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MOSL: Sadbhav Engg. (Upgrade to Buy)-Focus on business is the only remedy

Sadbhav Engg.: Focus on business is the only remedy; Upgrade to Buy

(SADE IN, Mkt Cap USD0.3b, CMP INR132, TP INR195, 48% Upside, Upgrade to Buy)

 

Sadbhav Engineering's (SADE) stock price has corrected by ~50% since the asset sale announcement as pledges have increased. In this note, we will briefly discuss on this topic along with some of the other concerns facing the company.

 

• Around 50% decline in stock price implies ~75% correction in EPC business valuation: Since the announcement of the asset sale a month back, SADE's stock price has corrected by ~50%. We note that the company draws ~45% of valuation (based on our SOTP methodology) on account of its stake in the listed subsidiary, Sadbhav Infrastructure Projects Limited. Thus, adjusted for the valuation of the subsidiary, valuation is down ~75% for the EPC business to FY20/21E P/E of 3.8x/3.2x.
• Pledged shares - an overhang on the stock: The promoter holding in SADE's stock stands at 46.6%. Of the total promoter holding, ~37.5% is pledged according to the last available data on the exchanges (down from the peak of 49.2% at end-Mar'19). The pledged share data now becomes a key monitorable in the near term, and any further reduction in the same will be viewed positively.
• Asset sale deal is positive for deleveraging and addresses the key concern: To recap, SADE had divested its stake in nine road assets at an EV of INR66.1b, resulting in debt reduction of INR40.6b at the project level and realization of INR25.5b in lieu of equity invested. Of this, INR19b is expected to be cash consideration by Oct'19, while the remaining INR6.5b is expected to be in the form of the units of the InvIT, IndInfravit Trust to the tune of 10% stake. We understand that the deleveraging would have been higher in case the entire deal would have been in lieu of cash, but do not see this as a major issue. An InvIT platform brings further business opportunity to the company in the form of O&M opportunities, further asset flipping in the platform and the likelihood of bidding for ToT (toll-operate-transfer) opportunities. Post the deal, we expect standalone net leverage to decline to 0.3x/0.2x by FY20/21 and consolidated net leverage to fall to 2.7x/3x by FY20/21.
• Loan default event of SPV did raise some questions: We recall that the company's SPV Rohtak Hissar had defaulted on payment to the lender and the rating of the same had been downgraded. However, there is no recourse of the same to the company and the primary issue with the project is the traffic diversion on account of parallel roads in the state of Haryana. SADE continues to be in dialogue with the NHAI for remedy for Rohtak Hissar and Rohtak Panipat project - either for revenue shortfall support or termination. However, the same needs to be handled in a careful manner, given that the NHAI is the primary client for the company.