Nagarjuna Construction: BUY

Investors with a 3-5 year perspective can consider taking exposure to the Nagarjuna Construction stock. Expansion into high margin segments, higher net worth that would help bid for larger sized projects and the traction gained by subsidiaries in the real estate and BOT segments, augur well for the company's earnings growth. On an expanded equity base (due to shares/warrants to be issued to Blackstone), the current market price discounts expected earnings for FY 2008-09 by 19 times. With the company making headway in the industrial infrastructure space, which offers significant potential, this valuation appears quite reasonable.

The equity overhang that threatened Nagarjuna's stock has ended after the company announced equity placement to the Blackstone Group. We believe that this infusion of equity would be beneficial over the long term as it would ramp up the net worth and improve the company's financial qualification to bid for larger orders. The entry of Blackstone may also have benefits for Nagarjuna's real estate subsidiary, as the private equity player is known to have expressed interest in Indian real estate.

Nagarjuna has made a big leap in the industrial ijnfrastructure space after the recent order win (worth Rs 1,558 crore) of a blast furnace complex in consortium with POSCO E&C. With this, the company is making a transition from being a civil structure contractor to a provider of complete plant works (such as electrical and mechanical works). This move may be margin accretive and takes the company to a less-competitive domain. Nagarjuna's venture with POSCO E&C to bid for more such projects appears to be a positive as the latter is well placed to provide the necessary technology.

The company also plans to bid for 'balance of plant' in power projects, wherein it would provide complete solutions for the unit around the key power technology. Success in bidding for these projects could help it capitalise on the huge capex spending expected in the power sector. The company's interest costs as a percentage of its sales has seen a 103-basis points increase in the quarter ended June, compared to the previous year. This, combined with the withdrawal of tax benefits under Section 80 IA, has slightly dented net profit margins in the recent quarter. However, a healthy debt service ratio and a waning of the one-time tax effect by FY 2009 are likely to ensure that profit margins recover over the medium term.