smallcap stock to buy: 3x growth in 1 year! This water engineering firm has a lot going for it
VA Tech Wabag, which has expertise in water engineering with many projects in India and abroad under its belt, has enthused analysts, who believe the next one year could be very rewarding for its shareholders with a 75 per cent potential upside in the stock.
So, what is really working for it?
First and foremost, the company is sitting on a decent order book. Analysts believe past concerns about the company piling up debt, low cash flows and slow-moving orders have largely been addressed.
“Financial closure of hybrid annuity model (HAM) assets and a strong well-funded order book or Rs 9,600 crore provide long-term sales visibility. The company’s strong track record of free cash flow generation in FY20 and also for the nine months of FY21 has largely addressed the debt concerns,” said Priyankar Biswas and Neelotpal Sahu, analysts at Nomura.
Even more encouraging is the fact that the order book is largely government-funded or multi-lateral funded, providing comfort in cash collections. With a significant rise in allocation to the water sector in the recent Union Budget, no significant payment issue is expected.
In its latest earnings announcement, the company said the pandemic has not brought down order volume.
“Our third quarter performance reflects the improvement in execution momentum, as most of our sites have started operating normally. It’s heartening to note that even during this tough economic situation globally, we could add about Rs 1,500 crore worth of orders, majorly from the MEA region, to our already robust order book,” said Sandeep Agrawal, Group CFO,
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Debt worries reduce
The company’s net debt has dropped from the FY19 peak of Rs 430 crore to Rs 200 crore in FY20 and declined further to Rs 140 crore this year. This was in spite of non-receipt of Rs 480 crore of stalled receivables pending since FY18, said Nomura analysts.
The sharp decline in debt levels within a short period signals strong free cash flow for the company. Now, with recoveries improving, this will not result in just trimming of debt, but also cause margins to spike.
“The company’s core ebitda margin remains strong, but has been masked in recent years by the expected credit loss (ECL) provisions. In the event the dues are recovered, reported Ebitda and core Ebitda margins will converge, leading to a positive surprise,” BIswas and Sahu said.
The company said its credit rating has improved in 2020, and it has seen rating upgrades to ‘A+’ for long term and ‘A1’ for short term papers with a stable outlook, on the back of strong performance.
Earnings beat
Analysts said the numbers reported by the company for the December quarter were better than expected. Profits grew 35 per cent year on year and revenue shot up 17 per cent.
Ebitda margin improved 171 bps on a sequential basis to 8.4 per cent due to lower cost of operation, but declined 108 bps year on year due to an increase in cost of sales.
Cyril Charly, Research Analyst at Geojit Financial Services, expects a revamp in revenue generation going forward, and projeets revenue to grow at a CAGR of 11.7 per cent over FY20-23.
“The improvement seen in revenue generation and debt level are expected to continue as execution is picking up with major projects having reached the revenue generation stage. Performance parameters of the core business look promising,” Charly said.
How much can the stock rise?
The stock has been seeing consistent buying after hitting a low in March 2020. The stock price has bounced over three times from the low point, as constant order flows and a reduction in debt levels have drawn investor interest.
Analysts say this is just the beginning of a huge rally in the stock, especially as it is still priced relatively cheaper. Initiating coverage on the stock, Nomura has set its price target at Rs 446.
“We believe VA Tech Wabag is a combination of value and growth with a reasonably low P/E multiple of 7 times on expected FY23 EPS of Rs 33.4 as well as on strong growth prospects – 100 per cent EPS growth from the FY21 level of Rs 16.1,” said Biswas and Sahu.
Their analysis said the justified trading range for the stock is in the Rs 239-573 range, with a favourable risk-reward at the current price levels.
Charly of Geojit said considering the positive outlook for the water treatment industry and expected revenue rebound along with improving cash position, the stock can be valued at a one-year forward PE of 10.5 times its FY23E earnings. The analyst has a 12-month price target of Rs 288.
Risk factors
According to Nomura analysts, key investment risks include:
- Slowdown in domestic capex and a sharp rise in commodity costs for overseas contracts
- Rising working capital could pose risks to cash flows, especially if weaker subcontractors and suppliers require further financial support.
- Execution delays could delay earnings growth, especially risks related to project completion and commissioning in international markets.
