Hi @jhasuraj, this is a great question. Let me dive deep into it.
I went through the annual reports to get a deeper dive into the company’s financials. In this case, the screener data seems a bit wrong. Screener includes in interest costs, non-interest costs as well. Around page 123-133 of AR 2018-19 contains the consolidated financial statement. Going over the notes for the individual items is very useful for an investor to understand the various line items.
The company doesn’t have a line item called interest in its consolidated P&L statement, it only has “Finance costs” which is explained in Note 35.
Going over to note 35 (Pg 174 of pdf) one will observe that interest costs are each of the type of loans are actually 6-11% (i’m using a broad range since i have not calculated exact numbers for each of them. Largest portion of debt is (working capital demand loans + cash credit) for which interest cost is 184 cr for total borrowings of 1637 cr. (Note 23) This works out to 11%).
What inflates the finance costs is the “Interest expense on Mobilisation Advance: 131.59 cr” and “Other Borrowing Costs: Commission on - Bank Guarantees: 97cr”.
A quick Google Search leads us to this quora answer clearly explaining what mobilization costs are. Having said that, I am also clueless what this mobilization advance interest expense is.
As far as bank guarantees are concerned, i don’t understand it well but would urge other ValuePickrs to contribute so that together we can figure out what this is.
Going over notes 19 and 23, we can see that the interest costs for company’s borrowings are in the 6-11% range.
You are right. Here is note 44 reproduced to highlight what you are saying
“Consequent to the encashment of Bank Guarantees (BGs) of ` 343.10 crores in the year 2017-18 by one of the customer, NCCL invoked the arbitration clause and submitted a claim of 1,571.41 crores towards refund of retention money, refund of BGs amount, payment of pending bills, additional works done and cost incurred on prolongation of the project by the customer. Against which, the customer has filed a counter claim of 1,071.46 crores towards liquidated damages, turbine replacement, balance works, etc.
As per the management assessment and legal advise, no provision is required for the subject matter and arbitration proceedings are expected to be completed in a year’s time.”
This seems to be the nature of the business though. I feel there are 2 aspects to this: Sector specific and company specific. We need to tease them apart to understand the merits of investing in the sector and also the company. Also, as investors we can and should certainly question the management about these things to get a deeper understanding into how things work in this sector and for this company.
I disagree with this. I dont think we can or should value construction companies on assets. Just because construction companies recognize revenue on a percent completion basis, i dont think it is a good enough reason to avoid revenue based valuation completely. Im sure management uses some leeway in recognizing revenue. But this is a nature of the business. This means that there would always be some degree of uncertainty in the revenue number. If management claims revenue is 10,000 cr it could potentially be in [8,000-12,000] range, unless we distrust the management entirely. There are two approaches to investment one can take:
- I will distrust all managements until management proves it is trustworthy.
- I will trust all managements until they prove through their actions to be untrustworthy.
I fall more in the second camp. Falling in 1st camp really restricts what one can invest in.
Estimating the fair value of a company is a herculean task and I do not claim to have any expertise in it. What i can say is that it is undervalued. Is it undervalued by 100% or 300% or 1000%? I do not know.
The metrics I use for valuation are MarketCap/Free Cash Flow and MaketCap/Revenue. The very fact that a construction company generates free cash flow is what makes me salivate when looking at NCC. It is not often that we find a construction company generating free cash flow. Forget free cash flow, L&T has not been able to generate even positive operating cash flows for the last 4 years: https://www.morningstar.in/stocks/0p0000c9dz/nse-larsen-n-toubro-ltd/financials-key-ratios.aspx
(the fourth year (FY20) data I got from its filings).
How the company decides to structure its liabilities and operate are more fine grained details. One can and should certainly deep dive into financials But there is always a concern that Analysis Paralysis might plague the investor in such cases.
Btw one thing i wanted to point out is that IMO looking for undervalued growth-oriented companies fundamentally requires us to look for sectors with tailwinds. I would vastly prefer investing in an undervalued company which is good (but not great) but exists in a sector with tailwinds as against a great fairly-valued company which faces headwinds at a sectoral level. And I do believe construction sector has great tailwinds. Covid has thrown government’s current plans out of the picture, but we are at the fag end of capex cycles as well. I expect India’s GDP growth, and subsequently the government’s ability to execute the NIP to improve drastically 2021 onwards. All these tailwinds would IMO result in NCC earnings to grow (construction company earnings are very closely tied to GDP and infra and capex growth), for NCC to become a turn-around story and hence get rerated (whichever valuation metrics one is using).