VKS Projects: Avoid

The initial public offer of VKS Projects, an engineering and construction contractor for industrial projects, doesn’t have much going for it.

VKS has a list of reputed clients; revenues and earnings have clocked good growth. But its low order book size, short execution cycle, limited diversification and lack of revenue visibility are significant deterrents.

There is also likely to be a massive earnings dilution in the near term with most of the issue proceeds financing equipment purchase and setting up design offices.

In the price band of Rs 55-60, the offer is priced at 13.2 to 13.7 times the annualised FY-12 earnings on the post-issue equity.

Valuations demanded are at a stiff premium to far bigger and more diversified construction players; peers have managed to grow revenues and stand to benefit much more as order inflows pick up. Investors can therefore avoid subscribing to the offer.

Order book limitations

As of end-December 2011 (the latest available numbers), the order book for the company stood at Rs 98.33 crore, about 1.01 times the revenues for FY-11. With existing orders are slated to be executed by the end of 2012, there is limited visibility on the revenue front.

A shorter execution cycle indicates that new orders have to be procured quickly to keep up revenue growth.

With the company engaged in setting up industrial piping, structures and equipment, the slowdown in industrial capital activity will have a direct bearing on new orders.

Adding to the uncertainty over order book, 46 per cent of the order book comes from a single client, and is also set to be completed in December 2012.

Small size

Revenues and profits for the company, on a compounded annual basis, have grown 124 per cent and 227 per cent over the past three years, helped by a low base. Even so, size is small — revenues and profits for the nine months to December 2011 stand at just Rs 98 crore and Rs 6 crore respectively.

Average order size is low at about Rs 10 crore; it has not yet partnered other players for larger projects and moved up the value chain.

The order book is likely to grow with an abundance of small-value orders, limiting room for improving qualifications and procuring better orders.

Equity expansion

VKS plans to raise Rs 55 crore, leading to an equity base expansion of over 50 per cent. Rs 22.6 crore will be used to purchase equipment.

This may improve execution time and operating margins by bringing down hiring costs and reducing risk of execution hiccups due to delay in equipment supply. Rs 10 crore will be used to set up design offices in five cities, which could enhance the company’s service offering.

In the near term, however, profit growth through investment of issue proceeds will be minimal, and there will be a severe dilution in earnings until cost-efficiencies kick in.

The remaining issue proceeds will be utilised for working capital. The working capital cycle has been sliding for the past three years; pre-issue debt-equity was on the higher side at 1.13 times and its cash credit facility is costly at current rates of 16 per cent.

Debt shot up from Rs 5 crore to Rs 18 crore by end-December 2011. Debtors too have seen huge jumps from FY-10 onwards.

Operating margins are strong at 12 per cent from FY-10 onwards, while net margins have moved between 5 and 7 per cent in the period. Net margins are likely to see some pressure on higher depreciation due to machinery investment.

The offer is open till July 4. Aryaman Financial Services is the lead manager to the issue.

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