2018; however, since then, OPM has witnessed a decline to 24% in FY2021.

To understand the reasons for the decline in the revenue of the company in FY2017 as well as to understand the reasons for fluctuations in its OPM, an investor needs to read the publicly available documents like annual reports, credit rating reports as well as its red herring prospectus (RHP: click here).

After going through the above-mentioned documents, an investor notices the following key factors, which influence the business of PNC Infratech Ltd. An investor needs to keep these factors in her mind while she makes any predictions about the performance of the company.

1) Almost the entire business of PNC Infratech Ltd depends on the infrastructure projects/orders by the Govt:

While analysing the business activity of PNC Infratech Ltd notices that all the projects undertaken by the company constitute the EPC work for the roads/runway projects being built by Govt. or the execution of BOT and HAM (hybrid annuity model) project allotted by the Govt. to the subsidiaries and joint ventures of the company.

A look at the list of the customers served by PNC Infratech Ltd indicates that the company derives almost its entire business from govt. departments, public sector units (PSUs) and other govt. entities.

Q1-FY2021 results presentation, page 28:

PNC Infratech Ltd Clients

The presence of Govt. agencies as major customers is not a recent change. Even more than 10 years back, in 2007, Govt. agencies used to be the only customers for PNC Infratech Ltd.

Credit rating report of PNC Infratech Ltd by CARE in March 2008:

PIL’s operations are dependent on infrastructure projects undertaken by governmental authorities. Contracts awarded by central, state and local government authorities constitute its entire order book as on Sep.30, 2007.

The company also highlighted its dependence on the investments/spending by Govt. on the infrastructure sector for its business. The company stressed that any change in Govt. policy related to the infrastructure sector can have a significant impact on its business.

RHP, May 2015, page 16:

Any change in government policies that results in a reduction in capital investment in the infrastructure sector could affect us adversely. If there is any change in the government or in governmental policies, practices or focus that results in a slowdown in infrastructure projects in such projects, our business, prospects, financial condition and results of operations may be materially and adversely affected.

An investor would appreciate that if a company were significantly dependent on the govt. projects for its business, then during the times where the priorities of the govt. change and it reduces spending on infrastructure, then the company’s business would be impacted. An investor would also appreciate that the infrastructure spending of the private sector is very small as compared to the Govt.

Therefore, if, in future, the current govt. reduces spending on infrastructure or any future govt. that might not prioritize infrastructure creation, then it would be difficult for the company to maintain its level of business activity. This is because the available business opportunity from the private sector’s spending on infrastructure would be very less and all the EPC players would be competing for the same.

A small example of how a business may get impacted due to Govt. policy change is the decline in the revenue of PNC Infratech Ltd in FY2017 when the sales had declined by more than 20% to ₹2,252 cr from ₹2,837 cr in FY2016. As per the company, the key reason for such a decline was demonetization done by the Govt. in Nov. 2016.

FY2017 annual report, page 9:

The Consolidated Revenue for FY17 was ₹ 2,252 crore as compared to ₹ 2,837 crore in FY16. The decline was a bit optical due to application of Indian Accounting standards (Ind-As) during the year, and were also significantly affected due to the demonetization drive in Q3 FY17.

Therefore, while analysing PNC Infratech Ltd, an investor should keep in her mind that PNC Infratech Ltd would face challenging times if the govt. shifts its priorities away from infrastructure creation. Any adverse govt. policy may have a serious impact on its business.

2) Infrastructure sector faces cyclicity: alternate periods of growth and de-growth:

While reading the credit rating reports of PNC Infratech Ltd prepared by the credit rating agency, CARE, then she notices that throughout its rating coverage, CARE has highlighted to the investors that the construction sector is faced with cyclical trends.

Credit rating report of PNC Infratech Ltd by CARE, November 2020:

The ratings, however, remain constrained by its geographical concentration risk,…inherent cyclical trends associated with the construction sector.

An investor would also appreciate from the above discussion that the infrastructure sector is highly dependent on the spending priorities of the govt. of the day. The priorities of the govt. keep on changes as per the changing socio-political situations. As a result, an investor would notice that there are periods when govt. spends a lot of money on infrastructure creation and there are periods when the govt.’s infrastructure spending almost comes to a halt.

In addition, infrastructure spending by Govt. as well as the private sector is linked to the economic activity in the country, which follows a cyclical pattern. When economic growth picks up, then the private sector increases its capital investments. At the same time, increased revenues for the govt. by way of increased tax inflow leads to the increased Govt. spending on infrastructure. On the contrary, when economic growth slows down, then both the private sector as well as the Govt. cut down on infrastructure spending.

Therefore, a combination of the factors of dependence on economic growth as well as the priorities of Govt. spending makes the construction sector a cyclical industry, which witnesses periods of good growth followed by periods of poor growth/de-growth.

An investor should keep the cyclical nature of the infrastructure industry in her mind whenever she analyses any infrastructure player.

Advised reading: How to do Business Analysis of a Company

3) There are very low entry barriers in the infrastructure sector:

An investor would appreciate that in the infrastructure sector, a player does not need to create any manufacturing plant. A company can outsource almost all of its man and material sourcing. As a result, during good times when the Govt. is spending a lot of money on infrastructure and is tendering many projects, then many new infrastructure players come up rapidly that increases the competition within a short period.

In the FY2017 annual report, PNC Infratech Ltd acknowledged the challenges faced by it due to low entry barriers in its business. The company highlighted how it creates a problem especially during the period when the project announcement by the Govt declines and only a few projects are available for allotment to EPC players.

FY2017 annual report, page 23:

Due to low entry barriers, the sector has witnessed entry of many large and small players which on one hand created a healthy competitive scenario however on the other hand, in the phase of low projects being awarded, it has becomes fiercely competitive which creates difficult operating environment.

Therefore, an investor would notice that during good times, many new EPC players come up, who earlier might be working as subcontractors or working as employees with the other EPC players. At times, erstwhile govt. employees also enter the EPC/infrastructure sector where they intend to use their network to obtain business contracts.

The fact that in the infrastructure sector, almost entire execution including workers, material as well as construction can be outsourced makes it possible for people to increase the supply/competition quickly.

Therefore, during good times, the competition increases significantly and tenders for every project witness intense competition by a large number of bidders. On the other hand, as the govt. spending on infrastructure slow down or the economy enters a down-phase, then the players start competing on prices to gain contracts. As a result, the profit margins in the construction activity decline and many EPC players are not able to survive the downturn.

An investor can assess the impact of cyclical phases of the construction industry on the EPC players when she reads the red herring prospectus (RHP) of PNC Infratech Ltd filed by the company before its IPO in 2015. In the RHP, PNC Infratech Ltd disclosed that previously, in FY2011-FY2012, the competition was very tough and every project witnessed bidding by almost 25-30 bidders whereas now (in 2015), the competition has reduced and only about 5 players bid for every project. The company also mentioned that now (2015); many projects are not witnessing even a single bid.

RHP, 2015, page 110:

Competition for bagging BOT projects has narrowed significantly over the past year. As against 2011-2012, when there were about 25-30 bidders for most projects, currently there are only around five bidders, with many projects not attracting even one bid.

Therefore, an investor would notice that in FY2011-2012, the construction industry witnessed very high competition and within 2-3 years by FY2015, the competition had reduced because many players would have gone out of the business.

Later, in FY2017, the competition increased once again when as discussed above, PNC Infratech Ltd highlighted to its investors that due to low entry barriers, many small and large players have entered the construction sector increasing the competition.

FY2017 annual report, page 23:

Due to low entry barriers, the sector has witnessed entry of many large and small players which on one hand created a healthy competitive scenario however on the other hand, in the phase of low projects being awarded, it has becomes fiercely competitive which creates difficult operating environment.

Advised reading: Understanding the Annual Report of a Company

Therefore, after witnessing a decline in competitive intensity in FY2015, the construction sector again saw an increase in competition in FY2017.

Because of increasing competition, PNC Infratech Ltd started to focus on large projects by stressing that large projects have lesser competition.

FY2018 annual report, page 20:

Mitigation: Our target is to bid larger projects as there is lesser competition.

However, it seems that the competition in the infrastructure segment has increased so much that even the large projects e.g. of value more than ₹1,000 cr have started witnessing many bids. In the Q3-FY2021 conference call, PNC Infratech Ltd highlighted that the competition is very steep as currently, even the large HAM projects of more than ₹1,000 cr value are getting more than 10 bidders for each project.

Q3-FY2021 conference call, February 2021, page 25:

T. R. Rao: We cannot say, which project, the competition is equally steep in both the cases, EPC as well HAM. In the HAM projects also we are getting more than 10 bids for a project of Rs.1,000 Crores value so we cannot say anything.

The company also intimated to the investors that it is not considering bidding for metro train projects because this segment has intense cut-throat competition.

Q4-FY2021 conference call, June 2021, page 13:

Yogesh Kumar Jain: We are not bidding metro projects because the competition is very high in the metro sector.

From the above discussion, an investor would appreciate that the construction industry follows a cyclical pattern with periods of intense competition (FY2011-2012, FY2017-2021) followed by periods of declining competition (FY2015). The low entry barriers in the construction space play an important role in the fluctuating levels of competition as the ability to outsource almost the entire workforce, material sourcing and construction makes it easy for supply to come up in short periods.

An investor should always keep this aspect of the construction industry with low entry barriers and a sharp increase in competition within a short period in her mind while she makes any prediction about the construction industry and the company participating in it. So, even if any EPC contractor shows high profits during a certain period, then due to low entry barriers, competition may come up very soon, which might bring down the profit margins.

4) Low bargaining power of EPC contractors with the customers (Govt. agencies):

An investor would appreciate that the primary customers of EPC contractors are govt. agencies and departments, who dictate terms as per the existing policies of the govt. The contractors can only accept or reject the offered terms. At times, there is no room for negotiation in the offered terms.

Such a situation puts the contractors in a difficult situation if after winning a contract, the business conditions change for worse.

PNC Infratech Ltd highlighted its position of low negotiating power with its customers in its red herring prospectus in 2015.

RHP, 2015, page 28:

Our ability to negotiate the terms of contracts with government authorities and state instrumentalities is limited and we may be required to accept unusual or onerous provisions in contracts in order to be engaged to execute such projects.

The company stressed that it cannot make the govt. change terms to suit it and at times, it has no other option to accept the offered terms even if they are detrimental to the business/profitability prospects. For example, in the tolling projects, the company cannot increase the toll on its own even if its costs increase. It is dependent upon the Govt. agencies agreeing to an increase in toll. Even if the Govt. agencies increase the toll, it may not sufficiently cover the increased costs, thereby, may affect profit margins.

The company highlighted its inabilities to increase toll rates in the RHP in 2015 on page 28:

The nature of contracts for our BOT projects and our OMT project are such that we have limited control over the terms relating to collection of tolling revenues. Generally, the government entity that has granted the relevant BOT concession to us unilaterally determines the terms on which we may collect toll revenues, and we are not permitted to amend such tolling rates without the prior written consent of such government entity… We cannot assure that the tolling rates set would be sufficient to recover our costs. Additionally, our ability to receive compensation on account of termination by the Government entities is limited.

Therefore, an investor would appreciate that if the Govt. agencies refuse to stipulate clauses in the contracts that provide for increasing revenue whenever there is an increase in costs, then the EPC/construction players can hardly do anything to negotiate with the Govt. agencies. It might be a “take it or leave it” proposition for the companies.

Therefore, an investor should keep in mind that first, the infrastructure players are highly dependent on the Govt. for their business and second, they do not have any pricing/negotiating power over the Govt. Therefore, if in a given period, the Govt. shows understanding to the contractors and provides then contracts with good profitability, then over time, the situation may change and the same or a different Govt. may choose to leave very little profit margins for the infrastructure players.

Therefore, an investor should always be cautious while projecting the business performance of infrastructure players.

Advised reading: How to do Business Analysis of a Company

5) Improving profit margins of PNC Infratech Ltd over last 10-years:

From the above discussion, an investor would remember that the operating profit margin (OPM) of PNC Infratech Ltd improved from 12% in FY2012 to 24% in the 12-months ended June 2021 i.e. July 2020-June 2021. Let us try to understand the key factors leading to an improvement in the profit margins of the company over the last 10-years.

5.1) Economies of scale:

While analysing the business history of PNC Infratech Ltd, an investor gets to know that one of the reasons for improving profit margins of the company as it has increased its size of operations is the “economies of scale”, which comes with the execution of a bigger order book. This is because, the company can execute more orders without proportionate spending on resources like workforce, material mobilization etc.

The credit rating agency, CARE highlighted the effect of “economies of scale” on the business of PNC Infratech Ltd in its credit report for the company in March 2011.

The profitability margins also improved on account of increased efficiency and economies of scale emanating from growing order book.

Even in March 2008, the credit rating agency, CARE mentioned that the increase in profit margins of PNC Infratech Ltd in FY2007 over FY2006 was due to the increasing ticket size of the contracts, which indicates economies of scale.

PBILDT margin have increased during FY06 and FY07 to 13.75% to 14.29% respectively due to increase in ticket size of the contracts

Advised reading: Credit Rating Reports: A Complete Guide for Stock Investors

Therefore, an investor would notice that when PNC Infratech Ltd grew its business to almost 5-times over the last 10-years from ₹1,273 cr in FY2012 to ₹6,157 cr in 12-months ended June 2021 (July 2020-June 2021), the economies of scale worked and as a result, the profit margins of the company increased.

5.2) Increase in toll/annuity revenue:

Another factor, which has led to the improvement of OPM over the last 10-years, is the increasing share of annuity/toll revenue in the overall consolidated sales of PNC Infratech Ltd.

As per the RHP filed by the company in 2015, page 301, in FY2012, PNC Infratech Ltd did not have any annuity/toll revenue. The company started to earn toll revenue in FY2013 and annuity revenue in FY2014.

PNC Infratech Ltd Consolidated Revenue Breakup FY2010 Dec 2014

From the above table, an investor would notice that in FY2012, PNC Infratech Ltd did not have any toll/annuity revenue. By FY2014, the company had toll and annuity revenue of about ₹150 cr, which was about 11% of its consolidated sales.

While analysing the FY2021 performance of the company, an investor notices that the toll and annuity revenue of PNC Infratech Ltd had increased to ₹919 cr, which is about 15% of the overall revenue.

Q1-FY2022 results, page 12, consolidated segmental results:

PNC Infratech Ltd Consolidated Segmental Results FY2021

Looking at the above table, an investor notices that the profit margin of toll/annuity revenue is about 60% (FY2021: 55,259.85/91,948.97 = 0.6), which is much higher than the profit margin on contract revenue (EPC) of about 10% (FY2021: 50,202.30/486,807.88 = 0.1).

Therefore, an investor would appreciate that as the share of toll/annuity revenue in the overall sales of a company would increase, then the overall profit margin for the company would improve. This is another reason for the increase in the OPM of PNC Infratech Ltd from 12% to 24% over FY2012-FY2021.

5.3) Focus of PNC Infratech Ltd only on projects with a minimum level of profit margin:

When an investor reads the comments of the management of PNC Infratech Ltd about their business strategy regarding obtaining contracts and profit margins, in the conference calls, then she notices that the company prefers to stick to a threshold of profit margin while bidding for projects. As per the management, it does not bid for projects with low-profit margins to show higher revenue growth.

In February 2021, the company intimated that it intends to get an EBITDA margin of about 13.5% on construction contracts whereas, on its equity investments in the HAM (hybrid annuity model) projects, it expects a return on equity of about 14%-15%.

Q3-FY2021 conference call, February 2021, page 23:

D. K. Maheshwari: In the HAM projects, there are two impacts, one is the EPC. So here we are expecting the EBITDA around 13.5% to 14% and as an equity part, where we bid on the equity return in the range of 14% to 15%

In June 2021, while discussing the Q4-FY2021 results, the management said that the company targets projects with EBITDA margins of 13.5% and it would not compromise on profit margins while bidding.

Q4-FY2021 conference call, June 2021, page 15:

D. K. Maheshwari: As already told earlier that we will consider the EBITDA around 13.5%. We will not compromise with the margins for taking the orders.

Therefore, the strategy of the management to bid only for projects of at least a minimum profit margin might also have led to an improvement in profit margins over the years.

5.4) Construction contracts with pass-through of increase in raw material costs:

On multiple occasions, PNC Infratech Ltd highlighted to the investors that the contracts entered by it with the customers (govt. agencies) allow for passing on of an increase in the raw material costs.

In the FY2015 annual report, the company intimated to its investors that it puts in price escalation clauses in its contracts with the customers.

FY2015 annual report, page 31:

The Company also puts in relevant clauses in the contracts to account for provable material cost escalations and thus protect margins.

The company once again highlighted the same in its FY2016 annual report at page 34.

The contracts we enter with government client are generally have with relevant cost escalation provisions that protect our margins.

In the conference call of the company in February 2021, while discussing Q3-FY2021 results, the management of the company indicated that the recent increase in raw material costs is not expected to have a significant impact on its profit margins due to price escalation clauses in the contracts entered by it with its customers.

February 2021 conference call, page 16:

Parvez Akhtar Qazi: Sure. And if I may ask one question. I mean recently, we have seen an increase in commodity prices so what is the kind of impact that we see on our margins in let us say Q4 or FY2022?

T. R. Rao: There is an escalation clause. So, we do not think any impact in the profitability because there is a price variation cause in the HAM projects as well as in the EPC projects.

From the above discussion, an investor would appreciate that the Govt. agencies tend to protect the contractors from raw-material-price-escalation-risk by permitting a pass on of the price increases. The ability of PNC Infratech Ltd to recover such an increase in raw material prices has allowed it to benefit from economies of scale with increasing business leading to improving profit margins over the years.

In the absence of such escalation clauses i.e. if these were fixed-price contracts, the company would have been severely impacted by highly volatile commodity price cycles like steel, cement etc. In such a situation, it would have been difficult for PNC Infratech Ltd to maintain its profit margins over the years.

The company highlighted the risk of fixed-price contracts in its RHP to the investors in 2015 on page 14.

Our ability to pass on increases in the purchase price of raw materials and other inputs may be limited in the case of contracts with limited, or no price escalation provisions and we cannot assure you that these variations in cost will not lead to cost-overruns. Further, other risks generally inherent to the development and construction industry may result in our profits from a project being less than as originally estimated or may result in us experiencing losses due to cost and time overruns, which could have a material adverse effect on our cash flows, business, financial condition and results of operations

From the earlier discussion, an investor would remember that infrastructure players have very low negotiating power over their customers, which are primarily Govt. agencies. Therefore, if any company has entered into a fixed-price contract, and later on costs increase, then it may have to complete the project at a loss.

An investor should keep this aspect in her mind while she projects the current performance of any infrastructure player. Even if the current profit margins are good, then in the future, the approach of the same govt. or the next govt. may change and it may force the infrastructure players to accept tough terms in the contracts.

5.5) Backward integration and other strategies to control costs by PNC Infratech Ltd:

While reading the annual reports of the company, an investor notices that PNC Infratech Ltd has taken steps for backward integration of its operations by setting up its own sources of key raw material like construction aggregates etc. In addition, the company has invested in its own equipment, which protects it from changing lease rates for equipment and as a result, it is able to keep the variations of its input costs under control.

In the FY2016 annual report, the company disclosed to the investors the benefits that it has received by the way of backward integration, at page 13:

Backward integration: The core of our cost management is derived from the captive in-sourcing of two of the biggest cost items – road construction equipment and construction aggregates. At PNC, we invested over ₹400 cr in gross block (select construction equipment) that has catalyzed timely projects completion; we invested in mines for the captive availability of aggregates, moderating our raw material costs.

PNC Infratech Ltd also highlighted that the decision of the company to produce the key raw material in-house and to own the construction equipment has allowed it to control its costs as well as to complete the projects in time. This is because, it is now less dependent on third-party vendors for material and equipment, which otherwise would lead to risks of disruption in the project construction for the factors outside its control.

The company has also highlighted its decision to execute the projects independently, thereby, protecting itself from dependence on other parties as one of the reasons for its record of timely construction of projects.

FY2014 annual report, page 14-15:

the Company undertakes construction activities of all its DBFOT projects (BOT-toll and BOT-annuity) independently making it less dependent on third parties for project implementation. These multifarious capabilities enhance control leading to scheduled project completion.

The Company owns a large equipment fleet, reducing its dependence on external vendors, facilitating timely and before-schedule completion of projects.

Apart from producing in-house construction aggregates, owning the road-construction-equipment and independently executing the construction contracts, PNC Infratech Ltd has also highlighted other aspects of its strategy like creating storage facilities of key raw material to ensure timely supplies as well as directly dealing with the largest suppliers for material as the reasons for keeping its costs under control.

FY2014 annual report, page 19:

The Company invested in storage facilities for petroleum products, machinery components and cement, among others, to ensure uninterrupted work at sites.

FY2020 annual report, page 29:

Apart from this, the Company procures other critical raw materials like cement and steel directly from leading manufacturers with whom we have developed strong relationships over a period, which ensures the best prices, quality and in-time supplies.

Another factor that has worked in the favour of the company is its decision to focus primarily on the projects in North India, as per the company, a radius of 500km. This has helped the company in quick movement of man and material as well as sharing resources among many projects leading to lower costs and fast execution of projects.

FY2016 annual report, page 13:

Geographical footprint: At PNC Infratech, we have selected to do business in a concentrated geographical area as opposed to working across the largest stretch of the Indian land mass. This focus has made it possible for us to generate huge logistic benefits: a faster sharing of road building equipment between projects as well as lower transportation costs of raw materials (aggregates) from mines to project sites. The result of this deliberate focus translated into nearly 90% of our projects being conducted within a radius of 500kms in North India (Haryana, Madhya Pradesh, Maharashtra, Rajasthan, Uttar Pradesh, Uttarakhand, Punjab and West Bengal).

An investor would appreciate that the above-mentioned strategies of PNC Infratech Ltd like owning the equipment, production of aggregates, buying material from large manufacturers, creating storage facilities, low dependence on other parties etc. have enabled it to control costs and complete projects within time. These seem to have protected the company from raw material price increases as well as cost overruns associated with project delays.

As a result, the company could keep its costs under control and enjoy improving profit margins as economies of scale worked in its favour with increasing project-ticket-sizes as well as a bigger order book.

5.6) Timely execution of projects by PNC Infratech Ltd:

From the above discussion, an investor would appreciate that PNC Infratech Ltd has taken many steps to control its costs, fast movement of man, material and equipment as well as a strategic decision to avoid dependence on third parties by executing the projects itself. These steps have helped it to complete its projects within time and at times, significantly earlier than the project deadline. As a result, for many projects, PNC Infratech Ltd has received an early completion bonus from the Govt. authorities, which has increased its profit margins.

The company highlighted its strategy to complete projects ahead of schedule to earn a bonus as a tool to improve its profit margins in the FY2018 annual report, page 20.

We aim to complete the project before the scheduled completion date and within the budgeted cost, which help us to earn bonus where ever there is such provision.

In the past, there have been many instances where PNC Infratech Ltd completed its projects before time. As a result, the company earned a significant amount of bonuses from Govt. authorities, which improved its profit margins.

As early as 2003, the company completed the four-laning road project of the Agra-Gwalior section before schedule and earned a bonus. The company also completed the Gwalior-Bhind road project before time and started toll collection three months earlier than the scheduled (FY2014 annual report, page 9).

In 2018, PNC Infratech Ltd received a bonus of about ₹58 cr when it completed its section of the Agra Lucknow Expressway before the deadline. In addition, the company also received a bonus annuity of about ₹33.7 cr when it completed Raebareli-Jaunpur section before time (FY2018 annual report, page 3).

In 2019, the company completed the Aligarh-Moradabad section of the road project about 73 days before the scheduled date and as a result, entitled it to an early completion bonus (FY2019 annual report, page 7).

Therefore, an investor would appreciate that PNC Infratech Ltd has taken steps, which have enabled it to complete many projects before the scheduled date of completion. As a result, the company has benefited in two manners; first, it could avoid cost overruns associated with project delays and second, it could get a bonus, which increased its profit margins.

Therefore, the instances of timely/early completion of projects are also one of the reasons for the improved profit margins of the company over the last 10-years from 12% in FY2012 to 24% in FY2021.

Overall, if an investor attempts to summarize the key business characteristics of PNC Infratech Ltd or for any infrastructure player, then she notices that such companies are highly dependent on Govt. agencies for their business. These companies do not have any pricing power over these Govt. agencies.

In addition, there are very low barriers to entry in the construction space. This is because almost everything from the workforce, material sourcing and construction can be outsourced. As a result, during good times, many new players enter the construction sector, which increases the competition.

The construction activity in the infrastructure sector is highly dependent on the Govt. spending and the phase of the economic cycle. Both of these factors are cyclical. As a result, during the down phase, the intense competition reduces the profit margins of the infrastructure players.

Therefore, to run the business efficiently, infrastructure players need to keep their costs under strict control, complete the projects on time to avoid cost overruns and selectively bid for projects that allow for pass-through of cost escalations. If any infrastructure player is not able to manage these different aspects of the business efficiently, then it may not survive the down phase of the economic cycle. There have been numerous instances of infrastructure firms, which have become bankrupt during an economic down-cycle.

From the analysis of different public documents of PNC Infratech Ltd, it seems that the company has managed its operations efficiently over the years. As a result, it has increased the size of its business operations and it has kept its costs under check. Therefore, it has managed to increase its profit margins significantly over the last 10-years.

However, going ahead, an investor needs to keep in her mind various factors like cyclicity of the infrastructure spending by Govt., high competition, low entry barriers, low bargaining power over the customers etc. before she projects the current performance of the company into the future. This is because; in the infrastructure sector any change in the priorities of the current or the future govt. may change the business fortunes of any company.

While analysing the tax payout ratio of PNC Infratech Ltd., an investor notices that for most of the years, the tax payout ratio of the company has been in line with the standard corporate tax rate prevalent in India. However, during FY2016-FY2019, the company has reported a negative tax payout ratio i.e. its profit after tax is higher than its profit before tax.

While going through the annual reports of the company during this period, an investor notices that it is because of the tax incentives of previous years, which were withheld by the Income Tax Department in the past; however, now the company got the decisions in its favour. As a result, the availing of past income tax incentives in the current years led to a negative tax payout ratio.

The following table from the FY2018 annual report, page 163, shows the reconciliation of the income tax expense reported by the company in the profit & loss statement (P&L) with the standard corporate tax rate for FY2017 and FY2018. During these two years, PNC Infratech Ltd had reported a negative tax payout ratio of (28%) and (12%) respectively.

PNC Infratech Ltd Income Tax Reconciliation FY2017 FY2018

An investor would notice that the key reasons for a very low/negative tax payout ratio of PNC Infratech Ltd during these years were the tax incentives of earlier years, which are adjusted in the current period as well as the other tax holidays available to the company.

Going ahead, an investor may keep a close watch on the tax payout ratio of the company and understand more about the tax incentives available to the company.

Further advised reading: How to do Financial Analysis of a Company

Operating Efficiency Analysis of PNC Infratech Ltd:

a) Net fixed asset turnover (NFAT) of PNC Infratech Ltd:

When an investor analyses the net fixed asset turnover (NFAT) of PNC Infratech Ltd in the past years (FY2013-21), then she notices that the NFAT of the company declined consistently during the initial period from 4.7 in FY2013 to 0.9 in FY2017. However, afterwards, the NFAT has increased consistently sharply to 3.1 in FY2021.

To understand the reasons behind such a contrasting change in the efficiency of asset utilization by PNC Infratech Ltd, an investor needs to understand how the business of the company has evolved over the years.

An investor notices that in the initial part of the last decade, PNC Infratech Ltd was working primarily as an EPC contractor. As a result, its fixed assets primarily consisted of road construction equipment and other material required for building roads. However, since FY2012, the company started focusing on toll/annuity projects.

The following table from the RHP filed by the company in May 2015 containing the breakup of consolidated fixed assets shows that until FY2011, PNC Infratech Ltd had very little assets under “intangible assets” and “intangible assets under development”, which represent toll/annuity projects like BOT (build, operate and transfer) and HAM (hybrid annuity model) projects.

RHP, May 2015, page 50:

PNC Infratech Ltd Fixed Assets FY2010 To Dec 2014

From the above table, an investor would notice that from FY2012 onwards, PNC Infratech Ltd started building many BOT/annuity projects and the share of intangible assets (IA) and intangible assets under development (IAUD) in its fixed assets started increasing. In FY2012, the share of intangible assets (IA) and intangible assets under development (IAUD) in the total fixed assets of the company was about 63%.

The following disclosure by PNC Infratech Ltd in its annual reports would help an investor understand that as per the accounting norms, the money spent by the company on creating toll/annuity assets is capitalized under intangible assets and intangible assets under development.

FY2020 annual report, page 171:

Service Concession Arrangements: The group constructs or upgrades infrastructure (construction or up-gradation services) used to provide a public service and operates and also maintains that infrastructure (operation services) for the specified period of time…The intangible asset model is used to the extent that the group receives a right (i.e. a franchisee) to charge users of the public service.

By FY2016-FY2017, the share of intangible assets (IA) and intangible assets under development (IAUD) in total consolidated fixed assets had increased to 85-90%.

FY2017 annual report, page 154:

PNC Infratech Ltd Fixed Assets FY2015 FY2016 FY2017

To assess the net fixed asset turnover of each of the two major business segments of PNC Infratech Ltd, an investor may calculate how much revenue each rupee of assets generally earns in the toll/annuity business and EPC/contract business.

The following table from the FY2017 annual report, page 199 shows the revenue earned by the two business segments of PNC Infratech Ltd: contract/EPC and toll/annuity.

PNC Infratech Ltd Segment Revenue FY2016 And FY2017

From the above data of the segment revenue and the assets deployed by PNC Infratech Ltd in each of the two business segments, an investor may calculate the net fixed asset turnover (NFAT) of each of the business segments.

In FY2017, about ₹350 cr of assets in the EPC/contract business earned a revenue of about ₹1,650 cr indicating an NFAT of about 4.7 (= 1,650 / 350). On the other hand, in FY2017, about ₹2,050 cr of assets deployed in the toll/annuity segment earned a revenue of about ₹600 cr indicating an NFAT of 0.3 (=600/2,050).

Therefore, an investor would appreciate that as the share of intangible assets (IA) and intangible assets under development (IAUD) in total consolidated fixed assets would increase, the NFAT of the company would decline. On the contrary, if the share of intangible assets (IA) and intangible assets under development (IAUD) in total consolidated fixed assets decreases, then the NFAT of the company would increase.

During the first half of the last 10-years, the share of intangible assets (IA) and intangible assets under development (IAUD) in total consolidated fixed assets of PNC Infratech Ltd increased sharply from FY2012 (63%) to FY2016-FY2017 (85%-90%). As a result, the NFAT of the company declined from 4.7 in FY2013 to 0.9 in FY2017.

Later on, the share of intangible assets (IA) and intangible assets under development (IAUD) in total consolidated fixed assets of PNC Infratech Ltd started declining and by FY2021, it had declined to 63% of fixed assets.

Q4-FY2021 results, page 15:

PNC Infratech Ltd Fixed Assets FY2020 And FY2021

As a result of the decline of the share of intangible assets (IA) and intangible assets under development (IAUD) in total consolidated fixed assets, the NFAT of PNC Infratech Ltd increased from 0.9 in FY2017 to 3.1 in FY2021.

Further advised reading: Asset Turnover Ratio: A Complete Guide for Investors

b) Inventory turnover ratio of PNC Infratech Ltd:

While analysing the efficiency of inventory utilization by PNC Infratech Ltd, an investor notices that during the last 10 years, the consolidated inventory turnover ratio (ITR) of the company has increased from 10.2 in FY2013 to 18.6 in FY2021.

An improvement in the ITR over the years indicates that PNC Infratech Ltd has improved the efficiency of inventory utilization over time.

From the above discussion, an investor would remember that the business of PNC Infratech Ltd constitutes EPC/construction and toll/annuity segments. The EPC business is primarily a part of the standalone entity whereas the toll/annuity projects are majorly a part of the SPVs/subsidiaries/joint ventures.

Therefore, if an investor wants to assess the inventory utilization efficiency of the EPC business PNC Infratech Ltd, an investor may assess the standalone performance of the company. On a standalone basis also, the ITR of PNC Infratech Ltd has increased from 10.3 in FY2013 to 15.9 in FY2021.

It seems that the various strategic steps taken by the company, which have been discussed above like limiting its geographical presence mainly in a 500 km radius in North India, having a captive construction aggregate unit etc. have resulted in the efficient utilization of its assets including inventory.

Going ahead, an investor may keep track of the inventory level of the company to understand whether the company is able to maintain its inventory utilization efficiency after mergers.

Further advised reading: Inventory Turnover Ratio: A Complete Guide

c) Analysis of receivables days of PNC Infratech Ltd:

Over the last 10 years, the receivables days of PNC Infratech Ltd have improved from 82 days in FY2013 to 21 days in FY2021. A reduction in the receivables days over the years indicates that PNC Infratech Ltd has been able to collect its dues from its customers (Govt. agencies) in time.

Even on a standalone basis, the receivables days of PNC Infratech Ltd have declined from 114 days in FY2013 to 61 days in FY2021. It indicates that even in the EPC business, the company is able to collect its money from the customers (govt. agencies).

From the initial discussion, an investor would remember that in the case of infrastructure players, the companies raise bills to the customer based on their estimate of the work done/stage of completion. However, the customer does its own evaluation for the project progress and releases the payment only after it is convinced.

An investor would appreciate that in such an arrangement, there is always a probability of dispute/difference in the opinion of the company and the customer with respect to the stage of project completion as well as the quality of the work done. The company highlighted this aspect of its business in its FY2014 annual report, page 21:

Disputes between project owners and contractors on issues (quantity variation, incremental billing, payment terms and timelines) have often warranted time-consuming government intervention.

Therefore, there is a possibility of the customer withholding the payment. As a result, in the case of infrastructure players, especially those dealing with Govt. agencies, many times, investors would notice that the companies face delays in getting payment from customers.

PNC Infratech Ltd had highlighted this risk to the investors in its RHP in May 2015 on pages 16-17:

Further, payments from the Central, state and local governmental authorities in India may be subject to several delays due to regulatory scrutiny and long procedural formalities, including any audit by the Comptroller and Auditor General of India.

We may further encounter disputes with certain governmental authorities in respect of the projects awarded by them, which may cause delay to our receiving payments due from such parties, or may inhibit our ability to recover our costs.

In the RHP, PNC Infratech Ltd also mentioned an example of a case where its joint venture company had to initiate an arbitration against the National Highways Authority of India (NHAI).

RHP, May 2015, page 17:

For instance, while the construction in respect of the four laning of National Highway 24 from Hapur to Moradabad in Uttar Pradesh… that we have undertaken through our joint venture, PNC-BEL JV, has been completed, arbitration proceedings were initiated by PNC-BEL JV against the NHAI in respect of alleged breach of certain terms and conditions of the project agreements.

While reading the annual reports of PNC Infratech Ltd, an investor comes across numerous instances where the company had disputes with the Govt. agencies. As a result, it had to resort to arbitration for recovering its dues.

As per the FY2020 annual report, SPVs of the company have pending disputes with NHAI for more than ₹1,000 cr.

FY2020 annual report, page 198:

PNC Kanpur Highways Ltd. has a pending arbitration case against National Highways Authority of India (NHAI)… The company has raised claims for total amount of 61,876.10 Lakhs including interest in the said arbitration against NHAI. The arbitration proceedings are underway.

PNC Raebareli Highways Pvt. Ltd. has a pending arbitration case against National Highways Authority of India (NHAI)… The company has raised EPC claims for total amount of 38,925.93 Lakhs including interest in the said arbitration against NHAI. The arbitration proceedings are underway.

Therefore, an investor should be aware of the risks that companies face in getting payments while dealing with govt. agencies. The Govt. agencies are subject to various audits, investigations, regulatory scrutiny, which leads to delays in the release of payments to the vendors.

Even if the company has been able to receive its payments on time until now; however, going ahead, an investor should closely monitor the trend of receivables days. This is because any change in the policies of the current govt. or the next govt. may lead to delays in payments and in turn, may increase the working capital requirements of the company.

Further advised reading: Receivable Days: A Complete Guide

When an investor notices that PNC Infratech Ltd has improved its inventory turnover ratio as well as receivables days over the last 10-years, then she can understand that the company has improved its overall working capital efficiency.

Such a performance on the working capital management looks good because as per the company, its business operations are working-capital-intensive. PNC Infratech Ltd highlighted that for any project a significant amount of working capital is used for man and material mobilization and at times, its customers make it mandatory to spend its money for such project mobilization.

RHP, May 2015, page 25:

Our business requires a high amount of working capital. In many cases, significant amounts of working capital are required to finance the purchase of materials and the performance of engineering, construction and other work on projects before payments are received from clients. In certain cases, we are contractually obligated to our clients to fund the working capital requirements of our projects.

When an investor compares the cumulative net profit after tax (cPAT) and cumulative cash flow from operations (cCFO) of PNC Infratech Ltd for FY2012-21 then she notices that the company has converted all of its profits into cash flow from operating activities.

Over FY2012-21, PNC Infratech Ltd reported a total cumulative net profit after tax (cPAT) of ₹2,268 cr. During the same period, it reported cumulative cash flow from operations (cCFO) of ₹2,539 cr.

It is advised that investors should read the article on CFO calculation, which would help them understand the situations in which companies tend to have the CFO lower than their PAT. In addition, the investors would also understand the situations when the companies would have their CFO higher than the PAT.

Further advised reading: Understanding Cash Flow from Operations (CFO)

The Margin of Safety in the Business of PNC Infratech Ltd:

a) Self-Sustainable Growth Rate (SSGR):

Read: Self Sustainable Growth Rate: a measure of Inherent Growth Potential of a Company

Upon reading the SSGR article, an investor would appreciate that if a company is growing at a rate equal to or less than the SSGR and it can convert its profits into cash flow from operations, then it would be able to fund its growth from its internal resources without the need of external sources of funds.

Conversely, if any company attempts to grow its sales at a rate higher than its SSGR, then its internal resources would not be sufficient to fund its growth aspirations. As a result, the company would have to rely on additional sources of funds like debt or equity dilution to meet the cash requirements to generate its target growth.

An investor may calculate the SSGR using the following formula:

SSGR = NFAT * NPM * (1-DPR) – Dep

Where,

  • SSGR = Self Sustainable Growth Rate in %
  • Dep = Depreciation rate as a % of net fixed assets
  • NFAT = Net fixed asset turnover (Sales/average net fixed assets over the year)
  • NPM = Net profit margin as % of sales
  • DPR = Dividend paid as % of net profit after tax

(For systematic algebraic calculation of SSGR formula: Click Here)

While analysing the SSGR of PNC Infratech Ltd, an investor would notice that over the years, the company had a low SSGR ranging from negative values to low single digits of 2%-4%. However, an investor notices that PNC Infratech Ltd has grown at a CAGR of about 18% in the last 10-years from ₹1,273 cr in FY2012 to ₹5,788 cr in FY2021.

As PNC Infratech Ltd has grown at a pace higher than what its internal resources could afford; therefore, over the years, the company has to rely on additional capital in the form of equity dilution and debt to meet its funds’ requirement.

  • Attempted IPO in January 2008: PNC Infratech Ltd tried to raise money by an IPO; however, it deferred the IPO even after getting a go-ahead from SEBI due to global financial meltdown. (DRHP, January 15, 2008)
  • FY2009: Raised ₹10 cr from promoters: As the plans of the IPO could not materialize in FY2009, therefore, the company had to raise ₹10 cr from its promoters (FY2009 annual report, page 27 & 31).
  • FY2010: IPO again deferred: PNC Infratech Ltd attempted to raise ₹160 cr via an IPO. However, despite getting all the regulatory approvals, the company once again deferred its IPO due to weak stock market conditions (DRHP, Nov. 17, 2009).
  • FY2010: Raised ₹19 cr by issuing shares under preferential allotment. As the company could not raise money via IPO; therefore, the company raised ₹19 cr by preferential allotment of shares (FY2010 annual report, page 20 & 26).
  • FY2011: Raised ₹150 cr from NYLIM Jacob Ballas India (FVCI) III LLC by diluting a 14.29% stake in the company (FY2011 annual report, page 3 & 27).
  • FY2016: IPO: PNC Infratech Ltd raised ₹434.7 cr by issuing 11,500,000 shares at ₹378 per share. In addition, the IPO also comprised of the sale of 1,421,708 shares by NYLIM Jacob Ballas India (FVCI) III LLC at ₹378 amounting to ₹53.7 cr.
  • An incremental debt of ₹3,383 cr: In addition to the above-discussed equity dilutions, PNC Infratech Ltd also raised a total of ₹3,383 cr by way of debt over FY2012-FY2021 because the total debt of the company increased from ₹373 cr in FY2012 to ₹3,755 cr in FY2021 (3,755 – 372 = 3,383).

Therefore, an investor would notice that the business of PNC Infratech Ltd is very capital intensive and the company is not able to achieve its desired growth rate only from its business profits. As a result, over the years, the company had to resort to raising more & more debt as well as multiple instances of equity dilution where it had to raise money from the promoters, preferential allotment, and private equity funds as well as from the public via IPO.

An investor arrives at the same conclusion when she analyses the free cash flow (FCF) position of PNC Infratech Ltd.

b) Free Cash Flow (FCF) Analysis of PNC Infratech Ltd:

While looking at the cash flow performance of PNC Infratech Ltd, an investor notices that during FY2012-2021, it generated cash flow from operations of ₹2,539 cr. During the same period, it did a capital expenditure of about ₹3,397 cr.

Therefore, during this period (FY2012-2021), PNC Infratech Ltd had a negative free cash flow (FCF) of (₹858) cr (=2,539 – 3,397).

In addition, during this period, the company had a non-operating income of ₹450 cr and an interest expense of ₹2,293 cr. As a result, the company had a net negative free cash flow of (₹2,701) cr (= -858 + 450 – 2,293). Please note that the capitalized interest is already factored in as a part of the capex deducted earlier.

As mentioned in the earlier discussion, PNC Infratech Ltd has attempted to meet this funds’ shortfall by raising debt as well as equity dilution.

In recent times, the company is attempting to sell its completed road projects to raise money to meet the cash shortfall. It is trying to sell one of its BOT projects, Ghaziabad-Aligarh Highway and has entered into an agreement with Cube Highways on April 1, 2021.

Corporate announcement by PNC Infratech Ltd dated April 2, 2021, page 1:

Company has on 01.04.2021 entered into a Share Purchase Agreement and other related transaction documents inter alia, with Cube Highways for sale of its holding in Ghaziabad Aligarh Expressway Private Limited (GAEPL), an “Associate” of the Company.

In addition, the company is also trying to sell some of its completed HAM (hybrid annuity model) projects to raise money.

Q3-FY2021 conference call, February 2021, page 18:

D. K. Maheshwari: As intimated to you earlier that the two BOT road projects are going to be completed in 2021, but we have given the mandate for monetisation of 6 HAM projects, and one BOT project Bareilly to Almora and one annuity project Raebareli.

Q4-FY2021 conference call, June 2021, page 5:

Mohit Kumar: I think we were in talks to monetize our HAM portfolio or a part of HAM portfolio. Do you expect this we can close some of the deal in this particular fiscal year?

D. K. Maheshwari: We are in discussions with two interested investors andwe are expecting that before the end of FY22 this should be finalized, if we get minimum expected valuation.

Therefore, an investor would appreciate that the business of PNC Infratech Ltd is capital intensive where the company is not able to meet its funds’ requirements from its business profits. As a result, the company has to raise additional money by way of debt, equity dilution as well as sell its existing assets.

An investor would notice that the company is continuously under pressure to raise fresh money from equity dilution/selling assets or raising more debt to meet its funding requirements. An investor should also note that the cash & investments balance reflecting in the balance sheet may not be entirely usable by the company freely for its funding needs. This is because a significant amount of cash balance is usually held up by the lenders of different projects as a part of their security for the loans.

The management of PNC Infratech Ltd intimated to the shareholders that on March 31, 2021, out of the total cash & investments of about ₹1,400 cr, a sum of about ₹600 cr is not available for use by the company because it is held up by the lenders.

Q4-FY2021 conference call, June 2021, page 7:

D. K. Maheshwari: As against the total cash and the bank in consolidated position is Rs. 1400 crores, out of that Rs. 800 crores around is on standalone. Remaining Rs. 600 crores of cash and bank balance is mainly because of DSCRA balances and the margins we have given.

Ashish Shah: It is not available. Basically the Rs. 600 crores of all the SPVs put together is not available for use for the parent company, correct? It is a locked with the banks for some commitments or margin?

D. K. Maheshwari: Right.

Going ahead, an investor should keep a close watch on the free cash flow generation by PNC Infratech Ltd to understand whether the company is able to generate surplus cash from its operations or it has to continuously infuse money by way of additional sources like debt and equity dilution.

Further advised reading: Free Cash Flow: A Complete Guide to Understanding FCF

Self-Sustainable Growth Rate (SSGR) and free cash flow (FCF) are the main pillars of assessing the margin of safety in the business model of any company.

Further advised reading: 3 Simple Ways to Assess “Margin of Safety”: The Cornerstone of Stock Investing

Additional aspects of PNC Infratech Ltd:

On analysing PNC Infratech Ltd and after reading annual reports, DRHP, its credit rating reports and other public documents, an investor comes across certain other aspects of the company, which are important for any investor to know while making an investment decision.

1) Management Succession of PNC Infratech Ltd:

PNC Infratech Ltd is promoted by four brothers: Mr Pradeep Kumar Jain (Chairman and Managing Director, aged 63 years), Mr Naveen Kumar Jain (aged 59 years), Mr Chakresh Kumar Jain (Managing Director & Chief Financial Officer, aged 57 years) and Mr Yogesh Kumar Jain (Managing Director, aged 49 years).

FY2018 annual report, page 65:

Except Mr. Pradeep Kumar Jain, Chairman and Managing Director, Mr. Naveen Kumar Jain, Whole time Director, Mr. Chakresh Kumar Jain, Managing Director, Mr. Yogesh Kumar Jain, Managing Director who are the brothers, none of the directors are relative of any other directors.

The phrase PNC in the name of the company seems to be the initials of Pradeep, Naveen and Chakresh.

Until December 2, 2017, all the four brothers were a part of the board of directors in the executive positions. However, from December 2, 2017, Mr Naveen Kumar Jain resigned from the position. However, the remaining three brothers are holding executive positions in the company.

FY2018 annual report, page 51:

During the year under review, Mr. Naveen Kumar Jain has resigned from the post of whole time director w.e.f. December 02, 2017

As per the RHP (May 2015, page 165-166) of the company, two other relatives of the promoter brothers held executive positions in the company.

  • Mr Ashish Jain, age 45 years (in 2015), who is brother-in-law of the promoter brothers, worked as project director in the company.
  • Ms Ishu Jain, age 33 years (in 2015), who is daughter-in-law of Mr Pradeep Kumar Jain, worked as the Deputy Director, Project Planning and Execution in the company.

The presence of younger family members at executive positions within the group, while the senior members are still handling responsibilities, looks like a good succession plan. This is because the young members can learn about the fine nuances of the business under the guidance of senior members until the seniors decide to take retirement.

An investor may contact the company directly to understand the exact planning of the promoters about the succession of leadership in the company.

Further advised reading: How to do Management Analysis of Companies?

2) Political risk faced by PNC Infratech Ltd:

While reading about the promoters of the company, an investor notices that the promoters of the company look close to the political party, Bharatiya Janata Party (BJP). This is evident from the fact that one of the promoters of the company, Mr Naveen Kumar Jain is a member of BJP and is currently, the mayor of Agra Municipal Corporation since 2017 (Source).

In FY2011, Mr Naveen Kumar Jain was part of a group, which conducted a mock funeral of the then chief minister of Uttar Pradesh (UP), Ms Mayawati. Thereafter, an FIR (first information report) was filed against Mr Naveen Kumar Jain. PNC Infratech Ltd disclosed these details in its RHP in May 2015.

RHP, May 2015, page 355:

An FIR dated March 17, 2011 was filed at the Hari Parvat police station, Agra against our Promoter, Mr. Naveen Kumar Jain and others on account of the fact that they were allegedly involved in carrying out a mock funeral of the then Chief Minister of Uttar Pradesh, Ms. Mayawati.

In August 2018, another political party, Congress, targeted the current BJP govt. in UP when there was an accident on the section of Agra-Lucknow Expressway built by PNC Infratech Ltd. (Source: Congress targets Yogi government over bonus to firm of Agra mayor’s brother: Times of India, August 5, 2018)

The Congress on Saturday attacked the Yogi Adityanath led state government for awarding a Rs 58 crore bonus to PNC Infratech Ltd for early completion of a stretch of Agra-Lucknow Expressway, which caved in within six months of the bonus being given. The firm, owned by the brother of Agra’s mayor Naveen Jain of BJP, had constructed the 56 km stretch of the expressway from Agra to Firozabad.

On Wednesday, an SUV had plunged into a 50-foot-deep ditch after a service road of the expressway caved in. The four occupants of the car had a narrow escape.

From the above incidences, an investor would appreciate that PNC Infratech Ltd seems to have political exposure due to the closeness of its promoters with the BJP.

An investor would notice that political affiliations might help the promoters/companies in getting more business when the political environment is in favour. However, political affiliations may work against the promoters/companies when the political environment is not in their favour.

The company itself recognised in its RHP (2015) that there are political influences/interferences have the potential of affecting the project allotments.

RHP, May 2015, page 17:

we rely heavily upon central and state governments and governmental authorities for executing large scale infrastructure projects in India, including the NHAI and public works departments of various state governments (“PWD”). Such governmental authorities can be subject to political influence, and contracts awarded thereby may be subsequently rescinded for reasons not connected to the project or the successful party.

Therefore, an investor should always keep in mind that political affiliations may act as a double-edged sword. While these may help the company in good times, these may have significant negative impacts on the company when political tables turn. Therefore, an investor should also keep the political dimension in her assumptions while projecting the performance of PNC Infratech Ltd.

Apart from the political risk, PNC Infratech Ltd faces another risk due to its dealing with Govt. entities and officers. It is the risk of getting involved in enquiries involving corruption charges against govt. officers.

In one such instance, premises of PNC Infratech Ltd and its promoters were raided by the Central Bureau of Investigation (CBI) in April 2012 on the charges of corruption involving a tender for construction at Lucknow Airport (Source: Lucknow airport scam: CBI conducts raids in four states: Indian Express, April 12, 2012)

CBI sources said they found that AAI officials and the proprietors of the firms were involved in criminal conspiracy in the two projects

The officials and the proprietors of the firms allegedly inflated the estimated costs of the projects.

Searches were also conducted at the residence and office of proprietor of IPL BB Bhaskar Reddy in Hyderabad and proprietor of PNC Infratech Ltd Pradeep Jain and his brothers in Agra

In the RHP filed by the company in May 2015, PNC Infratech Ltd disclosed that CBI did not find anything objectionable during these searches.

RHP, May 2015, page 17:

For instance, in 2012, the Central Bureau of Investigation, Anti-Corruption Branch, Lucknow undertook a search at certain premises of our Company….the search was conducted in the presence of our Promoter and Director, Mr. Yogesh Kumar Jain, and report dated April 11, 2012 was issued to our Company stating that no articles, documents or information were seized pursuant to such search proceedings. Our Company has not received any intimation, notice, summons or any other information or correspondence in this respect from the Central Bureau of Investigation…

However, an investor should always be aware that in the businesses, which have continued dealings with Govt. agencies where decisions about the large deployment of public money are taken, the companies are always at a risk of getting involved in anti-corruption investigations. PNC Infratech Ltd had highlighted it as a risk in its RHP in May 2015 at page 17:

we may be included in investigations or other proceedings in respect of offences alleged against the personnel of government authorities that we engage with in the ordinary course of business.

Therefore, an investor should always keep this aspect of business dealings of infrastructure companies in her mind while she analyses them.

Further advised reading: Why Management Assessment is the Most Critical Factor in Stock Investing?

3) Project execution by PNC Infratech Ltd:

As discussed above, an investor would appreciate that PNC Infratech Ltd has completed many projects before the scheduled completion date and earned a bonus from Govt. agencies like NHAI. Completion of projects ahead of schedule indicates good project execution skills by PNC Infratech Ltd.

However, while analysing the company, an investor comes across a few instances where it seems that the project execution by PNC Infratech Ltd left scope for improvement.

For example, the construction done by the company for Dholpur-Morena highway construction was not up to the mark. As a result, the Indian Institute of Technology (IIT), Kanpur was involved to overcome the shortcomings. PNC Infratech Ltd intimated the investor about it in its RHP in May 2015 on page 20:

For instance, in fiscal 2013, design-related deficiencies were discovered in certain parts of the construction in respect of the four laning of the Dholpur to Morena Section… The Indian Institute of Technology, Kanpur approved a rehabilitation scheme for strengthening the construction, and our supervision consultant, Wilbur Smith Associates, issued instructions on September 4, 2013, pursuant to which rehabilitation work was commenced in October 2013 and completed in December 2014.

The construction of a bridge over Chambal River by PNC Infratech Ltd was not up to the mark. As a result, IIT Kanpur was involved to recommend the rectifications.

RHP, May 2015, page 20:

Similarly, design-related deficiencies were discovered in respect of the Chambal Bridge construction forming part of the same project, and remedial design requirements were suggested by the Indian Institute of Technology, Kanpur.

An investor also gets to know that due to deficiencies in construction in the project, a public interest litigation (PIL) was also filed in the court requesting for cancellation of project-allotment to PNC Infratech Ltd, a fresh issue of tender for the project and an enquiry against guilty officials.

RHP, May 2015, page 352:

Mr. Sanjay Gupta filed a PIL (No. DBWP 3986/2014) before the High Court….directing NHAI to take action against our Company for allegedly using sub standard concrete and other raw materials for construction of four lane road on National Highway 3, service roads and over bridge in the city of Dholpur. It was also requested that the court direct a fresh initiation of the tender process on account of the report submitted by a professor of Indian Institute of Technology, Kanpur in addition to the request made for a consequent departmental inquiry against the guilty officials.

In the case of Ghaziabad-Aligarh Highway, PNC Infratech Ltd had a significant amount of delay in the construction. The originally scheduled completion date of this 126.30 km long highway project was March 2015. However, PNC Infratech Ltd could not complete it in time.

Later, NHAI extended the completion date to April 26, 2016. However, PNC Infratech Ltd could not meet this deadline. By November 25, 2016, the company could complete 123.30 km and work on the remaining 3.0 km was still pending.

Credit report of Ghaziabad Aligarh Expressway Private Limited prepared by CARE on April 24, 2017:

The project had already commenced partial tolling whereby 103.89 k.m. of stretch out of total project stretch of 126 k.m. had become operational from June 23, 2015, onwards vis-à-vis the scheduled COD of end of March, 2015. Such scheduled COD of the project had been further extended to April 26, 2016 by NHAI. The company has received provisional completion certificate for additional length of 19.40 k.m. on November 25, 2016 and tolling has started for this additional length from December 22, 2016. Hence, now the total operational length is 123.30 k.m. out of the total project length of 126.30 k.m.

Advised reading: Credit Rating Reports: A Complete Guide for Stock Investors

In another instance, a portion of the road constructed by PNC Infratech Ltd on the Agra-Lucknow Expressway caved in creating a 20m deep sinkhole due to rainwater accumulating on the road. (Source: Agra-Lucknow e-way cave-in: UPEIDA asks PNC Infra Tech to carry out repair: Times of India, August 1, 2018)

Taking cognizance of 20-meter deep cave-in at service lane of Agra-Lucknow expressway, Uttar Pradesh Expressways Industrial Development Authority (UPEIDA), CEO Awanish Kumar Awasthi has called for a probe.

Speaking to TOI, he said, “Due to heavy downpour and accumulation of water at service lane, the sinkhole was formed, but we called the third party- RITES (Rail India Technical and Economic Service), who will conduct a thorough investigation and submit its report in 15 days to ascertain the cause of 20-meter deep sinkhole. The stretch was constructed by PNC Infra Tech and they would restore the stretch at their own cost.”

An investor may contact the company directly to understand more about the reasons for the formation of a sinkhole on a newly constructed road. She may get clarification about whether it was due to some designing issue or construction defect or any other reason.

On one of the occasions, PNC Infratech Ltd could not achieve financial closure of one of the projects allotted to it by NHAI, within the stipulated time. As a result, the company had to compensate NHAI as it did not meet the deadline stipulated for the project and the allotment of the project to PNC Infratech Ltd was cancelled. The company intimated the same to the investors in its RHP, May 2015 at pages 13-14:

Separately, Hospet Bellary Highways Private Limited (“HBHPL”), a special purpose vehicle (“SPV”) formed by our Company, had entered into a concession agreement dated March 28, 2012 with the National Highways Authority of India (“NHAI”)…, in respect of which financial closure was not achieved within the stipulated period giving NHAI the right to encash performance security furnished by HBHPL in such respect of ₹ 91.00 million. HBHPL and the NHAI subsequently entered into a close-out and settlement agreement dated March 4, 2014, pursuant to which HBHPL agreed to submit a demand draft to the extent of 91.00 million as consideration towards complete closure of all existing and future claims and disputes with the NHAI in relation to such concession agreement dated March 28, 2012.

Therefore, an investor would appreciate that even though PNC Infratech Ltd had completed many projects before the scheduled time, which indicates good project execution skills. However, there have been some instances where the construction done by the company as well as meeting other benchmarks like financial closure was not found to be up to the mark.

Therefore, an investor should keep a close watch on the media coverage of the company to know if any more projects undertaken by PNC Infratech Ltd face any problems.

4) Weakness in internal processes and controls of PNC Infratech Ltd:

While reading the annual reports and other publicly available information, an investor comes across a few instances that indicate that internal processes and controls of PNC Infratech Ltd have a scope for improvement.

4.1) Weakness in inventory verification processes:

An investor notices that the auditor of the company have repeatedly pointed out that the processes of physical verification of inventory at PNC Infratech Ltd are weak and they need strengthening.

In the FY2015 annual report, on page 72, the statutory auditor of the company highlighted the weakness in the physical verification processes.

The process of recording of physical verification needs to be further strengthened considering the nature and cycle of various projects.

The statutory auditors of the company repeated the same observation in each of the subsequent years. However, the weakness was not rectified by the company.

FY2020 annual report, page 162:

The process of recording of physical verification needs to be further strengthened considering the expansion and nature & cycle of various projects.

4.2) Misplacement of share transfer deeds:

In its RHP in May 2015, PNC Infratech Ltd intimated to investors that the company has misplaced almost all the transfer deeds for a period of more than 6 years (August 1, 2000, to September 28, 2006). As per the company, it lost them while transporting and these transfer deeds are not traceable.

RHP, May 2015, page 33:

The transfer deeds for the period August 1, 2000 to September 28, 2006 (transfer serial No.001 to serial No. 157) in relation to the transfer of shares of our Company were misplaced while transporting them for certain purposes. Although we have, in this regard, filed a complaint dated March 31, 2010 at the Police Station, Agra, the misplaced transfer deeds are currently not traceable.

An investor may contact the company directly to know whether it has found the lost transfer deeds and if the company has to face any issues/penalties due to the loss of transfer deeds.

An investor may remember from the analysis of Quick Heal Technologies Ltd that the company had lost the records related to the issuance of some equity shares. At the same time, the company was fighting a dispute with Manohar Malani, managing director of a firm NCS Computech Ltd, related to his shareholding in the company where the shares were allotted to him in the year 2000.

Read: Analysis: Quick Heal Technologies Ltd

4.3) Delays in filing of statutory forms by PNC Infratech Ltd:

The secretarial auditor of the company has repeatedly highlighted that PNC Infratech Ltd has delayed filing of some of the required statutory forms and has a result has to pay penalty/additional fees.

In FY2016 annual report, page 52:

Late Filing of e-forms: The Company has been generally filing the forms and returns with the Registrar within the prescribed time. However, there are few instances where there have been delays, which were filed on payment of additional fees.

Despite pointing out by the statutory auditor, in every subsequent year, the company had delays in filing of e-forms and had to pay penalties/additional fees.

FY2020 annual report, page 48:

Late Filing of E-forms: The Company has filed few e-forms with additional fees and has complied with the requirement of the Act.

4.4) Delays in payment of undisputed statutory dues by PNC Infratech Ltd:

An investor would notice that the statutory auditor of the company have repeatedly highlighted in its report that PNC Infratech Ltd has not deposited wealth tax dues to the Govt. authorities despite there being no dispute in its liabilities.

In the FY2013 annual report, on page 18, the auditor highlighted that the company has not paid the wealth tax.

Company is generally regular in depositing undisputed statutory dues including Provident Fund…with the appropriate authorities except out of total wealth tax payable of ₹7.51 Lacs at the close of year more than six month payable at the year end is ₹5.35 Lacs.

However, despite pointing out by the auditors, PNC Infratech Ltd continued to delay the payment of undisputed wealth tax every year and the amount of the delayed tax increased in the subsequent years.

As per the FY2015 annual report, page 108, the pending wealth tax increased to ₹13.39 lac.

except out of total wealth tax payable of 13.39 Lacs at the balance sheet date, out of which outstanding for more than six months is ₹9.89 Lacs at the balance sheet date.

The said undisputed but delayed wealth tax of ₹13.39 lac was paid by the company after about 4-years in FY2019. This is because the statutory auditor repeatedly highlighted these delays every year until FY2018.

FY2018 annual report, page 85:

except the wealth tax payable of 13.39 Lakhs outstanding for more than six months at the balance sheet date.

Further advised reading: How to read the annual report of a company

4.5) Expired security certificate (SSL) of PNC Infratech Ltd.’s website:

When an investor visits the website of PNC Infratech Ltd (www.pncinfratech.com), then the first thing she notices is a prominent warning by the web-browsers stating that the browser is not able to connect securely to the website. As a result, the investor has to click on the warning message of accepting the risk to visit the website of the company.

PNC Infratech Ltd Warning From Web Browsers

On checking the details of the security message, an investor notices that the SSL certificate of the website of PNC Infratech Ltd expired on March 25, 2021; however, it has not been renewed by the company even after 5 months.

PNC Infratech Ltd SSL Certificate Is Expired

An investor would appreciate that in the current times where the focus of the internet community is to make the entire web/internet secure, letting the SSL certificate of the website expire and making a user go through strict warning messages from the web-browsers does not reflect well on any company.

The cost of renewal of an SSL certificate is only a couple of thousand rupees. Therefore, it seems that the expiry of the SSL certificate is more of an oversight than any cost-cutting measures by the company. As a result, the expiry of the SSL certificate without renewal in time may represent a case of weak internal control and processes at PNC Infratech Ltd.

5) Importance of consolidated financial analysis for PNC Infratech Ltd:

As per the above discussion, an investor would remember that in the case of infrastructure players, many times, companies for SPVs for each of their different projects. As each SPV is a separate legal entity; therefore, many times, investors prefer to look at the standalone financials of the parent/listed entity for their analysis. This is under the assumption that each of SPVs is a separate limited liability entity and its failure would not affect the parent/listed entity.

Many times, investors assume that the parent/listed entity is completely protected/ring-fenced from the fate of its SPVs. Investors believe that the risk of the parent entity is only limited to its equity contribution in the SPV and the rest of the risk is born by the lenders of the SPV.

However, by looking at the experience of PNC Infratech Ltd with some of its SPVs, an investor would appreciate that in the practical world, the linkages between the parent entity and the SPVs go much deeper. If any of the SPVs is under stress, then the parent companies end up supporting the SPV irrespective of the status of a separate legal entity with limited liability.

While analysing the history of PNC Infratech Ltd, an investor gets to know that some of the SPVs formed by the company are not doing well. These SPVs are not able to generate sufficient money to repay their lenders and meet their expenses. Therefore, PNC Infratech Ltd had to infuse money into these SPVs so that these could meet their funding requirements.

The credit rating agency, CARE, highlighted it in many of its reports for the company. E.g. credit rating report by CARE in March 2018:

The ratings are partially offset due to…moderate level of financial support towards few SPVs in which PIL has majority/substantial minority stakes,

However, PIL is supporting few of the SPVs (both toll based and annuity based, namely Ghaziabad Aligarh Expressway Private Limited, PNC Delhi Industrial Infra Private Limited and PNC Bareilly Nainital Highways Private Limited) for meeting their funding commitments

An investor may appreciate that if the parent company has to support the SPVs under stress even if the SPVs are separate legal entities with limited liability, then only looking at the standalone financials of the parent company may not present the complete financial picture to the investor.

An investor may take an example of one of the SPVs, Ghaziabad Aligarh Expressway Pvt. Ltd (GAEPL), which is a joint venture formed by PNC Infratech Ltd with two other partners.

An investor would remember from the above discussion that this project was delayed. In addition, the toll collections from the highway were not sufficient to meet the requirements of project expenses and repayments to lenders. As a result, the SPV failed to repay its bankers. It was declared a defaulter with a “D” rating by CARE.

Credit rating report of Ghaziabad Aligarh Expressway Private Limited (GAEPL) by CARE, April 2017:

Inadequate toll collection vis-à-vis the repayment obligation of the company has resulted in stretched liquidity position of the company, leading to delays in debt servicing. However, the promoters have been continuously infusing funds in the company in the form of unsecured loans to fund the project cost and debt repayments of the company.

In the Q4-FY2021 conference call, PNC Infratech Ltd intimated to its shareholders that it had put in about ₹400 cr in GAEPL by way of equity and unsecured loans etc.

Q4-FY2021 conference call, June 2021, page 12:

D. K. Maheshwari: Total investment including equity, unsecured loan and EPC is around Rs. 400 crores.

An investor would also appreciate from the earlier discussion that PNC Infratech Ltd is in the process of selling its 35% stake in GAEPL. It has entered into an agreement with Cube Highways on April 1, 2021, to sell its stake at an enterprise value (equity + debt) of up to ₹1,600 cr.

The corporate announcement by PNC Infratech Ltd to BSE on April 2, 2021:

Company has on 01.04.2021 entered into a Share Purchase Agreement and other related transaction documents inter alia, with Cube Highways for sale of its holding in Ghaziabad Aligarh Expressway Private Limited (GAEPL), an “Associate” of the Company.

The said transaction is being done at an Enterprise Value (EV) of upto Rs. 1600 crs.

An investor may appreciate from the above disclosure that the maximum enterprise value that GAEPL may get under the agreement is ₹1,600 cr. This is significant because, in the past, a similar sale agreement was signed by PNC Infratech Ltd with Cube Highways to sell its stake in GAEPL in May 2019 for an enterprise value of ₹1,835 cr. However, the sale could not materialize apparently due to differences in the value of the transaction.

FY2019 annual report, page 162:

The Company has entered into a Share Purchase Agreement (SPA) dated 4th May 2019 with a Purchaser inter alia, with Cube Highways and Infrastructure Pte Ltd. (”Cube Highways”) for sale of its entire stake

As per the proposed transaction the Enterprise value of the entire project is 1,834 Crores

It seems that Cube Highways was not willing to pay an enterprise value of ₹1,834 cr for GAEPL and therefore, it renegotiated the deal at a lower enterprise value of ₹1,600 cr.

However, if an investor looks at the amount of money spent by PNC Infratech Ltd and other joint venture partners to complete the project, then it is more than ₹2,266 cr.

Credit rating report by CARE for GAEPL, April 2018:

Out of the project cost, Rs.2266.82 crore has already been expended as on September, 2017 (incl. cash loss of Rs.49.80 crore). However, the work on a stretch of 2.30 k.m. is still pending.

Therefore, even if an investor assumes ₹2,266 cr as the total cost spent by the JV partners on the highway project, then it seems that at the sale consideration of ₹1,600 cr enterprise valuation, the equity shareholders and lenders would not be able to recover their money. As a result, its equity shareholders like PNC Infratech Ltd might have to bear a loss on its investment of about ₹400 cr in GAEPL.

Therefore, from the above example, an investor would appreciate that even if PNC Infratech Ltd and GAEPL are legally separate limited liability entities, still, when GAEPL was not able to repay its lenders, then PNC Infratech Ltd had to infuse funds in GAEPL over and above its equity commitment by way of unsecured loans. Now, it seems that the company would have to take a loss on the money infused by it in GAEPL because the sales consideration (enterprise value) is much lower than the cost spent on the project.

Such instances indicate that while assessing companies, which execute many projects in different SPVs, an investor should always focus on the consolidated financial statements. She should not restrict her analysis to standalone financial statements, as these may not present the complete financial picture to the investor. As a result, her analysis may remain incomplete and her decisions may be erroneous if she ignores the consolidated financial statements.

Advised reading: Standalone vs Consolidated Financials: A Complete Guide

6) Order book of PNC Infratech Ltd:

While analysing the order book of PNC Infratech Ltd year on year, an investor notices that consistently, the company had maintained an order book of about 2.5-3.5 times of last year’s revenue. Such a size of the order book seems to give great comfort to the investors because the size of the order book indicates assured revenue visibility for the next few years.

However, while assessing the projects/order book of any company, an investor should always be cautious while taking the comfort of the order book. This is because there is no standard benchmark followed by companies while reporting the order book.

Some companies may report a project/order into its order book when it has been selected as the lowest bidder. However, in such cases, there remains a possibility that the project bidding/tender itself may be scrapped before the final award.

Some companies may report a project/order in their order book when it has received the letter of allotment/award. However, there have been instances where even after the awarding of the letter of allotment, PNC Infratech Ltd could not start work on the project before it received the “appointed date”.

The appointed date is allotted by the Govt. agency like NHAI after it has acquired a certain portion of land and other approvals. All the scheduled timelines like the achievement of financial closure, construction progress benchmarks and completion date etc. are calculated from the appointed date.

There have been instances even in the case of PNC Infratech Ltd where it got the letter of allotment of the project; however, it did not receive the appointed date even after a delay of three years.

For example in the case of Challakere – Hiriyur HAM Project, PNC Infratech Ltd was awarded this project in June 2018; however, it received its appointed date after more than 3.5 years, in January 2021.

Credit rating report by CARE, April 2019:

company is awaiting declaration of AD in Challakere Hariyur HAM Project awarded in June 2018 (financial closure for the same already achieved).

PNC Infratech Ltd in the corporate announcement to BSE on February 3, 2021, disclosed that it received the appointed date of Challakere – Hiriyur HAM Project on January 25, 2021.

Similarly, the company faced delays in getting the appointed date for many other projects. In fact, in FY2019, the company mentioned that the subdued performance in the previous two years was primarily due to a delay in getting appointed dates from govt. authorities.

FY2019 annual report, page 13:

During earlier two years, on majority of new projects secured by our Company, physical execution couldn’t be commenced due to prolonged delay in declaration of appointed dates by the authorities owning to persistent holdups in timely acquisition and possession of vacant land by them.

Therefore, it is advised that an investor should always be cautious before she takes the comfort of the order book declared by the companies. This is because there might be significant delays from the day the project is included in the order book and the day when the actual construction starts on the project after getting all the requisite approvals.

7) Error in the annual report of PNC Infratech Ltd:

While analysing the FY2018 annual report, an investor notices that PNC Infratech Ltd has represented its revenue from EPC and Toll/Annuity business in FY2017 and FY2018 in the form of pie charts. In the pie chart, the company has shown the FY2017 revenue from Toll/Annuity as almost 3/4th of total revenue (₹1,687 cr) and EPC as 1/4th of total revenue (₹567 cr).

FY2018 annual report, page 6:

PNC Infratech Ltd Error In The Annual Report

However, the actual situation is totally opposite inverse of the stated situation. On page 172 of the FY2018 annual report, the investor notices that the company earns a higher share of the revenue from EPC (₹1,687 cr) and a lower share from Toll/Annuity business (₹567 cr).

FY2018 annual report, page 172:

PNC Infratech Ltd Segment Revenue FY2017 And FY2018

An investor may appreciate that it seems to be an error of oversight while preparing and verifying the annual report. Nevertheless, an investor should appreciate that such errors may be repeated for critical information as well. Therefore, an investor should always be cautious while reading the annual reports.

The Margin of Safety in the market price of PNC Infratech Ltd:

Currently (August 28, 2021), PNC Infratech Ltd is available at a price to earnings (PE) ratio of about 14.9 based on consolidated earnings of the last 12-months (July 2020-June 2021). An investor would appreciate that a PE ratio of 14.9 offers a small margin of safety in the purchase price as described by Benjamin Graham in his book The Intelligent Investor.

However, we recommend that an investor may read the following articles to assess the PE ratio to be paid for any stock, which takes into account the strength of the business model of the company as well. The strength in the business model of any company is measured by way of its self-sustainable growth rate and the free cash flow generating the ability of the company.

In the absence of any strength in the business model of the company, even a low PE ratio of the company’s stock may be signs of a value trap where instead of being a bargain; the low valuation of the stock price may represent the poor business dynamics of the company.

Analysis Summary

Overall, PNC Infratech Ltd seems a company, which has grown its sales at a growth rate of 18% year on year along with an improvement in profitability over the last 10-years. The company has benefited from economies of scale with increasing order book as well as project sizes. An increase in the share of toll/annuity revenue, focus on bidding only for projects with minimum profitability, backward integration for raw material and early completion of projects with bonuses has helped the company improve its profit margins.

Despite good growth in the past, an investor should always keep in her mind that the business of PNC Infratech Ltd is highly dependent on the Govt. policies and the focus of the Govt. on infrastructure spending. In case of any change in the priorities of the Govt., the business of the company would be significantly impacted because the spending on infrastructure by the private sector is very low when compared to spending by Govt. /public sector. As a result, infrastructure players like PNC Infratech Ltd have very little bargaining/pricing power over their customers who are large govt. entities. The Govt. agencies can easily make the infrastructure players accept very harsh and unfavourable terms in their contracts.

PNC Infratech Ltd operates in a sector with very low barriers to entry because almost every aspect of project execution like the workforce and material sourcing as well as construction can be outsourced. As a result, the sector witnesses high competition where many players go out of business when the sector witnesses a down cycle.

Despite being in a working capital intensive business, PNC Infratech Ltd has managed its working capital well. Over the years, the company seems to have improved its working capital efficiency.

However, when an investor analyses the overall cash flow position of PNC Infratech Ltd, then she realizes that its business profits are not sufficient to sustain its growth rate. As a result, the company has raised money from additional sources like debt, IPO, private equity, preferential allotment etc. In addition, the company is attempting to sell its existing projects to raise money to meet its funding requirements.

The company has shown good project execution skills by completing many projects ahead of the scheduled completion date. In turn, the company has earned a performance bonus on many projects. However, in some instances, the work done by the company was not up to the mark. As a result, at times, IIT Kanpur has to suggest improvements to rectify the shortcomings. In the case of the Ghaziabad-Aligarh highway, the company could not complete the project in the scheduled time and estimated costs. In the case of Agra-Lucknow Expressway, a portion of the road completed by the company was damaged and resulted in an accident.

The Ghaziabad-Aligarh highway has been a pain point for the company for a long time, as the project could not be completed in time. Moreover, the project did not generate sufficient toll income to meet the expenses and debt repayments. As a result, PNC Infratech Ltd had to invest more money to repay the lenders. Now, the sale consideration for the proposed sale of the project to Cube Highways seems insufficient to recover the investments done by the company in the project. It seems that PNC Infratech Ltd would have to accept losses on its investments in the project.

The company has consistently maintained an order book of more than about 2.5 times the previous year’s revenue. However, in the past, there have been instances where the projects allotted to the company by NHAI could not start on time because NHAI could not provide it with the appointed date. At times, the appointed date was received more than 3-years after the project allotment date. As per the company, its performance was subdued in FY2017 and FY2018 due to delays in receiving appointed dates for many projects. Therefore, an investor should be cautious while taking the comfort of the order book of any company.

Currently, three of the four promoter brothers are executive members of the board of directors of the company. In addition, a few other relatives of the promoters seem to be in executive positions within the company.

The promoters seem to be politically aligned to Bharatiya Janata Party (BJP) as one of the promoter brothers, Mr Naveen Kumar Jain is a BJP member and is the current mayor of Agra. As a result, when a portion of the Agra-Lucknow Expressway constructed by PNC Infratech Ltd suffered damages, then opposition parties like Congress protested against the BJP Govt. in UP as well as the company. Congress raised questions on the performance bonus paid by the Govt. to the company for Agra-Lucknow Expressway.

During analysis, an investor finds many instances that indicate weakness in the internal processes and controls at PNC Infratech Ltd. On multiple occasions, the auditor of the company has highlighted issues with the inventory verification process. The company has delayed payment of undisputed taxes for many years. The company misplaced share transfer certificates for over 6 years. The SSL certificate of the website of the company expired on March 25, 2021; however, it has not yet renewed the SSL certificate despite a delay of more than 5 months.

Going ahead, an investor should focus on the competition level in the sector and the profit margins of the company. The investor should also monitor the working capital position as well as the free cash flow generation by the company. The investor should attempt to assess each of the projects of the company to understand whether any large project is facing execution and liquidity issues that may prove to be a burden for the company. The investor needs to analyse the consolidated financial position of the company.

The investor should monitor the developments in the political environment in the key states where PNC Infratech Ltd has operations. This is because the promoters of the company seem to be aligned to one political party and any change in political equations may affect the company adversely.

Further advised reading: How to Monitor Stocks in your Portfolio

These are our views on PNC Infratech Ltd. However, investors should do their own analysis before making any investment-related decisions about the company.

You may use the following steps to analyse the company: “Selecting Top Stocks to Buy – A Step by Step Process of Finding Multibagger Stocks

I hope it helps!

Regards,

Dr Vijay Malik

P.S.

Disclaimer

Registration status with SEBI:

I am registered with SEBI as a research analyst.

Details of financial interest in the Subject Company:

I do not own stocks of the companies mentioned above in my portfolio at the date of writing this article.

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