Investors with a high-risk appetite can consider an exposure in the stock of engineering procurement and construction player, Petron Engineering Construction (Petron). Improved financials after the management changed hands in 2008 and the backing of an international parent, makes a case for investment in the company's stock. The stake acquired by the LN Mittal group in Petron's parent in mid-2011 also improves the Indian player's prospects. Benefits flowing from the association with the Mittal group may translate into improved valuations for Petron.

At the current market price of Rs 290 the stock trades at 5.5 times its expected per share earnings for FY-12. Investors with a two-year perspective can consider limited exposure to the stock. Limited liquidity in the stock, together with its small-cap stature, increases the risk profile of the company.

Improving performance

Besides engineering and construction work, Petron undertakes fabrication, insulation and mechanical works for a host of industries, including oil and gas, power, cement and fertilisers. Despite a well-diversified profile, Petron's growth did not keep pace with peers until FY-08. Sales and net profits, in fact, declined between FY-05 and FY-08. This scenario changed after Kazakhstan-based engineering group, KazstroyService, picked majority stake in 2008. Sales expanded 18 per cent, compounded annually over the next three years, to Rs 462 crore in FY-11. Net profits jumped seven-fold to Rs 31 crore over the same period, thanks to control in operating costs and steep decline in interest costs.

Operating profit margins improved from 7.8 per cent in FY-08 to 11.7 per cent in FY-11. Given the improved quality of orders undertaken, margins can be expected to remain at about 11 per cent, unless commodity costs shoot up. Repayment of Rs 25 crore of unsecured loans in FY-11 more than halved interest outgo.

Petron's return on equity also saw a jump from a little over 10 per cent until 2007 to 29 per cent in FY-11. This is far higher than the return of 15 per cent generated by peers such as Sunil Hi Tech Engineers.

Concurrently, the company also benefitted from the huge domestic capex in the power, and oil and gas space with its parent's background in the oil and gas field acting as a good reference point. Oil and gas sector accounted for half of Petron's order book of Rs 1,100 crore as of June 2011. Power, cement, fertiliser and metal sectors made up for the rest. With major capex plans under execution in the oil and gas space, this sector may not continue to dominate the order scene. While there will be maintenance projects in this space, the power segment may gain ground instead. An improved regulatory scenario in the fertiliser and chemical sectors, and expected capex in the metal space once regulatory hurdles are crossed, may be the next key triggers for order flows. For now, order book at 2.3 times FY-11 sales appears comfortable to keep revenue ticking.

International label

Petron can also be expected to receive a facelift from its association with billionaire LN Mittal's business group. Mittal Investments S.a.r.l, the investment arm of the steel baron, picked up stakes in Kazstroy group, indirectly gaining a strategic holding in Petron. This triggered an open offer in Petron in August, raising promoter group holdings to 72 per cent now. We view this as a positive development for two reasons. One, Mittal Investment's keen participation in oil field and refinery projects, including the HPCL-Mittal Energy joint venture locally, can translate into orders for Petron. A few such orders have already been bagged and executed. Two, the company's participation in international projects, can also receive a boost, given the Mittal label. While its parent, Kazstroy, is already operating in many regions abroad, Petron could possibly emerge as a support system in the areas of electrical, mechanical and instrumentation works, given its sound base in these operations in India.

The Petron stock rallied close to its open offer price of Rs 386 until August and declined thereafter.

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