Sameeksha Capital’s founder is impressed by PSP Projects’ execution and capital efficiency
Catch ‘em young is a phrase used by James J Heckman, a Nobel laureate economist, in devising a public policy which shows that investing in disadvantaged young children has a high economic return. Though the policy is aimed at promoting fairness and social justice, it does find application in investing as well. Identifying businesses at an early stage with a sound revenue model creates wealth in the long run.
An industry which is perceived, generally as inefficient and murky, stands disadvantaged to attract investments. Construction is one such business. The market cap of all listed standalone building construction companies combined is less than 35,000 crore and their performance has been patchy.
The more familiar you are with a company and the more you understand its business and competitive environment, the better are your chances of finding a good ‘story’. This is why Peter Lynch is a strong advocate of investing in companies with which one is familiar, or whose products or services are relatively easy to understand. Lynch’s bottom-up approach means that prospective stocks must be picked one by one and then thoroughly investigated — there is no formula or screen that will produce a list of prospective ‘good stories’.
I came across one such company in my hometown (Ahmedabad) that has found the right balance of growth and financial discipline that distinguishes itself from most companies in the construction space.
Prahaladbhai Shivrambhai Patel (PSP), a civil engineer and first generation entrepreneur, started PSP Projects with his personal savings in 2009. The company got its big breakthrough in the same year when it won and completed within the stated time line a 100 crore-hospital project in Ahmedabad. Since then, it has executed over 80 projects worth 1,200 crore across all segments. Timely execution and quality outcome are the two key reasons clients keep coming back to PSP. Since inception, the company has executed 13 projects for Cadila Healthcare and its affiliates, six projects for Torrent Pharmaceuticals and its affiliates and four projects for Nirma and its affiliates. The company has also executed many marquee projects for the government, including portions of the Sabarmati River Front and renovation of the Legislative Assembly of Gujarat.
Thanks to Prahaladbhai’s accessibility and reputation, PSP recently won the 1,575-crore Surat Diamond Bourse project against very stiff competition. This project will add annual revenues at a run rate equivalent to the current run rate of the whole company, which will double its revenue base. More importantly, the successful completion of this project will cement PSP’s reputation and help it execute large projects, even outside its home territory.
Besides strong execution, the promoter himself pays acute personal attention to every project. Construction is a complex activity, and the many layers of decision-making at large companies add to this complexity. Delays are quite common. Prahaladbhai uses his experience and strong business acumen to identify bottlenecks and finds solutions in a way that helps him deliver results and win respect not only from customers but also suppliers and service providers. Unlike larger companies, at PSP, the project manager is not only the decision-maker but also the owner of the business and that means decisions are taken at a quick pace, even if calculated risks need to be taken.
PSP has developed unique internal capabilities to execute projects without having to use much of its own capital. The only capital it requires to put upfront is the margin money it needs to give to a bank to avail non-fund based limit. Such limits are used to issue performance guarantees required by customers. As is common practice, the company receives advance from clients to start the project and secure initial supply of materials on credit. However, by being able to bill for timely completion of work, PSP receives payments from customers that are used to cover internal costs and the payments to suppliers, continuing the cycle till the end of the project.
PSP has the lowest receivable days among its peers given that it does a better job in collecting payments: its three-year average (debtor days) is just 29 compared with 128 for its peers. Along with advance received for mobilisation (which supports 20-25 days of execution), PSP, in effect, is able to run its operations on a negative carry mode (35-40 days of negative cash conversion cycle). This also helps PSP in keeping its suppliers happy as reflected in its creditor days (three-year average of 75 days) compared with 124 for its peers. This is also because, instead of ordering large quantities of materials, the company orders just enough material to continue the work. As a result, it has been able to maintain inventory at less than five days against an industry average of 50-90 days. To support this seamless coordination, PSP has implemented ERP solutions to monitor operations not only at the corporate but also at the project level.
In their 2017 annual review of Indian operations, Peri Group, one of the world’s largest manufacturers of formwork and scaffolding, mentioned 25 marquee projects where their formworks were used by contractors, and it singled out PSP for having ‘excellent capabilities’.
Good history, great future
PSP is well-poised to deliver high growth in revenues and cash flows. In fact, it won’t surprise us if in the years to come, PSP becomes a name that will be in the same league as industry giants Larsen & Toubro and Shapoorji Pallonji.
While there is no relevant data on the upcoming development opportunity in Gujarat, the management has indicated that in the Gift City itself over 150 projects are being considered. PSP is venturing into other states as well, which is reflected in its order backlog mix wherein over 26% orders are from non-Gujarat states compared with nil couple of years back. The strategy outside Gujarat for PSP is to be very selective and bid for referral or repeat clients as the management understands that executing projects outside its core region comes with its own challenges on mobilisation and resource management.
The company is likely to branch out of Ahmedabad (as it has done with the Surat project). This will test the management’s bandwidth and scaling-up capabilities. Also, any hiccups in Surat project can materially affect its abilities to meet our forecast. While such risks are real, we believe that PSP represents an excellent opportunity for a long-term investor.
The company has seen its revenue, operating profit and PAT grow at 18%, 34% and 38%, respectively, over FY12-FY17. We expect a CAGR of 50%, 37% and 44%, respectively, during FY17-FY20. The company has thus far grown while maintaining return on equity (ROE) in excess of 30%. We expect PSP to achieve an average ROE of 53% over FY17-FY20. With an order-book of over 2,700 crore (including Surat Diamond Bourse project) to be executed over 24-30 months, the company has a firm visibility up to FY20. It also gives PSP the flexibility to bid for projects that meets its profitability and other selection criteria. More importantly, we do not expect the company to stretch itself too thin. Furthermore, as administrative overheads get allocated to a larger revenue base, there is a scope for margin expansion as well.
PSP currently trades at 16x, one-year forward. With earnings expected to clock a CAGR of 44% over FY17-FY19, investors can expect a meaningful appreciation in the stock in the coming years.
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