Engineering Stocks: No More a Delight

by Rachna Monga/BWI

With the big push for India’s infrastructure build-up, the engineering and construction stocks have been every stock-picker and fund manager’s delight. But analysts have started putting the sector on watch. For instance, brokerage house First Global Securities has downgraded Hindustan Construction, IVRCL, Gammon and Nagarjuna Constructions to underperformers.
Despite a robust demand, the report cites concerns about the funding and managing of growth. It argues that being a capital-intensive business, lot of cash generated by companies will be consumed as working capital and little of the free cash flows will remain to fund growth. So companies will be constantly under pressure to raise capital, which will affect their return on capital. In fact, during the fiscal ended March 2006, Gammon India generated 10.1 per cent return on capital, down from 18.4 per cent in March 2005.
The report also warns about the pressure on operating margins due to rising interest costs, the upturn in the commodity cycle and competition. As it is, these stocks are currently trading at an average multiple of around 21 times (based on FY07 earnings), which appears expensive when compared to the Sensex multiple of 14-14.5 times. “The current prices make the risk-reward ratio unfavourable for them as the positives are already priced in, whereas the risks are not,” the report says.
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