Picking beaten angels : SREI (BSE:523756, NSE:SREINTFIN)

In our quest to provide timely advice to investors, we have been putting in a lot of time and efforts off-late to find out value stocks. Recent market crash has given us some opportunities in finding beaten angels and one such angel we believe is SREI (BSE:523756, NSE:SREINTFIN)

Why we like SREI
With 25% of the construction equipment financing market, SREI is India’s largest private NBFC with over Rs.6, 500 crs of assets under management. A 50:50 JV with BNP Paribas will help the company to aggressively expand its business with having access to low cost funds and to expand on its Project financing business.

With net NPA of approx 0.3%, strong management, domain expertise, expected BV of Rs.60 for FY08 and Rs.75-80 for FY09, SREI is available at 1.75x FY09 expected BV. We believe that last 20 years of knowledge in the equipment financing business will help SREI to make a formidable entry in Project Financing business.

With the additional kicker of QUIPO, SEZ, Ports and Roads projects which we have not included in our estimations, we believe SREI is attractively priced at the current valuations. The allotment of 2.5 crs warrants by promoters to themselves at Rs.100 per share is a big positive. We expect the stock to trade at 2.5x FY09 BV in the next 9-12 months.

Let’s dig deep

SREI is India’s largest construction equipment finance private NBFC located out of Kolkata. The company holds 25% of the India’s equipment financing market with IDFC, ICICI Bank and few other players sharing the rest. Promoted by the Kanoria family, the company has a 2 decade history behind it.

SREI has assets more than Rs.6, 500 crs under management and its activities include financing of construction equipments, equipment leasing, project finance and renewable energy equipment financing. SREI has floated subsidiaries for merchant banking, syndication services and forex services. Currently more than 90% of the revenues and profit comes from the equipment financing business, but project finance and equipment leasing are expected to contribute significantly from FY08 onwards. Now we will discuss all the businesses in detail:

1. Equipment Financing
Equipment expenditure is estimated to be 20-25% of the construction outlay which is estimated to be 40-45% of the infrastructure spending. While the government has plans to spend $250bn on infrastructure in next 5 years, the opportunity is just too big for SREI.

The company raises money from all available sources including banks, bond markets, public deposits and multilateral agencies. With an average borrowing rate of 8% in FY06 and 9% in FY07, the company’s operational expenses are just 2% due to its high ticket size transactions. With average yields of approx 13%, the company also maintains an interest rate reset clause in all the agreements to take care of the rising interest rates.

At 3QFY08 end, SREI had Rs.6, 500 crs of assets under equipment financing. This is up from Rs.3, 500 crs at FY07 end. For an effective utilization of its assets, SREI frequently utilizes the route of securitization. As SREI book the income over the life of the asset and not at the time of securitization, it maintains a conservative approach and provides a smooth sales pattern. Now we will discuss the major step taken by the company to make it big in the business.

A 50:50 JV with BNP Paribas
Considering the expertise developed by SREI, BNP Paribas and SREI has formed a 50:50 JV for the equipment financing business. Under the terms of the agreement, the equipment financing business will flow from SREI into the JV and BNP will introduce Rs.775 crs as their contribution. Out of this Rs.775 crs, approx Rs.375 crs will flow to the parent company which they will utilize to grow the Project Finance business which is mentioned below.

The JV will help SREI to have access to low cost funds and to utilize the world-wide expertise of BNP in this business. At the same point in time BNP will get access to the growing Indian equipment financing

Competition from banks is a major threat to SREI for the business, but as the banks are not willing to lend money to small contractors, the area where SREI operates and specializes, it is difficult for banks to make any sizable impact.

SREI intends to have a Net worth of Rs.800 crs and with a leverage of 8x-10x, the company aims to build a book of Rs.6, 000- 8, 000 crs from its current Rs.4, 400 crs (post securitization). The company in first nine months of FY08 has been disbursing loans of roughly Rs.300 crs per month.

2. Project Financing
SREI is trying to make big into project financing business where the Net Interest Margins (NIM’s) are lower in the range of 2.5% to 3.5%. The projects would specifically be in the infrastructure space only, as the company has good understanding of the same.

With getting Rs.375 crs from JV and roughly Rs.250 crs of cash infusion by promoters over a period of 1 year by converting the warrants into shares, the company plans to have a Net worth of Rs.800 crs for the business. With a leverage of 8x-10x, the company again aims to build a loan book of Rs.6, 000 – 8, 000 crs over a period of 2-3 years.

SREI is in serious talks with many parties for the project financing, but will announce the actual details only after the completion of all formalities.

3. Stake in QUIPO
QUIPO Infrastructure Equipment Limited (QIEL) is India’s largest renting out construction equipment company. SREI holds 17% of the company and it is supported by Construction Industry Development Council (the apex industrial body formed by the Planning commission and the Ministry of Surface Transport, Government of India).

SREI is in talks with other shareholders of QUIPO and intends to raise its stake in the company. In last few quarters, SREI has raised its stake to 17% from 15%. The estimated value of QUIPO is Rs.1, 500 crs and SREI stake of 17% can be valued at Rs.235 crs.

Positives
1. Excellent asset quality – With its gross NPA less than 1% and provisioning exceeding 80%, the asset quality is comparable to that off HDFC and IDFC. With its excellent track record, we can assume the management to deliver best results in this aspect.
2. BNP Paribas association – We expect that SREI would be able to increase its NIM as they would be having access to low cost funds from BNP. With its predominant position in the infrastructure equipment financing business, growing Indian economy and steady relationships with its clients, the opportunity is huge for the company.
3. Low tax rate – The Company is expected to have its tax rate at 9%-12% over the next 3 to 4 years as it keeps on paying MAT.
4. Strong Book Value – SREI had a book value of Rs.47 at FY07. We expect the same to increase to Rs.58-60 at FY08 and Rs.75-80 at FY09. We have not factored in any of the money infusion by promoters at Rs.100 and any major appreciation from the project financing business.
5. Warrants allotment to promoters – In Nov 07, the promoters allotted 2.5 crs shares to themselves with a conversion price of Rs.100 per share. On April 1, 2008, promoters converted 72 lac warrants into shares. After the entire conversion, the promoters holding will go up to 35% from its current 20.1%.

Take off - Point

One of the biggest deals cracked by the company was of recently allocated Rs.25, 000 crs Ganga Express Highway project. SREI is the sole advisor to the UP government for the project. The company is going to play a key role in project management and advisor for the project. The advisor fee of roughly 1% of the project cost is to be shared between SREI and UP government. SREI will receive its share of Rs.100 – 125 crs over a 5 year period. We believe that if SREI management can figure out some mechanism to get the entire amount upfront through some bill discounting route that will add a one time Rs.6.5 to the book value.

Other Major Initiatives
1. SEZ – SREI is developing 2 SEZ’s, one auto SEZ where SREI holds 89% of the equity and another one in collaboration with QUIPO where SREI holds 50%. Both the projects are close to 1000 acres of land development and involve hundreds of crs. As there is substantial time involved for the cash flows to happen, we have not included them in our calculations.
2. Road projects –SREI under one of its subsidiaries has got 7 road projects worth Rs.4000 crs and 950 kms where SREI holds anywhere from 26% to 49%.
3. Port project –SREI is developing a port in Rewas where the initial capex is as high as Rs.4000 crs and the project is expected to be profitable at the net profit level post 2014. Again we are not including the same into our calculations.

Pressing the button

We believe that SREI with its strong fundamentals, strong domain expertise, JV with BNP Paribas, low NPA and strong management is available at reasonable valuations. We expect SREI to trade at 2.5x-3x of its FY09 BV in next 1 year. We expect an appreciation of 50% from the CMP of Rs.140 in next 9-12 months time frame.