national buildings construction corporation nato.ns...

Rating Starts at BuyTarget price Starts at INR 1049

Closing price 22 September 2014 INR 706

Potential upside +48.6%

Anchor themesNBCC, a niche public sector entity, is a play on the redevelopment of government housing colonies. With 30 old government housing colonies being identified for redevelopment in Delhi, we believe there is a strong growth opportunity for the company over the medium term.

Nomura vs consensusOur TP is significantly ahead of consensus; however, we note that the stock is not well covered.

Research analysts

India Engineering & Construction

Amar Kedia - NFASL [email protected] +91 22 4037 4182

Vineet Verma - NSFSPL [email protected] +91 22 4037 4487

Key company data: See page 2 for company data and detailed price/index chart

National Buildings Construction Corporation NATO.NS NBCC IN

EQUITY: ENGINEERING & CONSTRUCTION

Initiate with Buy; upside potential of 49%

Strong growth prospects with an asset light business model to drive further re-rating; Buy A niche play on redevelopment opportunities in India; initiate with Buy The National Buildings Construction Corporation (NBCC) is the largest public sector undertaking (PSU) in India’s construction sector, where its ‘public works organisation’ status helps it bag orders without much competition and even on a nomination basis, in some cases. It has a strong presence in the project management contract (PMC) business with a strong customer base in mostly government organisations that brings in a base order inflow of ~USD800mn p.a. It is fast emerging as a strong play on large redevelopment opportunities (margin-accretive too – we estimate 180bps EBITDA margins rise over three years) from government bodies and other PSUs. NBCC also enjoys negative working capital (and a cash-rich balance sheet) and passes on risks to sub-vendors on back-to-back contracts, thus remaining asset light. We initiate with at Buy with a TP of INR1,049, implying a 49% upside. Catalysts: Multiple triggers to drive >34% revenue CAGR over FY14-17F Four large housing colony redevelopment orders worth USD3-4bn are in the

pipeline, which can potentially add USD3-4bn to its order backlog. The company is discussions with various financially distressed PSUs

(including Air India) and the Waqf Board (0.6mn acres of landbank) for the development of surplus land, which could be a large multi-billion dollar opportunity. Together with the upcoming 100 Smart Cities opportunity, this could drive strong growth over next several years, in our view.

The company is aggressively looking to expand land bank (without leverage though) to pursue opportunities in residential/commercial real estate.

Valuations: Inexpensive despite the run-up, initiate with Buy Despite the run-up, NBCC still seems inexpensive at ~12.6x FY16F EV/EBITDA, given its strong order backlog and new order pipeline visibility leading to EPS CAGR of ~38% over FY14-17F, FY16-17F ROE of 30-35% and net cash balance sheet. We value NBCC at 15x Sept-16F EV/EBITDA (+1 SD of Engineers India’s historical mean) to arrive at our TP of INR1,049; Buy.

Year-end 31 Mar FY14 FY15F FY16F FY17F

Currency (INR) Actual Old New Old New Old New

Revenue (mn) 40,511 N/A 50,435 N/A 67,698 N/A 96,565

Reported net profit (mn) 2,585 N/A 3,247 N/A 4,633 N/A 6,824

Normalised net profit (mn) 2,585 N/A 3,247 N/A 4,633 N/A 6,824

FD normalised EPS 21.54 N/A 27.06 N/A 38.61 N/A 56.87

FD norm. EPS growth (%) 15.1 N/A 25.6 N/A 42.7 N/A 47.3

FD normalised P/E (x) 32.8 N/A 26.1 N/A 18.3 N/A 12.4

EV/EBITDA (x) 30.9 N/A 19.5 N/A 12.6 N/A 7.6

Price/book (x) 7.5 N/A 6.2 N/A 5.0 N/A 3.9

Dividend yield (%) 0.7 N/A 0.9 N/A 1.3 N/A 1.9

ROE (%) 24.9 N/A 26.1 N/A 30.3 N/A 35.1

Net debt/equity (%) net cash N/A net cash N/A net cash N/A net cash

Source: Company data, Nomura estimates

Global Markets Research 23 September 2014

See Appendix A-1 for analyst certification, important disclosures and the status of non-US analysts.

Nomura | National Buildings Construction Corporation 23 September 2014

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Key data on National Buildings Construction Corporation Relative performance chart

Source: Thomson Reuters, Nomura research

Notes:

Performance (%) 1M 3M 12MAbsolute (INR) 59.0 132.4 500.5 M cap (USDmn) 1,393.1Absolute (USD) 58.1 129.8 514.3 Free float (%) 10.0Rel to MSCI India 57.0 125.1 470.0 3-mth ADT (USDmn) 10.2 Income statement (INRmn) Year-end 31 Mar FY13 FY14 FY15F FY16F FY17FRevenue 32,241 40,511 50,435 67,698 96,565Cost of goods sold -28,206 -35,790 -44,280 -59,454 -84,708Gross profit 4,035 4,721 6,155 8,244 11,857SG&A -492 -560 -734 -971 -1,394Employee share expense -1,708 -1,821 -2,094 -2,513 -3,141Operating profit 1,836 2,340 3,327 4,760 7,321EBITDA 1,850 2,354 3,357 4,795 7,361Depreciation -13 -13 -30 -35 -40Amortisation

EBIT 1,836 2,340 3,327 4,760 7,321Net interest expense -53 -224 -265 -299 -331Associates & JCEs

Other income 1,405 1,333 1,553 2,124 2,711Earnings before tax 3,188 3,449 4,615 6,585 9,701Income tax -941 -864 -1,369 -1,953 -2,877Net profit after tax 2,247 2,585 3,247 4,633 6,824Minority interests

Other items

Preferred dividends

Normalised NPAT 2,247 2,585 3,247 4,633 6,824Extraordinary items 0 0 0 0 0Reported NPAT 2,247 2,585 3,247 4,633 6,824Dividends -450 -600 -772 -1,085 -1,574Transfer to reserves 1,797 1,985 2,474 3,548 5,250Valuations and ratios

Reported P/E (x) 37.7 32.8 26.1 18.3 12.4Normalised P/E (x) 37.7 32.8 26.1 18.3 12.4FD normalised P/E (x) 37.7 32.8 26.1 18.3 12.4Dividend yield (%) 0.5 0.7 0.9 1.3 1.9Price/cashflow (x) 94.0 na 12.1 17.8 18.0Price/book (x) 8.9 7.5 6.2 5.0 3.9EV/EBITDA (x) 37.5 30.9 19.5 12.6 7.6EV/EBIT (x) 37.8 31.1 19.7 12.7 7.6Gross margin (%) 12.5 11.7 12.2 12.2 12.3EBITDA margin (%) 5.7 5.8 6.7 7.1 7.6EBIT margin (%) 5.7 5.8 6.6 7.0 7.6Net margin (%) 7.0 6.4 6.4 6.8 7.1Effective tax rate (%) 29.5 25.0 29.7 29.7 29.7Dividend payout (%) 20.0 23.2 23.8 23.4 23.1ROE (%) na 24.9 26.1 30.3 35.1ROA (pretax %) na 9.0 10.5 12.6 14.8Growth (%)

Revenue 25.7 24.5 34.2 42.6EBITDA 27.3 42.6 42.9 53.5Normalised EPS 15.1 25.6 42.7 47.3Normalised FDEPS 15.1 25.6 42.7 47.3Source: Company data, Nomura estimates

Cashflow statement (INRmn) Year-end 31 Mar FY13 FY14 FY15F FY16F FY17FEBITDA 1,850 2,354 3,357 4,795 7,361Change in working capital -579 -5,024 4,547 1,303 -838Other operating cashflow -369 -1,385 -919 -1,325 -1,811Cashflow from operations 901 -4,055 6,985 4,773 4,711Capital expenditure -22 3 -35 -42 -50Free cashflow 880 -4,052 6,950 4,731 4,661Reduction in investments 615 154 0 0 0Net acquisitions Dec in other LT assets Inc in other LT liabilities Adjustments 1,119 1,006 1,198 1,644 2,002CF after investing acts 2,614 -2,892 8,148 6,375 6,664Cash dividends -488 -526 -904 -1,269 -1,842Equity issue Debt issue Convertible debt issue Others CF from financial acts -488 -526 -904 -1,269 -1,842Net cashflow 2,126 -3,419 7,244 5,106 4,822Beginning cash 13,252 15,378 11,959 19,203 24,309Ending cash 15,378 11,959 19,203 24,309 29,130Ending net debt -11,959 -19,203 -24,309 -29,130 Balance sheet (INRmn) As at 31 Mar FY13 FY14 FY15F FY16F FY17FCash & equivalents 15,378 11,959 19,203 24,309 29,130Marketable securities 1,048 894 894 894 894Accounts receivable 8,303 12,457 12,793 17,168 24,479Inventories 6,324 9,670 10,944 12,907 16,186Other current assets 2,849 3,837 4,886 6,522 9,256Total current assets 33,902 38,816 48,720 61,799 79,945LT investments 573 573 573 573 573Fixed assets 243 225 230 238 249Goodwill Other intangible assets Other LT assets 2,572 2,293 3,075 3,805 5,024Total assets 37,290 41,908 52,598 66,415 85,792Short-term debt Accounts payable 8,205 9,192 12,302 18,344 27,464Other current liabilities 16,912 19,388 23,484 26,719 30,086Total current liabilities 25,117 28,580 35,787 45,064 57,550Long-term debt Convertible debt Other LT liabilities 2,666 2,055 3,196 4,372 6,280Total liabilities 27,783 30,635 38,982 49,436 63,830Minority interest Preferred stock Common stock 1,200 1,200 1,200 1,200 1,200Retained earnings 8,307 10,073 12,416 15,779 20,762Proposed dividends Other equity and reserves Total shareholders' equity 9,507 11,273 13,616 16,979 21,962Total equity & liabilities 37,290 41,908 52,598 66,415 85,791

Liquidity (x)Current ratio 1.35 1.36 1.36 1.37 1.39Interest cover 34.5 10.5 12.6 15.9 22.1LeverageNet debt/EBITDA (x) net cash net cash net cash net cash net cashNet debt/equity (%) net cash net cash net cash net cash net cash

Per shareReported EPS (INR) 18.72 21.54 27.06 38.61 56.87Norm EPS (INR) 18.72 21.54 27.06 38.61 56.87FD norm EPS (INR) 18.72 21.54 27.06 38.61 56.87BVPS (INR) 79.22 93.94 113.46 141.49 183.01DPS (INR) 3.75 5.00 6.44 9.04 13.12Activity (days)Days receivable 93.5 91.4 81.0 78.7Days inventory 81.6 85.0 73.4 62.7Days payable 88.7 88.6 94.3 98.7Cash cycle 0.0 86.4 87.7 60.1 42.7Source: Company data, Nomura estimates


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Key charts Fig. 1: Strong PMC order book growth led by four redevelopment orders

Note: In FY17F, the book:bill ratio could decline as we are not building in any incremental redevelopment orders into our estimates. (Other than four projects, which are in the pipeline and awaiting government approval)


Fig. 2: PMC order book break-up (as of 1QFY15) Order book of ~INR170bn


Fig. 3: PMC business to be the main growth driver EPC only accounts for ~2-3% of overall top line


Fig. 4: EBITDA margins improvement led by increasing contribution from higher margin redevelopment projects


Fig. 5: Negative working capital due to higher customer advances


Fig. 6: Balanced debtors and creditors’ profile


77 82

132 154

311

403 383

2.6 2.6

5.2

4.7

7.3 7.0

4.5

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1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

-

50

100

150

200

250

300

350

400

450

FY11 FY12 FY13 FY14 FY15F FY16F FY17F

Order book Book:bil (RHS)

19%

28%

31%

14%

8%

Residential Infrastructure Institutional Hospital Commercial

29,825 32,442 26,600

33,837

42,392

57,956

85,569

1,442 1,851 5,268 6,250 7,501 9,001 9,901

‐

10,000

20,000

30,000

40,000

50,000

60,000

70,000

80,000

90,000


PMC & EPC Real Estate

3.2%

4.2% 4.4%

5.7% 5.8%

6.7%7.1%

7.6%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

8.0%

9.0%

10.0%

FY10 FY11 FY12 FY13 FY14 FY15F FY16F FY17F

EBITDA margins

Highmargin

redevelopment

business to drive margin expnasion

(7.2)(7.9) (7.8)

(2.6)

(7.5)

(9.3) (9.1)(10.0)

(9.0)

(8.0)

(7.0)

(6.0)

(5.0)

(4.0)

(3.0)

(2.0)

(1.0)

-FY11 FY12 FY13 FY14 FY15F FY16F FY17F

Working capital

Due to investments in land

66

100 95

113

94 94 94

113 125

94 84

90 100

105

‐

20

40

60

80

100

120

140


Debtors days Creditors days


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Fig. 7: Valuation comparison with NBCC vs. construction companies vs. Engineers India Ltd (there are many similarities between Engineers India and NBCC)

Note: EV is calculated on current net debt

Source: Bloomberg, Company data, Nomura estimates. Bloomberg consensus for NR stocks. Pricing as on 22 September 2014

EV/EBITDAEBITDA CAGR

EPS CAGR

Company Rating Ticker Price FY15F FY16F FY17F FY15F FY16F FY17F FY15F FY16F FY17F FY15F FY16F FY17F FY15F FY16F FY17F FY14-16F FY14-16F

Hindustan Construction NR HCC IN 36 NA 89.2 13.2 23.5 21.5 17.0 1.8 1.9 1.5 0.4 3.4 11.1 14% 14% 14% 7% NA

Nagarjuna Construction NR NJCC IN 44 23.7 12.8 7.2 10.3 8.8 6.9 0.7 0.7 0.6 3.0 5.4 9.2 8% 8% 9% -11% 51%

Simplex Infra NR SINF IN 259 16.9 10.0 6.4 6.9 6.0 5.8 0.9 0.8 0.7 5.1 8.9 12.2 10% 10% 9% 7% 29%

J Kumar Infra NR JKIL IN 323 9.3 7.5 7.2 5.5 4.7 4.2 1.3 1.1 1.0 14.8 15.3 15.0 18% 18% 17% 15% 13%

Supreme Infra NR SPII IN 360 7.1 5.9 NA 11.1 9.7 NA 1.0 0.9 NA 16.8 15.6 NA 15% 15% NA 8% 3%

Ahluw alia Contractors NR AHLU IN 180 23.1 16.2 NA 12.8 10.0 NA 4.1 3.3 NA 19.5 22.6 NA 9% 9% NA 47% NA

KNR Construction NR KNRC IN 298 14.7 11.1 8.2 8.9 7.2 5.6 1.5 1.3 1.1 10.6 12.6 15.0 15% 15% 15% 11% 16%

Engineers India Ltd (consol) NR ENGR IN 251 17.9 14.5 14.2 15.0 10.8 10.8 3.1 2.9 2.8 18.1 20.3 18.9 20% 24% 23% 9% 5%

NBCC BUY NBCC IN 706 26.1 18.3 12.4 21.4 15.0 9.8 6.2 5.0 3.9 26.1 30.3 35.1 7% 7% 8% 27% 21%Average (Ex-HCC & NJCC, EIL & NBCC) 14.2 10.1 7.3 9.0 7.5 5.2 1.8 1.5 1.0 13.4 15.0 14.1 13.3% 13.3% 13.6%

Overall average (EX-NBCC) 16.1 20.9 9.4 11.8 9.8 8.4 1.8 1.6 1.3 11.0 13.0 13.6 13.6% 14.1% 14.4%

EBITDA marginROE (%)P/BV (x)P/E (x)


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A solid play on land redevelopment and infrastructure development In our view, NBCC presents a strong growth story on the back of its niche presence in government housing colony re-development as well as strong presence in the project management contract business for Central and State Government bodies, ministries and organizations. We see multiple triggers for the company over the next 6-12 months that could escalate the growth profile of the company manifold for several years.

To highlight, NBCC is the only government-owned project management company in India, focusing on civil construction projects. It has a strong pedigree of designing and executing several important projects over the years.

We highlight three key stories that are likely to drive over 34% revenue CAGR for the company over FY14-17F:

1) A strong PMC franchise for largely government-funded projects in housing, civil infrastructure, etc. With 70-80% of orders receiving on negotiation / nomination basis, NBCC enjoys better margins, negative working capital (WC) and an asset light business model. In our view, this segment provides a fair visibility for a 10-15% p.a. growth on the current INR40-50bn order inflow.

2) Significant government housing re-development opportunity coming up with NBCC already proving its track record and is best-placed to win big projects shortly, we believe. Based on our discussions with the company, the government has identified about 30-old housing colonies for redevelopment in Delhi. After the successful execution of the New Moti Bagh project awarded to it earlier (in 2007), NBCC is likely to be a key beneficiary of these opportunities coming up over the next few years.

3) The company is now increasingly focused on developing its own land bank to pursue opportunities in the residential and commercial real-estate segments. With sufficient cash on the books and INR4-5bn of FCF generation (from the PMC business) every year, NBCC has been slowly building its land reserves for pursuing its own real estate ambitions as a developer. Unlike private developers, NBCC is very focused on projects that it starts and has principally decided to not lever up the balance sheet for buying land.

Strong franchise of project management consultancy focused towards public sector units/government bodies

The PMC business is the largest segment for NBCC (~82% of FY14 revenues) and also the bread and butter for the company. NBCC is categorised as a ‘public work organisation’ (PWO) and this yields benefits in the form of projects being given to NBCC on a nomination basis by several Ministries and Government bodies or even other PSUs.

Government-owned PMC is a key need from customers – a key strength for NBCC Most of the PMC contracts secured by NBCC are from government clients, which, in our view, are not best equipped to handle project management themselves. For example, the Ministry of Defence or Ministry of Urban Development or financially distressed PSUs are all engaged in their core businesses and might not be able to manage civil construction projects in the best way.

Being 90% held by the government of India (GOI), NBCC fits in to this need of a third-party project manager who can co-ordinate between the requirements of customers and the work of the contractor in a better way. NBCC, in our view, thus works as a central PMC resource for all Central government-owned entities and this ensures demand for its services.


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Moreover, the significant rise in scams associated with private sector involvement in coal mining, defence contracts or even telecom over the past few years, in our view, builds a favourable case for clients involving NBCC for their services rather than directly employing private sector contractors. Outsourcing a project to NBCC avoids getting entangled in compliance audits as it is primarily a government-owned entity.

This, in our view, is the key strength of NBCC and will likely ensure order inflow visibility.

Contracts are typically received on nomination/negotiated basis Based on our discussions with the company, almost 70-80% of the orders that it receives are directly negotiated with clients and thus face very little competition. This helps NBCC earn better margins as well as enjoy terms and conditions of its choice. For example, NBCC is able to command 10-25% advance from its customers against the order size which is one of the highest in the industry. This allows the company maintain a negative working capital. With relatively no fixed asset deployed in the business due to its PMC nature and a negative working capital, NBCC enjoys a very high return on practically very negligible investment.

Strong order backlog and high revenue visibility provide comfort Currently, NBCC’s order backlog stands at ~INR170bn, which is almost 4.2x its FY14 reported revenue, thus providing solid visibility for revenue growth over the next two-three years. In addition, as discussed later in this report, few large orders in the pipeline for property redevelopment are set to take NBCC’s growth profile into a different orbit, in our view.

Negative working capital cycle as customer advances are high One key attractive trait of NBCC’s PMC business has been the negative working capital cycle that it enjoys on the back of high level advances that it receives from customers. Due to this, the PMC business is fairly asset-light and ensures higher returns.

Fig. 8: Working capital for NBCC has been consistently negative, thus boosting returns INR bn


Fig. 9: NBCC’s advance from customers as a % of order book compares favourably with peers Advance as a % of order backlog


A profile with mostly government clients poses negligible risk on receivables In this segment, NBCC’s key customers include mostly government bodies, ministries or other PSUs. In our view, while these entities may delay payments, the absolute quantum of receivable is largely without risk.

Some key customers for NBCC include:

Employee State Insurance Corporation, Ministry of Defence, Ministry of Home Affairs (including security forces), Ministry of External Affairs, Ministry of Urban Development, Ministry of Commerce and Industry, Ministry of Corporate Affairs, Ministry of Finance, Haryana Urban Infrastructure Development Board, IIT Roorkee, IIT Kharagpur, IIT Patna, etc.

Most of these customers have a long-term relationship with NBCC and a significant portion of ongoing order flow for NBCC is normally additional or repeat business from such clients.

(7.2)(7.9) (7.8)

(2.6)

(7.5)

(9.3) (9.1)(10.0)

(8.0)

(6.0)

(4.0)

(2.0)


Working capital

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%BHEL L&T NBCC


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Fig. 10: Strong order inflow in the core PMC business over the years INR mn


Fig. 11: Sectoral breakdown of current order backlog INR mn

Source: Company data

Fig. 12: Sectoral breakdown of current order backlog # of projects


Fig. 13: Key projects executed by NBCC INR mn


-40%

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Base order inflow Growth in base order inflow

S. no Project Cleint Cost (INR mn) City State Sector1 Energy Center & Corporate Off ice Complex ONGC 3,915 Vasant Kunj New Delhi Energy Efficient and Environment2 Trenchless Technology Projects Jal Nigam 3,100 New Delhi New Delhi Trenchless Technology3 220 KVA sub station, CTPS Ph-III CTPS 2,240 Jharkhand Jharkhand Pow er4 CBI Head Quarter Building CBI 1,820 New Delhi Delhi Office5 MDU Hotel and Tourism Management MDU 1,767 Rohtak Haryana Institutional8 Main Plant BHEL 1,622 Korba Chhattisgarh Pow er9 DMRC Project Delhi Metro Rail Corporation 1,530 Cannaught Place New Delhi Road, Bridges, Airports10 Boys Hostel Building IIT Roorkee 1,428 Roorkee Uttarakhand Institutional

11 Site Levelling w orks NTPC 1,210 Barh Bihar Industrial12 NIFTEM Entrance Gate Ministry of Food Processing 1,200 Sonepat Haryana Institutional13 270 Cusec Raw Water Pipe Line Project Delhi Jal Board & UP Jal Nigam 1,200 Murad Nagar to

Sonia ViharNew Delhi Water and Effluent Treatment

14 1000 EWS/LIG Houses NOIDA Authority 1,140 NOIDA Uttar Pradesh PMG/Consultancy15 SVNIT SVNIT 1,130 Surat Gujrat Infrastructure16 NBCC Vibgyor Tow ers NBCC 1,100 Salt Lake , Kolkata West Bengal Housing17 Defence Housing Project Ministry of Defence 1,044 Jodhpur Army Rajasthan Housing


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Significant redevelopment opportunity likely in the offing to drive the next leg of strong growth

The government is placing much emphasis on the re-development of old dilapidated flats and pre-independence era government colonies by constructing multi-storeyed residential units and building commercial office space to harvest the benefits from the utilisation of increased permissible floor space index (FSI) in the locality.

NBCC has successfully executed the New Moti Bagh project in New Delhi earlier (bagged in 2007) along similar lines and was awarded the East Kidwai Nagar project recently on the basis of the successful execution of New Moti Bagh project.

According to the company, there are 30 other old government colonies identified by the government for such redevelopment in phases.

The model adopted by NBCC for such redevelopment has been well appreciated by the government as well as other government bodies or sick PSUs. It entails using land as a resource and leveraging fund available upon the sale of commercial offices constructed on a portion of this land to meet the entire cost of the project. Most of the sale of commercial offices (or even residential flats) is on a lease basis to government bodies/PSUs, thus assuring visibility.

It alleviates the need for any fresh investment by either the government or by NBCC. The key concern over such redevelopment projects is often the time taken to vacate the flats occupied by existing government officers.

According to media reports (Source: NBCC to redevelop government properties; Business Standard, in March 2014) as well as our subsequent discussion with the company, there are several such redevelopment projects where NBCC is already well placed to receive orders in a short period.

Fig. 14: Summary model of redevelopment for East Kidwai Nagar project by NBCC INR mn, unless mentioned

Source: Company data, Nomura research

Four large redevelopment projects in Delhi awaiting order approval to NBCC While NBCC is already redeveloping the East Kidwai Nagar project in Delhi (worth ~INR50bn), it has already been told to redevelop three more properties--Netaji Nagar, Kasturba Nagar and Tyagraj Nagar--in the vicinity for which cabinet approval is expected by end-CY14. Execution on these projects will commence once the approval is received, while we expect the order value for these projects to be in the range of INR120-150bn. In addition, NBCC has also been asked to undertake a greenfield project in Ghitorni, Vasantkunj in New Delhi along similar lines.

NBCC is mandated to set up a modern township comprising 10,000 residential flats on a 240-acre land parcel near Vasant Kunj in South Delhi, bordering Gurgaon.

East kidwai Nagar

Project cost 50,000

Area 71 acres

Project duration 5 yrs

No. of units demolished 2,311

PMC margins 10%

Margin on sale of units 2%

No. of units to be built

~4,264 dw elling units + 104,413 sq m of commercial

space

Equity requirement from NBCC (Initial money) 2,000

IRR guaranteed on initial investment by NBCC 15%


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To be called Vasant Kunj Extension, the project will be implemented by NBCC on land owned by the Central Public Works Department (CPWD) in Ghitorni. As per NBCC’s estimates, the project cost, would be ~INR100bn, which is likely to be raised through commercial exploitation of around 30% of the land earmarked.

Once the government approves the NBCC proposal, the project would be developed within four-five years, according to the company.

Together, these four housing projects could add INR220-250bn of orders to the backlog in FY15/16F, in our view.

Fig. 15: Redevelopment projects to drive strong order growth INR mn


Fig. 16: Summary model for Netaji nagar redevelopment project INR mn


Fig. 17: Summary model for Kasturba nagar redevelopment project INR mn


FY13 FY14 FY15F FY16F FY17FEast Kidw ai Nagar 42,640 Netaji Nagar 45,000 Thyagaraj Nagar 45,000 Kasturba Nagar 45,000 Vasant Kunj 100,000 Total order from redevelopment projects 42,640 - 145,000 90,000 Base order inflow 29,237 49,327 54,259 59,685 65,654 Total order inflow 71,877 49,327 199,259 149,685 65,654 Total orderbook 132,000 154,274 311,141 402,871 382,955

Netaji Nagar

Project cost 45,000

Project StatusReceived go-ahead from Ministry

of Urban DevelopmentExpected timeline to receive f inal order By Dec-15

ModelLikley to be similar to East Kidw ai

Nagar Model

Project size 45,000

FY15 FY16 FY17 FY18 FY19 FY20

% completion 5% 10% 20% 20% 20% 25%

Revenue 2,250 4,500 9,000 9,000 9,000 11,250

Kasturba Nagar

Project cost 45,000



Model Similar to East Kidw ai Nagar Model

Project size 45,000


% completion 5% 10% 20% 20% 20% 25%

Revenue 2,250 4,500 9,000 9,000 9,000 11,250


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Fig. 18: Summary model for Thyagaraj nagar redevelopment project INR mn


Fig. 19: Summary model for Vasant Kunj Extension project INR mn


MoU inked with the National Waqf Board to develop several properties as institutional and commercial projects In September 2014, NBCC signed an MoU with the National Waqf Development Corporation (NAWADCO) to develop waqf properties. NAWADCO has identified several waqf properties including one in Delhi, two in Rajasthan, six in Madhya Pradesh and seven in Karnataka which should be undertaken by NBCC for development as institutional and commercial projects. To begin with, properties lying vacant will be taken up for easy and early development.

As per the company, the development is expected to be along similar lines as the East Kidwai Nagar project in Delhi, though this is expected to be a large and multi-decade project, in our view.

India has more than 0.49mn registered waqf properties in India and the current annual income from these properties is about INR1.63bn (for the Waqf Board). With the intention of maximising revenue from these properties, the Waqf Board has, thus, decided to commercially exploit this land bank by utilising the services of NBCC.

As per a press release issued by NBCC, the total area under waqf properties all over India is estimated at about 0.6mn acres.

Many of these properties are on prime land and they have the potential of generating considerable returns, according to NBCC.

While the opportunity is undoubtedly huge and expected to unfold over several years to come, we think the market’s absorption capability for such large supply of commercial/residential supply needs to be seen before NBCC can start exploiting these properties.

Thyagaraj Nagar

Project cost 45,000



Model Similar to East Kidw ai Nagar Model

Project size 45,000


% completion 5% 20% 20% 20% 20% 15%

Revenue 2,250 9,000 9,000 9,000 9,000 6,750

Vasant Kunj Extension

Project cost 100,000

Project StatusReceived order but expecting approval in next 6 months

Model30% of total built up area w ill be used for construction of entire complex

Project size 100,000


% completion 5% 15% 20% 20% 20% 20%

Revenue 5,000 15,000 20,000 20,000 20,000 20,000


11

Potential MoU with Air India for the development of vacant land could translate into an USD1bn revenue opportunity for NBCC, according to our estimates As per various media articles (Air India to tie up with National Buildings Construction Corporation to offload assets, Economic Times, dated 8 September 2014), NBCC is in discussion with Air India (as well as other financially distressed PSUs) to help monetise the latter’s surplus land assets.

In the development process, land will be Air India's equity and NBCC will invest in creating any infrastructure on the land. The profit from any asset will be shared as per the equity stake decided beforehand.

NBCC is expected to develop only land and not the apartments and flats that Air India owns.

NBCC, we understand, has suggested three models: 1) outright sale, where Air India sells everything to NBCC and keeps the money; 2) lets NBCC develop the land on its own so that the airline can earn from rentals and share the revenue that the developed asset generates; and 3) Air India shares the cost of developing an asset on the land and the revenue generated from it in the future.

While the company has not denied the news reports, it is yet to confirm the news as well citing nothing has been signed with the client yet. It has maintained a position that NBCC is in discussion with several sick PSUs for similar monetisation of land bank, with Air India being one of them.

As per our understanding, the opportunity from Air India, if it materialises, could be worth INR50-60bn of order inflows.

In discussion with several other states for similar redevelopment opportunities According to NBCC, it is almost in final stages of talks with the Rajasthan government for a joint venture for redeveloping properties in Jaipur as well as other towns. Similarly, it is talking to the Odisha government which is interested in the redevelopment of two colonies in Bhubaneswar.

While it is too early to estimate the potential order value from these opportunities, we note that the redevelopment of land bank could well be the next growth catalyst for NBCC in years to come and a sustainable business model as well.


12

Real estate development business is the next focus area and will drive long-term growth

Real estate: Management commentary bullish on the business In the real estate business, NBCC operates like private developers wherein the company buys land (or enters into a JV arrangement), develops the land and sells it. NBCC is focussed on growing its real estate business by selectively acquiring land parcels or through the JV model as the business segment will be one of the key areas which will be driving growth for the company in the next few years. This business currently accounts for ~15% of total top line and the company intends to increase this contribution to ~30% over the next four-five years. To grow the business, NBCC will look to redeploy profits back into the business for procuring land parcels, although it will refrain from taking leverage on the balance sheet for powering growth.

Diversifying land reserves: expanding to smaller cities The company has land reserves totalling ~155 acres spread across the Delhi NCR region, Gurgaon, Kolkata, Kochi, Alwar, Patna, etc. With an intention to diversify into smaller cities, the company has recently procured land parcels in Meerut and Ghaziabad. In our view, value wise the land bank will still be concentrated in the Delhi NCR region.

In a vantage position to procure expensive resource (land) for real estate business Land prices have seen a multi-fold jump in the past few years. As a result, purchasing land for real estate development now entails large capital investment. But in the case of NBCC, we believe being a government company, it is able to procure land at cheaper rates from the state and central governments. In our view, this puts NBCC at an advantageous position vis-a-vis private developers as it is able to launch projects at more competitive rates (NBCC’s prices will usually be 5-7% lower than private developers). This attractive pricing translates into large upfront sale (in certain cases due to higher demand the company even has to resort to a lottery-based system) thereby providing upfront cash for execution as well as lower risk of unsold inventory.

NBCC is also exploring opportunities with various public sector enterprises for outright purchase/joint development which have surplus land and are easily monetizable. Apart from this, NBCC is even pursuing the Board for Re-construction of Public Sector Enterprises (BRPSE) to utilise unlocked land assets of sick PSUs which can be developed though the JV model. As commercial exploitation of land parcels of Public Sector Enterprises (PSE) is a sensitive subject, the involvement of private developer could invite lots of criticism. But NBCC being a PSU company, we believe it will have an edge to be selected as the preferred JV partner for the development of large tracts of land. If this model works out favourably, it can open a large opportunity for the company’s real estate business as it will provide access to cheap and easy monetisible land, in our view.

Skew towards residential projects limits capital commitment The company looks to have a split of 80:20 between residential and commercial projects. We view this skew towards residential segment as positive because residential projects are usually self-funded and thus NBCC doesn't need capital commitment for the development which is not the case for commercial real estate projects.


13

Financials

Multiple triggers to drive >34% revenue CAGR over FY14-17F

NBCC’s revenue growth is at the inflection point as we estimate its revenue to record a CAGR of 34% over the next three years helped by the contribution from large redevelopment projects in Delhi. These large redevelopment orders, which are in the range of INR40-50bn (per project), provides strong long-term revenue visibility as these projects are expected to be executed over the next five-six years. As a result, we estimate the PMC business will continue to account for > 85% of total revenue over the next few years. We estimate the revenue from the real estate business to grow at a more measured pace -- ~17% CAGR over the next three years underpinned by the new four-five project launches slated for this year.

In our revenue estimates we have accounted for projects where the company is only awaiting final approvals from the government. We exclude potential opportunities which are in the pipeline such as: 1) redevelopment opportunities from Rajasthan and Odisha governments; 2) the recent MOU signed with the Ministry of Minority which can open up multi-year opportunity in developing Wakf Board land; and 3) opportunity from the development of surplus land of public sector companies such as Air India.

Fig. 20: Revenue to record a CAGR of 34% over the next three years INR mn


Fig. 21: PMC will continue to be the main revenue contributorINR mn


Redevelopment opportunities to be margin-accretive

NBCC typically earns 7%-8% gross margins from PMC orders. But, in the case of redevelopment projects the company makes higher gross margins of around ~10% on PMC works and also receives 2% fees on the sale of residential or commercial areas (as discussed above, a part of the project area in redevelopment project is commercially exploited to fund construction cost). With increasingly higher revenue contribution from redevelopment projects, we estimate NBCC’s EBITDA margins will rise to ~7.6% (by FY17F) from 5.8% currently. Led by margin expansion, we estimate the operating profit to record a solid CAGR of 48% over FY14-FY17F, outpacing revenue growth over the same period.

29,820 31,268 34,293 31,868 40,088

49,892

66,957

95,470

-

20,000

40,000

60,000

80,000

100,000

120,000

FY10 FY11 FY12 FY13 FY14 FY15F FY16F FY17F

Revenue

CAGR revenue growth 34%

29,825 32,442 26,600

33,837

42,392

57,956

85,569

1,442 1,851 5,268 6,250 7,501 9,001 9,901

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

‐

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20,000

30,000

40,000

50,000

60,000

70,000

80,000

90,000


PMC & EPC Real Estate % of revenue from real estate (RHS)


14

Fig. 22: EBITDA margins to improve -- higher revenue contribution from the redevelopment business


PAT to record a 38% CAGR over the next three years

NBCC enjoys a negative working capital as it receives large customer advances on the receipt of PMC orders. These customer advances usually varies between 10% and 25% of the total order size. With no debt on the balance sheet and free cash available as part of customer advances, NBCC has been able to earn significant amount of treasury income. In fact, other income (largely includes treasury income) had accounted for almost 50%-70% of overall PAT in the past four years. Going forward, since NBCC’s orderbook growth is driven by redevelopment orders, the contribution of other income to overall PAT will come down as NBCC doesn’t receive any advances on redevelopment orders, in our view. This is because the cash raised to fund the construction of projects (through the sale of residential and commercial area) is kept in the escrow account.

Due to the fall in the contribution of other income to PAT, NBCC’s PAT CAGR at 38% over the next three years will be lower than the operating profit CAGR of 48% over the same period, but still a very strong pace nevertheless, in our view.

Fig. 23: Contribution of other income towards PAT to come down INR mn


Fig. 24: PAT to grow at a solid rate – a CAGR 38% over the next three years INR mn


4.2% 4.4%

5.7% 5.8%

6.7%7.1%

7.6%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

8.0%

9.0%

10.0%


EBITDA margins

Highmargin

redevelopmentbusiness to drive margin expnasion

854

1,346 1,405 1,333

1,553

2,124

2,711

0%

10%

20%

30%

40%

50%

60%

70%

80%

‐

500

1,000

1,500

2,000

2,500

3,000


Other income Other income % of PAT

1,403

1,902 2,247

2,585

3,247

4,633

6,825

-

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000


PAT

PAT CAGR 38% over FY14‐

FY17F


15

Negative working capital – unusual in the construction business

NBCC has been able to operate with negative working capital. This is because it receives customer advances on PMC orders plus at the same time it tries to balance its receivables and payable days by entering into similar back-to-back arrangement with customers as well as construction contractors. However, in reality, we note that in FY11 and FY12, creditors’ days were significantly more than debtors’ days (refer to the Fig below). Although this got reversed by end-FY14 when debtors’ days have crept up to 113 days, while creditors days have come down to 84 days. We believe the gap between payables and receivables days (approximately 30 days) at end-FY14 was still at a manageable level and doesn’t raise any red flag, especially when the past two-three years have been quite challenging for the construction industry. We expect this gap should correct going forward with improving liquidity and a new and stable government at the centre. In a worst case, even if this current gap between debtors and creditors sustains going ahead, the working capital, in our estimates, will still remain negative for NBCC on the back of customer advances.

Fig. 25: Higher customer advances and alike payment terms with customers and clients allow NBCC operate at negative working capital INR bn

Note: Debtor and creditor days are based on revenue


Reasonable operating cash flow yield of ~6% (on current market cap) without accounting for interest income on customer advances

With rising profitability, we estimate NBCC will generate strong operating cash flows over the next three years, although this amount may vary depending upon the quantum of investments the company will make in replenishing its land bank (gets reflected in inventory line item). We estimate NBCC to generate an operating cash flow of around INR5.5bn per year which translates into a reasonable operating cash flow yield of ~6% (on current market cap). These yields look more attractive, especially when the business doesn’t necessitate any significant capex into fixed assets (high fixed asset turnover of >100x). Apart from this, these yield calculations also don’t take into account the interest income which NBCC is able to generate from outstanding customer advances (which form part of NBCC’s regular operations).

INR bn FY11 FY12 FY13 FY14 FY15F FY16F FY17F FY16F FY17F

Trade receivables [A] 5.7 9.4 8.3 12.5 12.8 17.2 24.5 29.8 33.7

Debtors days 66 100 95 113 94 94 94 94 94

Trade payables [B] 9.7 11.8 8.2 9.2 12.3 18.3 27.5 33.4 37.8

Creditors days 113 125 94 84 90 100 105 105 105

Difference (payables-receiveables) [C]=[B]-[A] 4.0 2.4 (0.1) (3.3) (0.5) 1.2 3.0 3.6 4.1

Advance from clients [D] 10.0 9.1 12.4 14.5 16.9 19.1 21.1 23.3 25.7

% of unexecuted order book 13% 11% 9% 9% 5% 5% 6% 7% 8%

Advance to suppliers [E] 4.3 4.2 2.6 3.6 4.6 6.3 9.0 11.0 12.5

Net advance available for NBCC [F]= [D]-[E] 5.7 4.8 9.8 10.9 12.3 12.8 12.1 12.3 13.3

Earnest money & security deposits [G] 3.7 4.1 4.1 4.4 6.1 6.9 7.6 8.4 9.3

Total (Net advance + security deposits) [H]= [F]+[G] 9.4 8.9 13.9 15.2 18.4 19.7 19.8 20.8 22.6

Negative WC (ex-Inventories) (13) (11) (14) (12) (18) (21) (23) (24) (27)

Cash balance+current Investments 13 15 16 13 20 25 30 36 44

% of cash from WC 105% 76% 84% 93% 89% 83% 76% 68% 61%


16

Fig. 26: Working capital negative even after (investments in land in FY14) INR bn


Fig. 27: Attractive operating cash flow yield of ~6% on current market cap INR bn


NBCC offers higher ROE despite net cash on books

NBCC has a strong ROE profile despite having zero leverage. We expect the ROE to improve to ~35% (by end-FY17F) from current levels of ~25%, led by the strong earnings momentum, notwithstanding increasing cash levels on the balance sheet. Although unlevered balance sheet provides enough room to invest higher amount in the real estate business to boost equity returns, our interaction with management seems to suggest that it doesn’t intend to take leverage for growing its business.

Fig. 28: ROE (DuPont analysis)


(7.2)(7.9) (7.8)

(2.6)

(7.5)

(9.3) (9.1)(10.0)

(9.0)

(8.0)

(7.0)

(6.0)

(5.0)

(4.0)

(3.0)

(2.0)

(1.0)


Working capital

Due to investments in land

1.3 1.7 1.9 2.1

3.4

5.0

7.7

1.0 1.2 0.9

(4.1)

7.0

4.8 4.7

(6.0)

(4.0)

(2.0)

‐

2.0

4.0

6.0

8.0

10.0


Operating cash flow b/f wc changes Net operating cash flow


ROE 23% 26% 26% 25% 26% 30% 35%

Profit margin (Net profit/sales) 4.5% 5.5% 7.1% 6.4% 6.5% 6.9% 7.1%

Asset turnover (Sales/Assets) 4.8 4.3 3.4 3.6 3.7 3.9 4.3

Equity multiplier (Assets/Equity) 1.0 1.0 1.0 1.0 1.0 1.0 1.0


17

Valuations Since NBCC doesn’t have a long trading history to arrive at an appropriate valuation multiple, we compare NBCC with other construction companies and separately with Engineers India as we see lots of similarities between these two companies.

NBCC deserves to trade at higher multiples vs. other construction companies

In our view, NBCC will be the only company operating in the construction sector in India which has been able to maintain: 1) a negative working cycle; 2) a net cash balance sheet; and 3) a solid ROE profile in the past few years. Moreover, it is set to enter a string growth orbit with very string visibility on upcoming orders. Thus, NBCC deserves to trade at a premium to its peers as most of the companies operating in the construction sector are struggling with debt-laden balance sheets and an elongated working capital cycle. In fact, the expected ROEs of these construction companies in the last construction upcycle don’t even match what NBCC has been able to deliver in the past three-four years (despite the government being in a policy paralysis (Fig. 29).

In Fig. 30 we note that on an average construction companies are trading at EV/EBITDA of 7.5x and P/E of 10.1x on FY16F consensus estimates. We believe that NBCC should get a higher multiple not only for the reason highlighted above (better ROE, a negative working cycle and a solid balance sheet), but also the earnings growth profile of NBCC over the next few years is expected to be much superior, in our view. We expect NBCC’s operating profit/net profit to record CAGRs of 48%/38% over FY14-FY17F, much higher than other construction firms over the same period.

Fig. 29: Expected ROE’s of construction companies over upcycle and downcycle (2005-2014)

Source: Bloomberg, Nomura research

Fig. 30: Valuation comparison of construction companies

Source: Bloomberg consensus, Nomura research. Prices as on 22 September 2014

Company FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14

Simplex Infra 26.3 29.1 32.5 18.6 15.6 14.5 12.6 8.2 5.9 4.7

J Kumar Infra 28.5 24.3 27.5 20.3 17.3 15.2 14.7

Supreme Infra 28.4 34.8 26.2 26.8 20.4

Ahluw alia Contractors 37.9 41.1 28.4 -3.2 -33.1 -2.4

KNR Construction 18.0 17.0 11.1 10.2

Hindustan Construction 9.4 9.6 8.3 8.1 5.5 -5.9 -10.2 -7.9

Nagarjuna Construction 16.8 15.4 14.2 10.5 9.7 8.5 2.8 2.7 1.4

IVRCL 16.9 13.6 12.2 11.6 9.7 0.9 -4.1 -25.2

Engineers India Ltd (consol) 14.8 17.4 35.3 38.0 37.4 28.9 20.7

Average (ex‐EIL) 26.3 22.9 18.5 16.9 18.1 20.1 17.2 7.9 1.8 2.0

EV/EBITDAEBITDA CAGR

EPS CAGR

Company Rating Ticker Price FY15F FY16F FY17F FY15F FY16F FY17F FY15F FY16F FY17F FY15F FY16F FY17F FY15F FY16F FY17F FY14-16F FY14-16F

Hindustan Construction NR HCC IN 36 NA 89.2 13.2 23.5 21.5 17.0 1.8 1.9 1.5 0.4 3.4 11.1 14% 14% 14% 7% NA

Nagarjuna Construction NR NJCC IN 44 23.7 12.8 7.2 10.3 8.8 6.9 0.7 0.7 0.6 3.0 5.4 9.2 8% 8% 9% -11% 51%

Simplex Infra NR SINF IN 259 16.9 10.0 6.4 6.9 6.0 5.8 0.9 0.8 0.7 5.1 8.9 12.2 10% 10% 9% 7% 29%

J Kumar Infra NR JKIL IN 323 9.3 7.5 7.2 5.5 4.7 4.2 1.3 1.1 1.0 14.8 15.3 15.0 18% 18% 17% 15% 13%

Supreme Infra NR SPII IN 360 7.1 5.9 NA 11.1 9.7 NA 1.0 0.9 NA 16.8 15.6 NA 15% 15% NA 8% 3%

Ahluw alia Contractors NR AHLU IN 180 23.1 16.2 NA 12.8 10.0 NA 4.1 3.3 NA 19.5 22.6 NA 9% 9% NA 47% NA

KNR Construction NR KNRC IN 298 14.7 11.1 8.2 8.9 7.2 5.6 1.5 1.3 1.1 10.6 12.6 15.0 15% 15% 15% 11% 16%

Engineers India Ltd (consol) NR ENGR IN 251 17.9 14.5 14.2 15.0 10.8 10.8 3.1 2.9 2.8 18.1 20.3 18.9 20% 24% 23% 9% 5%

NBCC BUY NBCC IN 706 26.1 18.3 12.4 21.4 15.0 9.8 6.2 5.0 3.9 26.1 30.3 35.1 7% 7% 8% 27% 21%Average (Ex-HCC & NJCC, EIL & NBCC) 14.2 10.1 7.3 9.0 7.5 5.2 1.8 1.5 1.0 13.4 15.0 14.1 13.3% 13.3% 13.6%

Overall average (EX-NBCC) 16.1 20.9 9.4 11.8 9.8 8.4 1.8 1.6 1.3 11.0 13.0 13.6 13.6% 14.1% 14.4%

EBITDA marginROE (%)P/BV (x)P/E (x)


18

Benchmarking NBCC’s valuation multiple with Engineers India (market cap – USD1.4bn, ADT ~USD3mn) as we see many similarities

Since NBCC doesn’t have a long trading history (it was listed in 2012), we benchmark our valuation multiple for NBCC with respect to Engineers India (EIL) as we find many similarities in the two companies as we discuss below:

1) CPSE (Central Public Sector Entities) -- NBCC and EIL (ENGR IN, not rated) are both Central Public sector entities and have received Navratna status from the government which provides them more flexibility of operational and financial autonomy.

2) Government entities/ministries are their key customers -- Both entities derive a large proportion of their revenue from state or central government entities/departments. In particular, NBCC receives all its PMC orders of building construction from different government ministries or departments such as Ministry of Home Affairs, Ministry of Defence, Airport Authority of India, AIIMS, BSNL, etc, where as EIL is dependent upon oil & gas state or central PSUs such as Indian Oil, BPCL, GAIL and GSPC for its order inflow in both consultancy and turnkey projects.

3) Negative working capital: Due to higher customer advances, both of them get on-receipt of an order, and they enjoy negative operating working capital despite working in the construction industry.

4) High fixed asset turnover: NBCC and EIL provide only consultancy or PMC services and outsource the construction to third parties; this results in high asset turnover for them and requires very limited capital investments into fixed assets.

5) Net cash companies: NBCC and EIL are debt-free and have healthy cash balances on their balance sheets.

6) Consistent dividend payout: Being government companies, both the companies have maintained healthy dividend payout ratios.

7) Healthy ROE profile: Both NBCC and EIL enjoy a healthy ROE profile. Over the past four years, NBCC has generated an average ROE of 25%, which is quite similar to that of EIL at 29%.

Fig. 31: Comparison of NBCC and EIL

Source: Company data, Nomura research

Paramters FY11 FY12 FY13 FY14 Average

Negative working capital (INR bn)

NBCC (7) (8) (8) (3)

Engineers India (11) (8) (7) (5)

Net cash balance sheet (INR bn)

NBCC 13 15 16 13

Engineers India 23 22 24 25

High fixed asset turnover

NBCC 124 135 104 146

Engineers India 45 66 47 15

Consistent dividend payout

NBCC 22% 20% 23% 22%

Engineers India 37% 37% 37% 53% 41%

ROE profile

NBCC 23% 26% 26% 25% 25%

Engineers India 36% 34% 28% 19% 29%


19

NBCC deserves to trade at a premium to EIL’s multiple

Based on our discussion above, we think it’s reasonable to benchmark the valuation multiple of NBCC with respect to that of Engineers India. In EIL’s case, consensus’ target price is based on a P/E of 15.3x or EV/EBITDA of 11.7x on FY16F earnings (consensus) estimates, but in our view, NBCC deserves to trade at a premium given its strong earnings growth profile (earnings CAGR of 46% over FY14-FY17F, our estimate) over the next three years vs. a muted 5% earnings growth for EIL over the same period. Even from an ROE perspective, we expect NBCC to have a better ROE profile with ROE increasing to ~35% by FY17F vs. EIL which is expected to have flattish ROE profile averaging c.19% over the next three years (consensus estimate). Based on this, we believe it would be appropriate to value NBCC at 15.0x EV/EBITDA (equivalent to +1 SD EIL’s historical trading range).

Fig. 32: Strong earnings growth for NBCC Earnings CAGR over the next three years (FY14-17F)

Note: EIL nos are based on consensus estimates

Source: Bloomberg, Nomura estimates

Fig. 33: NBCC to have superior ROE profile relative to EIL

Note: EIL’s numbers are based on consensus estimates

Source: Bloomberg, Nomura estimates

NBCC – EV/EBITDA methodology yields a TP of INR1,049

High levels of cash vs. high levels of debt with other construction companies justify that we look at EV/EBITDA for these companies rather than on a P/E metric. The fair valuation range, in our view, is 10-15x 1-year forward EV/EBITDA for NBCC vs. other construction companies (including EIL) that are trading at 8-11x 1-year forward EV/EBITDA currently, while NBCC should command a premium vs. them. We value NBCC on 15x Sept-16F EV/EBITDA (implied P/E of 22x), to arrive at our TP of INR1,049 per share, which implies a ~49% upside potential. Thus, even at the lower end, we should have ~9% upside on the stock.

48%

38%

9%5%

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60%

EBITDA CAGR Net profit CAGR

NBCC Engineers India

26%

18%

30%

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35%

19%

0%

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15%

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NBCC Engineers India

FY15F FY16F FY17F


20

Historical valuation charts (based on consensus estimates) Fig. 34: Engineers India- 1 yr fwd P/E


Fig. 35: Engineers India- 1 yr fwd EV/EBITDA


Fig. 36: Simplex Infra- 1-yr fwd P/E


Fig. 37: Simplex Infra- 1-yr fwd EV/EBITDA


-

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EV/EBITDA Average +1 SD ‐1 SD


21

Key investment risks

We foresee two key risks to our investment argument for NBCC:

Overhang of further dilution by the government of India in the stock NBCC is currently owned 90% by the government of India. The Securities and Exchange Board of India (SEBI) has earlier this year proposed to the Finance Ministry to:

Make it mandatory for all government-owned companies to bring down their government ownership to a maximum of 75% or in other words increase the free float to 25%.

Similar norms were made by SEBI in 2010, when all the private sector companies were forced to raise their free float to a minimum of 25%.

While at this stage, the government is yet to agree to this norm by SEBI, we see this as a medium term overhang for the stock. In our view, even if this norm does come through, companies will still get two-three years to bring down government stake and hence unlikely to be a major overhang.

Execution delays could delay earnings growth A large part of the growth that we are estimating over the next few years is due to the significant redevelopment orders that we estimate for the company. We believe that these orders do not suffer from risks of cancellations or resistance from existing dwellers for redevelopers. In any case, the onus of getting the housing colonies vacated lies with the government and not with NBCC.

In our view, since these are government-allotted housing colonies, where the residents are asked to move on a temporary basis, there is hardly any risk of the residents posing any major resistance. If at all, these projects could face execution delays rather than outright cancellation. In that sense, these projects are different from slum-rehabilitation projects where the developer is faced with relocating unauthorised slum dwellers.

In our view, the residents are actually incentivised in this case, as they get a newer and better housing colony after redevelopment in the same location as against slum-rehabilitation where slum dwellers are asked to shift to a different (and non-prime typically) location.

Nevertheless, the common disruption in these projects is that some residents might hold up the process because of personal reasons. Overall, we think execution pace is the only risk in such projects, which might at worst delay earnings growth to an extent.

We have, accordingly, assumed six years of execution timeline for these projects as against the company’s guidance of four-five years.

Outstanding contingent liabilities have been higher in the past In the past, the outstanding contingent liabilities on the company’s balance sheet have been higher. We believe this could be due to the claims or counter claims raised by the vendor or client. As NBCC will be executing large sized redevelopment orders, any potential contingent liabilities which can arise from the projects of this magnitude can severely impact company’s earnings, if it materialises.


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Annexure

History of NBCC

The National Buildings Construction Corporation (NBCC) was established as a Government of India Enterprise in 1960. It was recently conferred the status of a Schedule ‘A’ Navratna company under the Ministry of Urban Development, Govt. of India.

NBCC provides civil engineering construction services in a wide gamut of projects of varied, complexities and at socio-political geographical locations, both in India and overseas.

NBCC’s areas of operations are categorized into three main segments – (i) Project management consultancy (PMC) (ii) Real estate development (iii) EPC contracting

It has been executing many landmark projects as a PMC as its core strength leveraging its rich experience in sectors as diverse as roads, hospitals, institutions, offices, residential & commercial, etc.

NBCC’s real estate business could be distinctively viewed falling into two categories based on source of origin of the projects; i.e. one is internally originated & conceptualised projects, wherein the company buys land from private and government agencies alike, develops the land and sells it off; while others are sourced from government wherein, NBCC carries out re-development of government colonies on a model, i.e. self sustaining and does not call for any government funding. The New Motibagh Complex (Delhi) under General Pool Residential Accommodation (GPRA) Scheme is one of the finest examples of such a re-development in recent times.

NBCC has been operating in the infrastructure segment as well, wherein it has been executing projects such as chimneys, cooling towers, and various types of power plant works.

NBCC is also designated as the implementing agency for executing projects under Jawaharlal Nehru National Urban Renewal Mission (JNNURM), Pradhan Mantri Gram Sadak Yojna (PMGSY), Solid Waste Management (SWM) and developmental work in the North Eastern Region. Due to the vast experience and quality of services rendered by NBCC, a number of central government ministries and various state governments are utilizing the services of NBCC as their extended engineering arm.

Recently, NBCC has been notified as a public works organization (PWO) explicitly, a construction agency covered under revised Rule 126 (2) of GFRs, as per which government departments/ PSUs can award orders to NBCC on a nomination basis.

PMC segment background

As a background, NBCC started operations in 1960 and has since then established client relationships with different state and central government ministries, department and agencies and various public sector undertakings (PSUs). Over the past five decades, its ability to successfully manage projects as well as maintain quality standards have helped it in developing it as a trusted service provider.

NBCC has, over the years, leveraged its PMC expertise in diverse segments of the civil construction such as residential and commercial complexes, institutions, hospitals and other buildings, sewage treatment plants, roads; and civil infrastructure for power sector such as cooling towers, chimneys and other civil and structural works.

On a simplistic basis, NBCC charges a fee range of 7-10% in the PMC segment to its customers (gross margin level). This might be slightly higher in the case of redevelopment projects (up to 12%). The fees are charged on the actual cost of the


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project and its responsibility is right from concept to commissioning, and the revenues are booked once the actual work is done. For example, if the total project cost is INR100bn and for a period of 20 months, and if we assume INR5bn worth execution every month, then NBCC would charge 10% of INR5bn every month as its own fees. Thus, the revenue booking every month would be INR5bn + 10% of INR5bn = INR5.5bn/month. Note that this example assumes a straight line execution of the project every month, while in reality it could be non-linear.

Fig. 38: Typical PMC project service cycle


Sourcing of project / business development NBCC sources PMC projects: (i) mostly through nomination, i.e, where its old clients / prospective clients approach them for projects or (ii) participation in tenders invited by the client or (iii) through its own business development efforts. Upon identification, NBCC starts with the survey and investigation.

Preparation of conceptual plan and detailed project report Conceptual plans, detailed project report (DPR) including a preliminary estimate, based on client requirement are prepared in-house or by engaging architects-consultants. The appointment of these consultants is done by inviting tenders, who are then selected based on the fulfilment of technical and financial pre-requisites. The appointed consultant prepares the conceptual plan which is then submitted to the client. After confirmation from the client, the appointed consultant prepares a DPR which contains estimated project cost and details regarding the construction of the project.

Execution of contract with client NBCC executes a letter of intent / agreement / MoU with the client setting out the principal terms of engagement and its fees. This agreement is prepared in some projects even before the preparation of the conceptual plan and in some cases after the conceptual plan and / DPR have been approved by the client.

Pre-construction activities and appointment of contractors The appointed consultant prepares Bill of Quantities, in consultation with NBCC and the same is submitted to the client for its approval. Further, NBCC creates packages for civil work, HVAC, lifts, etc, based on the divisibility of the work at hand and floats tenders for the appointment of contractor(s) for each package. The bidding contractor fulfils the technical and financial criteria set out in the tender. The contractor who has quoted the lowest bid among the qualified contactors is awarded the work and agreements are executed with such contractors. For this purpose, NBCC engages with among the best private developers in the business such as Larsen & Toubro, Shaporrji Pallonji and Ahluwalia Contracts.


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Project monitoring, co-ordination and execution After the appointment of contractors, the requisite pre-construction governmental licences and approvals for the project are obtained by the contractor so appointed by NBCC. The work on the site commences after obtaining the requisite pre-construction approvals and licenses. NBCC monitors and supervises the work done by each of the contractor so appointed through a team which includes unit in charge along with his site team and the concerned regional / strategic business group. A NBCC team ensures that the project meets the specifications set out by the clients and all the obligations under the contract with the client are met. Contractors submit periodical bills to NBCC in terms of the contract, based on which NBCC raises bills on the client.

Completion of project Upon completion of construction on project, the project is handed over to the client. NBCC raises the final bill on the client and payment is accordingly received. At this stage, the client generally issues a completion certificate in connection with the project.

Defect liability period Contracts with clients often stipulate a defect liability period of 12 months from the date of completion of the project. In some projects vs. the projects undertaken for PMGSY, the defect liability period is five years. During such a period, NBCC might need to rectify any defects that may arise in the project as a consequence of the construction services. Further, in its contracts with the contractors for projects, NBCC would stipulate a similar defect liability period and the contractors are required to rectify any defects that arise in the project as a consequence of the construction.

Real estate segment background

The real estate development segment focuses on principally two types of projects, namely: (i) residential projects, such as apartments and townships; and (ii) commercial projects, such as office buildings and shopping complex.

The company's land reserve (~170 acres currently) is mostly located in Delhi, Patna, Gurgaon, Kolkata, Kochi, Alwar, Meerut, Ghaziabad, Faridabad and Lucknow. NBCC continues to participate in auctions undertaken by the government.

Fig. 39: Typical real-estate project service cycle



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Identification of potential land and projects Land is identified, evaluated and acquired either from the government or from private owners or through joint venture arrangements. NBCC’s existing land bank is a mix of land acquired (either owned or through long leases from the government on a nomination basis or through a competitive bidding process or through joint venture arrangements). Land from private owners or through joint venture arrangements is identified and evaluated based on criteria’s like, location, size and shape of the plot, surrounding development, approach and accessibility, terrain, topography, demographic trend, availability of infrastructure. Upon identification of the suitable land, independent consultants are engaged to prepare a valuation report and the company prepares a feasibility report. The senior management then analyses and takes a decision on the acquisition of land at the recommended price.

Acquiring land In order to acquire land, NBCC enters into a sale deed or a perpetual lease deed. For the projects to be undertaken through joint ventures, it would enter into a joint venture agreement with the land owner.

Project planning, design and regulatory approvals NBCC engages the services of architects and structural consultants for the architectural and structural design of the project. The in-house real estate project department conducts the estimates of the requirements for manpower, materials and machinery.

Appointment of contractors NBCC outsources the construction of projects to a number of contractors for different aspects of the project, while retaining a project management role. Selection of contractors is through an open tender process.

Project execution The project execution commences once the detailed specifications and drawings have been prepared, the project structure is finalised, necessary approvals have been obtained and the contractors have been appointed.

Post-construction licenses and approvals After the project has been completed, the company obtains post-construction licences including completion certificates/occupation certificates from the appropriate authorities.

Sales and marketing NBCC has a dedicated real estate marketing team which focuses on the sale of residential and commercial projects.

Management background

NBCC’s board consists largely of its senior management and nominees appointed by the Ministry of Urban Development. The key managerial personnel, i.e. CMD and the Director (Projects), both have strong experience in this industry and thus bring in knowledge and expertise required for successful execution of projects.

Dr. Anoop Kumar Mittal, Chairman and Managing Director, joined NBCC on 1 March 1985 and subsequently succeeded as the CMD on 1 April 2013. Before taking over the charge of CMD, Dr. Mittal was Director (Projects) since 5 December 2011. Dr. Mittal holds a Bachelor's degree in Civil Engineering and was recently conferred an honorary Doctorate, by virtue of his attaining eminence in the field of civil & construction engineering. As CMD, Dr. Mittal oversees policy and strategic decision making of NBCC.

Mr. S.K. Chaudhary joined NBCC on 13 November 2013 as Director (Projects). Mr. Chaudhary is a civil engineering graduate from Delhi College of Engineering (DCE) and a masters in management from IIT, Delhi. He holds expertise in project financing and business development. Prior to this assignment, he has served at Housing and Urban Development Corporation (HUDCO) as senior executive director and has an overall experience of 31 years in the field of executing and managing several national and international projects.


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Mr. S.K. Pal joined NBCC on 1 February 2013 as Director (Finance) and apart from being head of finance; he is also the overall In-charge of the law & contract engineering divisions, board / RTI sections, and training & CSR divisions of the corporation. He is an ACS, ACA and holds B.Com Degree. Before joining NBCC, Mr. Pal has served at Ircon International Ltd. (IRCON), another Central PSU under the Ministry of Railways as General Manager (Finance). He has more than 30 years of experience in the profession.

Fig. 40: Organisational chart


Chairman‐cum‐Managing Director, Dr. A.K. Mittal

Director Finance, Mr. S.K. Pal

CS & Compliance Officer

ED Law

ED Engineering (Real

Estate)

Director Projects, Mr.

S.K. Chaudhary

ED Engineering

ED Human Resource

Group GM Engineering

ED Engineering

ED Engineering

Chief Vigilance Office


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Appendix A-1

Analyst Certification

We, Amar Kedia and Vineet Verma, hereby certify (1) that the views expressed in this Research report accurately reflect our personal views about any or all of the subject securities or issuers referred to in this Research report, (2) no part of our compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this Research report and (3) no part of our compensation is tied to any specific investment banking transactions performed by Nomura Securities International, Inc., Nomura International plc or any other Nomura Group company.

Issuer Specific Regulatory Disclosures The term "Nomura Group" used herein refers to Nomura Holdings, Inc. or any of its affiliates or subsidiaries, and may refer to one or more Nomura Group companies.

Materially mentioned issuers Issuer Ticker Price Price date Stock rating Sector rating Disclosures National Buildings Construction Corporation NBCC IN INR 706 22-Sep-2014 Buy N/A

National Buildings Construction Corporation (NBCC IN) INR 706 (22-Sep-2014)

Buy (Sector rating: N/A) Chart Not Available

Valuation Methodology We value the stock on 15x EV/EBITDA Sept-15F earnings to arrive at our TP of INR1,049 per share. The benchmark index for this stock is MSCI India. Risks that may impede the achievement of the target price (1) The overhang of further dilution by the Government of India in the stock. (2) Execution delays could delay earnings growth.

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appropriate valuation methodology determined by the analyst. Valuation methodologies include, but are not limited to, discounted cash flow analysis, expected return on equity and multiple analysis. Analysts may also indicate expected absolute upside/downside relative to the stated target price, defined as (target price - current price)/current price. STOCKS A rating of 'Buy', indicates that the analyst expects the stock to outperform the Benchmark over the next 12 months. A rating of 'Neutral', indicates that the analyst expects the stock to perform in line with the Benchmark over the next 12 months. A rating of 'Reduce', indicates that the analyst expects the stock to underperform the Benchmark over the next 12 months. A rating of 'Suspended', indicates that the rating, target price and estimates have been suspended temporarily to comply with applicable regulations and/or firm policies. Securities and/or companies that are labelled as 'Not rated' or shown as 'No rating' are not in regular research coverage. Investors should not expect continuing or additional information from Nomura relating to such securities and/or companies. Benchmarks are as follows: United States/Europe/Asia ex-Japan: please see valuation methodologies for explanations of relevant benchmarks for stocks, which can be accessed at: http://go.nomuranow.com/research/globalresearchportal/pages/disclosures/disclosures.aspx; Global Emerging Markets (ex-Asia): MSCI Emerging Markets ex-Asia, unless otherwise stated in the valuation methodology; Japan: Russell/Nomura Large Cap. SECTORS A 'Bullish' stance, indicates that the analyst expects the sector to outperform the Benchmark during the next 12 months. A 'Neutral' stance, indicates that the analyst expects the sector to perform in line with the Benchmark during the next 12 months. A 'Bearish' stance, indicates that the analyst expects the sector to underperform the Benchmark during the next 12 months. Sectors that are labelled as 'Not rated' or shown as 'N/A' are not assigned ratings. Benchmarks are as follows: United States: S&P 500; Europe: Dow Jones STOXX 600; Global Emerging Markets (ex-Asia): MSCI Emerging Markets ex-Asia. Japan/Asia ex-Japan: Sector ratings are not assigned. Explanation of Nomura's equity research rating system in Japan and Asia ex-Japan prior to 21 October 2013 STOCKS Stock recommendations are based on absolute valuation upside (downside), which is defined as (Target Price - Current Price) / Current Price, subject to limited management discretion. In most cases, the Target Price will equal the analyst's 12-month intrinsic valuation of the stock, based on an appropriate valuation methodology such as discounted cash flow, multiple analysis, etc. A 'Buy' recommendation indicates that potential upside is 15% or more. 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