Va Tech Wabag

Stock Opportunities Not-so-Hidden Gems
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I have just read a few research reports and liked the optimism surrounding the business (water and sewage sectors) and most importantly recent spike in order book. Hence, took a position. In hindsight, it turned out to be a good pick. But now I want to understand this animal better.

In a nutshell this is my thesis:

)- High quality business, no doubt about this. Almost debt-free.

)- The company is surpassing guidance consistently

)- Order book is growing rapidly with revenue visibility of 3 years @ 20% CAGR (this should be treated as floor growth since mgmt. has been giving conservative guidance)

)- Growth entirely driven by diversified international orders. India story is still NOT considered in growth!

)- Management has guided for improvement in margins, this should lead to a higher CAGR in profits.

)- Valuations wise it is trading at 29x TTM earnings. This is similar to another (water sector player, albeit mostly domestic) KSB Pumps trading at 29x TTM earnings too. This provides comfort to me as KSB pump’s operations are limited to mostly India and the company has shown no growth in the last 4 years, still trading at similar multiple like VA Tech Wabag. This clearly shoes that market is upbeat on water sector picking up in India. Which will be an icing on the cake for VA Tech Wabag, which will reap awards of both current International growth and future Domestic growth!

Views invited,

Sushil

Disclaimer: Invested in both Va Tech Wabag / KSB pumps

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This is a PE comparison chart of Wabag and KSB. We can clearly see the extremely high correlation.

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Chart did not get uploaded, trying once again.


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Dear Sushil,

KSB Pumps valuation could be high due to the ongoing trend of buybacks by multinationals.

Anil

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Rajiv Mittal, MD of the co addressed the meet.Highlights of the call by Capital Mkt:

India has seen a stable government and the new government has translated in buoyant mood and sentiment across business communities.There are early signs of economic recovery.There is a paradigm shift in respect of policymaker.The new government has increased focus on Water and Sanitation.The budget 2014-15 had host of initiatives for the water industry.

The âNamami Ganga’project is a project for cleaning up of Ganga and the government has allocated Rs 237 crore for the same. The management feels that this allocation is likely to increase manifold going forward.The budget also came out with Rs 3600 crore project for National Rural Drinking Water Programme.It has also provided Rs 500 crore for reforms in the water sector.

Government keen to bring much needed reforms in Power sector which will increase demand for the company’s products.100 smart cities will create more demand for water.Development of SEZs and creation of 100 smart cities will also increase demand for water.

The new government in India has shown keen interest in the water sector and the management is confident that Wabag with its inherent skills and execution capabilities is well placed to capture a large share of the upcoming water treatment business in the country.The company is investing and focusing on capturing the large opportunity in the water business.There is healthy pipeline of orders in the water sector. `Good traction in AP, Maharashtra, Orissa

Election in few countries led to wait and watch policy. Company had built pipeline of international orders. Slow off take is interim phenomena and will increase in second half.The company is cautious in Libya and Middle East.Its diversification across geographies augurs well during such time. The company is moving towards being local service provider in many countries.Order pipeline in, Philippines and Qatar and Latin America is promising.Due to its focus last year, now the company is well placed in South East Asia and also in Nepal, Sri Lanka and Bangladesh.

This year the company is putting special focus on Middle East as it thinks it has good chance of growing there. It is also investing its time and money in Sub Sahara market.Receivables stand at Rs 1412.39.Debt is close to Rs 206 crore. Long term debt is Rs 110 crore taken for BOOT project for Namibia.Debt for Indian business is Rs 97 crore.

The company is very bullish on India geography after the new government came in. but it does not expect any major impact till second half and feels that the benefits will come in fourth quarter FY 2015 onwards.For the quarter ended June 2014, Va Tech Wabag reported 40% rise its consolidated sales to Rs 401.04 crore. OPM improved from 4.1% to 6.2% which took OP up 112% to Rs 24.81 crore.The company has made provision of Rs 8 crore as per conservative policy of the company for receivables included in other expenses. If during the year the company collects the same it will be reversed.

Also, the OPM is lower because of the mix of the projects contributing to Revenue during the Quarter.OPM for the FY will be same as what the company reported in FY 2014.The total cost of operations in the International Business is under control and this will enable the improvements in the margin.

Interest and finance charges have increased due to servicing of new orders received during FY14 and cost on long term borrowings for the BOOT project in Namibia apart from cost incurred for Oman Desal proect (there was lower cost in June 2013 quarter for Oman project).

Depreciation for the quarter includes a reversal of Rs 2.76 crore which represents the impact of change in accounting policy for providing depreciation on Written Down Value Method to Straight Line Method.

The company has performed impressively during the quarter. The company has won a new large framework contract worth Euro 45 million in the O&M space in Turkey which reiterates the growing stature of Wabag in Turkey and the company’s continued focus on increasing O&M revenues.

The company has order book of Rs 6351 crore including Framework Contracts of Rs 1331 crore (on receipt of advances/LC/Notice to proceed or achieving financial closure, Framework contracts will form part of the company’s firm order book)O&M revenue targeted to increase from CY 20% level to 25% over a period of 3-4 years.

The management is confident of achieving annual guidance for FY 2015 of sales of Rs 2600-2700 crore and Order intake of Rs 3200-3400 crore.

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Hi,

looks to be getting to very big level across the world across different geos/countries. 2013-14 AR looks very good read and having lots of good insights. Aiming to become top#3 water treatment across the life-cyle.

Looks prepared for all municipal water treatment (60% revenue comes from there) and river water cleaning. Also will be beneficiary of smart city setup and water treatments.

Asset light model and cash rich company! Getting covered/recommended in lots of research and reviews. Targeting to become Euro 1billion revenue making in few years.

VPs – Please share your research and views on this beast!

Disc: Having tracking position

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the one thing that I am not comfortable with VA is its’ weak cash flows - I would expect a OCF yield of at least 10-12% but it is only 4-5% and given the more than 5 months of receivables, I find this a significant risk.

I know of at least one company where a large customer refused to pay for a project that was 20% of its revenues and it had to take a write-off. Given the counterparty risks in an EPC business and the weak enforceability, I would not look at such a high multiple for this business.

It trades likea business that has significant float.

Hi,

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Varadharajan,

VA has increased the average project cost from 100cr to 200cr in last 5 years and improving to pick the projects which aare not having risks of writing off. They’re also exploring paths into Operations and Maintenance (O&M) after the setup to get the revenue coming full cycles. Would this lead into improvements in the operation margin improvements.

Please let me know if we can get OCF yield based on screening in tools like screener.in. Looks to be a good lever to sort.

-Muthu

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Muthukumar

You do not get it from screener - I look at the annual report and check - the OCF yield is only about 5 % for VAT, which IMHO is too low - I look for 10% OCF for a secular growth FMCG type business and 20% for a cyclical stock - say auto or construction.

Ask yourself in the EPC business, if the average project size going up will improve cash flows - because most of these projects get paid for at the end, cash flows might actually become tighter unless you can get better advances.

the one thing I have learnt in investing is not to invest based on “what can happen in an optimistic scenario” but if your capital can be protected in a pessimistic scenario.

In VAT’s case, I prefer to wait. For the record, I have heard extremely good things about the management and it’s a clean, ethical company but only the price is not right.

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Thanks Varadharajan for the detailed response. It has really helped me to learn great lessons on the views we need to put while making investment decisions.

I was looking at the AR and trying to reproduce in an optimistic way. But whether the project size increases or not, business requires improvements in advances!

Agreed and good lesson to learn as investor.

Business valuation looks very stretched with current price. Critical aspects like management is clean/great, so will have to wait for the reasonable valuation/price to come-up to explore more.

In the pessimistic scenario – Please guide me the valuations we can assign for this business (20 to 25?). They’re having cash in the balance sheet and normal dividend payments.

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I agree with Raghu on this. 1-2 years of low OCF are fine but it shouldn’t be regular. I had a quick look and found what Raghu mentioned so left it.

Varadharajan,

VA has increased the average project cost from 100cr to 200cr in last 5 years and improving to pick the projects which aare not having risks of writing off. They’re also exploring paths into Operations and Maintenance (O&M) after the setup to get the revenue coming full cycles. Would this lead into improvements in the operation margin improvements.

Please let me know if we can get OCF yield based on screening in tools like screener.in. Looks to be a good lever to sort.

-Muthu

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Varadharajan,

I am just wondering what adjustments you did to arrive at OCF yield. OCF of VAT according to the last annual report was about Rs11,241 lakhs and EV was about Rs173,459. Market cap of about Rs212,378, long term debt of Rs97, and cash and investments about Rs39,016. Based on these numbers, VAT’s OCF yield comes to about 6.8% for 2014 and 8.3% for 2013.

I agree that other global stocks with significant revenues from the government business usually have much higher OCF yield plus I am uncomfortable giving 25PE to a cyclical stock.

Varadharajan,

VA has increased the average project cost from 100cr to 200cr in last 5 years and improving to pick the projects which aare not having risks of writing off. They’re also exploring paths into Operations and Maintenance (O&M) after the setup to get the revenue coming full cycles. Would this lead into improvements in the operation margin improvements.

Please let me know if we can get OCF yield based on screening in tools like screener.in. Looks to be a good lever to sort.

-Muthu

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Alpha masters - such a wonderful name.

I just look at the OCF and divide it by EV like you had suggested. I look for at least 12-15% in the case of a cyclical business and 8-10% for a steady compounder (FMCG etc.).

I would look at a 5% only if it was a phenomenal company like - for eg., google or a just dial or a naukri which can grow revenues non-linearly and in a short period of time.

Think of it, if I can get google at a 4% OCF yield with optionality for youtube + android baked in with the world’s best management team plus great governance plus global growth, why look at a 5 % yield for a government driven business restricted by geographies and by hiring of manpower to a much larger extent.

at 4-5 % OCF yield, my sense is that the available universe expands to some pretty phenomenal businesses which have a global market, are driven by IP, have substantial network effects and can compound over a long time without worries. Hence, the pass on VA tech.

Muthukumar

You do not get it from screener - I look at the annual report and check - the OCF yield is only about 5 % for VAT, which IMHO is too low - I look for 10% OCF for a secular growth FMCG type business and 20% for a cyclical stock - say auto or construction.

Ask yourself in the EPC business, if the average project size going up will improve cash flows - because most of these projects get paid for at the end, cash flows might actually become tighter unless you can get better advances.

the one thing I have learnt in investing is not to invest based on “what can happen in an optimistic scenario” but if your capital can be protected in a pessimistic scenario.

In VAT’s case, I prefer to wait. For the record, I have heard extremely good things about the management and it’s a clean, ethical company but only the price is not right.

Varadharajan,

-Muthu

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Thank you for your comment!

I picked up my screen id from Maneet Ahuja’s book by the same name. It is a great compilation of interviews of fundamental investors.

I agree with you about VAT’s OCF yield. I have also started looking at HIL after reading your pitch. I am asking around some friends and acquaintances in construction. I will let you know how it goes.

Varadharajan,

I am just wondering what adjustments you did to arrive at OCF yield. OCF of VAT according to the last annual report was about Rs11,241 lakhs and EV was about Rs173,459. Market cap of about Rs212,378, long term debt of Rs97, and cash and investments about Rs39,016. Based on these numbers, VAT’s OCF yield comes to about 6.8% for 2014 and 8.3% for 2013.

I agree that other global stocks with significant revenues from the government business usually have much higher OCF yield plus I am uncomfortable giving 25PE to a cyclical stock.

Varadharajan,

VA has increased the average project cost from 100cr to 200cr in last 5 years and improving to pick the projects which aare not having risks of writing off. They’re also exploring paths into Operations and Maintenance (O&M) after the setup to get the revenue coming full cycles. Would this lead into improvements in the operation margin improvements.

Please let me know if we can get OCF yield based on screening in tools like screener.in. Looks to be a good lever to sort.

-Muthu

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Thank you for your comment!

I picked up my screen id from Maneet Ahuja’s book by the same name. It is a great compilation of interviews of fundamental investors.

I agree with you about VAT’s OCF yield. I have also started looking at HIL after reading your pitch. I am asking around some friends and acquaintances in construction. I will let you know how it goes.

Varadharajan,

I am just wondering what adjustments you did to arrive at OCF yield. OCF of VAT according to the last annual report was about Rs11,241 lakhs and EV was about Rs173,459. Market cap of about Rs212,378, long term debt of Rs97, and cash and investments about Rs39,016. Based on these numbers, VAT’s OCF yield comes to about 6.8% for 2014 and 8.3% for 2013.

I agree that other global stocks with significant revenues from the government business usually have much higher OCF yield plus I am uncomfortable giving 25PE to a cyclical stock.

Varadharajan,

VA has increased the average project cost from 100cr to 200cr in last 5 years and improving to pick the projects which aare not having risks of writing off. They’re also exploring paths into Operations and Maintenance (O&M) after the setup to get the revenue coming full cycles. Would this lead into improvements in the operation margin improvements.

Please let me know if we can get OCF yield based on screening in tools like screener.in. Looks to be a good lever to sort.

-Muthu

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Great to read so much on the Valuation Part of VA Tech. (I am basically a MBA student)

Correct me if I am Wrong Sir, but can company like VA Tech be called a Cyclical.

I kind of doubt it as i consider it a more and more necessity of such business in our world.

Irrespective of the economy performing its demand is going to grow. (As water has no substitute).

Please sir do enlighten my thoughts.

Thank-You

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Rishit

Water is unlike most commodities:

)- it has no price and is free in most places - eventually now we have come to realize that supply is not unlimited but ironically price is still zero

)- that brings me to the second point - because price is zero, almost all of the investments into water comes from the Government and the rate of return for these projects is below cost of capital - for eg., for the sewage disposal rates that you and me pay, constructing a sewage line underground is a bad project and hence would attract no private builders.

)- Since Government funds these projects through taxes that you and me pay and tax collection is fairly cyclical, these large infrastructure projects in turn are cyclical.

However, a large chunk of these projects is coming from private sector - for eg., pepsi, coke who see merit in recycling water/disposing off sewage safely. And given the acute water scarcity in India, the situation described above is at an inflection point and scheduled to change.

So, it’s still not a secular growth business but moving away from cylicality. With a larger chunk of BOT projects which involve maintenance and consumables, the revenues can also become more predictable.

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Sir I was looking at the Balance Sheet of VA Tech and its near most competitor in the same segment of Business - ION Exchange

Something weird did strike me. Why does VA Tech have such a high Contingent Liability to Total Sales

I am attaching the details

VA Tech Wabag Rs. Cr
Mar '14 Mar '13 Mar '12 Mar '11 Mar '10
Sales Turnover 1,152.24 1,057.17 1,003.47 732.17 700.97
Contingent Liabilities 1,034.93 620.66 194.97 143.6 272.58
ION Exchange Rs. Cr
Mar '14 Mar '13 Mar '12 Mar '11 Mar '10
Sales Turnover 711.95 767.34 651.36 591.18 513.93
Contingent Liabilities 108.5 78.78 51.39 52.81 43.33
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Royal HaskoningDHV and WABAG to deliver Nereda wastewater treatment technology to India and Switzerland.

For More:

http://www.royalhaskoningdhv.com/en-gb/nereda/news-and-events/20141105pr-nereda-technology-india-and-switzerland/3845

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Rajiv Mittal MD & Vardharajan, CFO add the call.Highlights by Capital Mkt:

For the quarter ended December 2014, Va Tech Wabag reported a 5% rise its consolidated sales to Rs 619.41 crore. OPM fell 80 basis points to 6.2% which saw OP fall 6% to Rs 38.61 crore. Consolidated net profit was down 36% to Rs 13.83 crore.For the nine months ended December 2014, consolidated sales grew 21% to Rs 1527.42 crore. OPM stood at 6.4% which saw OP grow 15% to Rs 98.00 crore. Consolidated net profit was down 6% to Rs 29.61 crore.

There has been an adverse impact of about 8% because of the impact of Euro exchange rate for the quarter.Increase in total cost is mainly due to increase in Employee expenses in Turkey due to site employee cost for Istanbul O&M Project.Provision of about Rs 10 crore towards LD in Oman Desalination Project as prudent and conservative accounting practice led to lower EBITDA margin.

Tax as % on PBT is higher because of impact of consolidation and tax is paid by entities on their profits in their geography as per their regulation.Higher Forex loss is mainly due to reinstatement of JPY receivable from Nepal Project.Increase in Finance charges mainly due to increase in borrowings for working capital and Finance charges for new contracts.Increase in y-o-y depreciation charges for the quarter is mainly due to capitalization of corporate office in India in March 2014.Board recommended Bonus issue of 1:1.

Order Intake during the quarter stood at Rs 665 crore.Order Intake stood at Rs 2310 crore during the nine months including Framework Contract of Rs 860 crore.Order Book stood at Rs 6973 crore including Framework Contracts of Rs 1687 crore (On receipt of advances / LCs / Notice to Proceeds or achieving financial closure, Frame work contracts will form part of the company's firm order book).

The company has achieved good order intake and the execution is also progressing well across various projects.Overseas MDU like Turkey and Philippines have performaed phenomenally. Philippines business bagged back to back orders funded by the World Bank.

Turkey has continued with consistent performance. Turkey business booked new orders worth 78 million Euros. It now has good chunk of Maintenance business where margins are higher.Wabag is one of the key players in the Turkish market.The management expects to see a faster turnaround in the business environment in India.

Va Tech Wabag won an order for a value of Rs 220 crore for design and construction of 140 MLD sewage treatment plant at Dinapur, Varanasi including operation and maintenance for 10 years. The scope of work includes design, engineering, supply, installation, testing and commissioning of the sewage treatment plant whereas the civil construction will be carried out by the joint venture partner, it added.

The order is part of JICA - Funded Ganga Action Plant Project and the implementation agency for this project is Ganga Pollution Prevention Unit of UP Jal Nigam, Varanasi. "Activated sludge process with biogas based power generation will not only help the project to reduce its operational costs but will also reduce the carbon emissions and thus will qualify for carbon credits.

Ganga cleaning and Yamuna cleaning present strong opportunity of the company and the company expects good orders from the same.It expects good demand from Oil and gas sector.The company has given sales guidance to be in the range of Rs 2600 â 2700 crore and order intake in the range of Rs 3200 â 3400 crore.It does not give any guidance on margins.

With the government's focus in India on improving water infrastructure being clearly visible with the various directives being announced recently, the management foresees a strong traction in award of projects in India in next few months.