FINANCIAL ANALYSIS OF THE INFRASTRUCTURE INDUSTRY

COMPANIES ANALYSED:

DLF RELIANCE INFRASTRUCTURE L&T PUNJ LLOYD GMR

Made by: Anshul monga Anu Agarwal Alok Kumar Vatsala Khetawat Harita Singh

COMPANY INFORMATION
L&T Infrastructure
L&T Infrastructure Finance Company Limited (L&T Infra) is promoted by the engineering and construction conglomerate Larsen & Toubro Limited (L&T) and L&T Finance Holdings Limited (a subsidiary of L&T). L&T Infra, incorporated in 2006, is registered as an Non Banking Financial Company (NBFC) under the Reserve Bank of India (RBI) Act 1934, and is among the select few financial institutions classified as an Infrastructure Finance Company (IFC). It was set up with an initial capital of 500 crore (US$111 million) and has expanded at a rapid rate since inception. It provides a wide range of customized debt & equity products as well as Financial Advisory Services for the development of infrastructure facilities in the country with a focus on power, roads, telecom, oil & gas and port sectors. The company functions with high Corporate Governance standards and Independent Directors constituting 50% of its Board and the key committees. As a testimony to its strong credentials and sound operating performance, L&T infra enjoys AA+ credit ratings by both CARE and ICRA.

Punj Lloyd
Punj Lloyd provides integrated design, engineering, procurement, construction and project management services in the energy and infrastructure sectors. With operations spread across the Middle East, Africa, the Caspian, Asia Pacific and South Asia, Punj Lloyd provides EPC services in Oil & Gas, Process, Civil Infrastructure, and Thermal Power. Further, Punj Lloyd is today a diversified conglomerate, owing to its successful foray into aviation, defense and upstream, through its subsidiaries and joint ventures. The expanding list of satisfied clients reflects the companys ability to execute challenging projects, despite all odds. Difficult weather or terrain has been no deterrent to its team which has delivered consistently and brought accolades to the company. The high percentage of repeat orders stand testimony to this. It has also achieved many milestones and broken many records. As a reflection of international quality standards, construction and project management techniques, Punj Lloyd holds ISO 9001:2008, ISO 14001:2004 and OHSAS 18001:2007 certification. The companys ability to manage operations in diverse industries and economies, coupled with the track record in mobilizing financial and human resources makes it the preferred contractor for critical projects. Adding to that, their fleet of sophisticated construction equipment, including horizontal directional drilling rigs and pipe-laying barges, gives them a competitive edge over the competitors.

GMR Group
GMR Group is one of the fastest growing infrastructure enterprises in the country with interests in Airports, Energy, Highways and Urban Infrastructure sectors. Employing the Public Private Partnership model, the Group has successfully implemented several iconic infrastructure projects in India. The Group also has a global presence with infrastructure operating assets and projects in several countries including Turkey, South Africa, Indonesia, Singapore and the Maldives. GMR Infrastructure Limited is the infrastructure holding company formed to fund the capital requirements of various infrastructure projects across the sectors. It undertakes the development of the infrastructure projects through its various subsidiaries. The Groups commitment to inclusive growth is achieved through its Corporate Social Responsibility arm the GMR Varalakshmi Foundation (GMRVF). GMRVF works with the under-privileged sections of the community in all the locations where the Group has business interests.

Reliance Infrastructure
With the rapid growth of the economy in recent years, the importance and urgency of removing infrastructure constraints have increased. Here, Reliance Infrastructure, one of Indias largest is purposefully surging ahead in a quest to develop world-class infrastructural facilities. Aggressive strategies are being adapted to kick-start projects that otherwise would have never seen the light of the day. Enjoying a premier brand image, Reliance Infrastructure in partnership with the government has funded and launched a number of roads, metro, airports, ports and real estate projects. The organization dreams of enriching our country by conceptualizing, executing and implementing mammoth projects that are manned by a team of highly motivated professionals. It is playing a pivotal role in undertaking major road projects that encompass hundreds of kilometers all across the country. They understand the growing opportunities that exist and have been relentlessly pursuing them to realize the dream of turning India into a developed nation.

DLF

DLF has over 60 years of track record of sustained growth, customer satisfaction, and innovation. The company has 349 msf of planned projects with 44.9 msf of projects under construction. DLF's primary business is development of residential, commercial and retail properties. The company has a unique business model with earnings arising from development and rentals. Its exposure across businesses, segments and geographies, mitigates any down-cycles in the market. DLF has also forayed into infrastructure, SEZ and hotel businesses.

With over six decades of excellence, DLF is a name synonymous with global standards, new generation workspaces and lifestyles. It has the distinction of developing commercial projects and IT parks that are at par with the best in the world. DLF has become a preferred name with many IT & ITES majors and leading Indian and International corporate giants, including GE, IBM, Microsoft, Canon, Citibank, Vertex, Hewitt, Fidelity Investments, WNS, Bank of America, Cognizant, Infosys, CSC, Symantec and Sapient, among others.

LEVERAGE
Leverage is defined as The use of various financial instruments or borrowed capital to increase the potential return of an investment. The amount of debt used to finance a firm's assets.

TYPES OF LEVERAGE
OPERATING LEVERAGE:
Operating leverage is a measure of how revenue growth translates into growth in operating income. It is a measure of leverage, and of how risky (volatile) a company's operating income is. It examines the effect of change in the quantity produced on the EBIT of the company and is measured by calculating the Degree of Operating Leverage (DOL). DOL= When at a given sales, the EBIT of a company is zero, this is the operating break-even point. DOL is undefined at break-even. If sales are less than the operating break-even point, then DOL will be negative. Above it, DOL will be positive. As sales increase, DOL approaches to 1. For a given level of sales and profit, the DOL is higher, the higher fixed costs are and hence its Operating Income increases more rapidly with Sales than a company with lower fixed costs. DOL as a measure of business risk: The greater the DOL, the more sensitive is EBIT to a given change in unit sales i.e. the greater is the risk of exceptional losses if sales become depressed. From our analysis in the year 2011, the DOL of DLF and Reliance Infra are greater in comparison to GMR and L&T. For GMR, DOL of 0.56 means that for every percent increase in sales, the companys EBIT will increase 0.56 times whereas in DLF, DOL is 2.289 which means that the EBIT will increase 2.289 times for every percent increase in sales. This shows the EBIT is more sensitive to change in sales for the higher DOL companies and there is greater business risk associated. Also, a higher fixed cost is being used by them.

FINANCIAL LEVERAGE:
Financial leverage measures the magnifying effect of change in EBIT on its EPS when fixed financial charges are present. DFL implies what will be the change in EPS with the 1% change in EBIT.

Combined or Total leverage measure the total risk of firm. i.e. operating + financial risk. it measures what will be the % change in EPS with the 1% change in sales. A company should keep its optimal capital structure in mind when making financing decisions to ensure any increases in debt and preferred equity increase the value of the company. The measure of financial leverage is Degree of Financial Leverage. DFL= This is a measure of the sensitivity of EPS to changes in EBIT as a result of changes in debt. With a high degree of financial leverage comes a higher burden of interest payment. As interest payments increase, as a result of increased financial leverage, EPS is driven lower. From our analysis in the year 2011, we see that the DFL of Punj Llyod is greater than 2. This means that with every percent increase change in EBIT, the EPS increases 2 times. The negative DFL of L&T in year 2011, i.e, -11.06 means that the EBIT is below the financial break-even point and thus the effect does not apply here. Higher the DFL, higher is the financial risk taking capability of the company.

TOTAL LEVERAGE:
A combination of the operating and financial leverages is the total or combined leverage. Degree of Combined Leverage (DCL) is measured as DCL= It is a product of DOL and DFL. It measures the change in EPS with change in sales. If a firm has a high amount of operating leverage and financial leverage, a small change in sales will lead to a large variability in EPS. The DCL of Punj Llyod, DLF and Reliance are higher. The DCL in 2011 for L&T is negative which means that the sales are less than the overall breakeven point. A firm that operates with both high operating and financial leverage makes for a risky investment. A high operating leverage means that a firm is making few sales but with high margins. This can pose significant risks if a firm incorrectly forecasts future sales. If a future sales forecast is slightly higher than what actually occurs, this could lead to a huge difference between actual and budgeted cash flow, which will greatly affect a firm's future operating ability. The biggest risk that arises from high financial leverage occurs when a company's ROA does not exceed the interest on the loan, which greatly diminishes a company's return on equity and profitability.

FINANCIAL STATEMENT ANALYSIS

We know that business is mainly concerned with the financial activities. In order to ascertain the financial status of the business, every enterprise prepares certain statements, known as financial statements. Financial statements are mainly prepared for decision making purposes. But the information as is provided in the financial statements is not adequately helpful in drawing a meaningful conclusion. Thus, an effective analysis and interpretation of financial statements is required. Analysis means establishing a meaningful relationship between various items of the financial statements with each other in such a way that a conclusion is drawn. By financial statements we mainly mean two statements: (i) Income Statement (ii) Balance Sheet or Position Statement These are prepared at the end of a given period of time. They are the indicators of profitability and financial soundness of the business concern. The term financial analysis is also known as analysis and interpretation of financial statements. It refers to the establishing meaningful relationship between various items of the financial statements i.e. Income statement and position statement. It determines financial strength and weaknesses of the firm. Analysis of financial statements is an attempt to assess the efficiency and performance of an enterprise. Thus, the analysis and interpretation of financial statements is very essential to measure the efficiency, profitability, financial soundness and future prospects of the business units. One very important tool to measure the effectiveness and efficiency of any business organization is Financial Ratios. There are 4 main types of ratios. They are: 1. Liquidity Ratios: These are a class of financial metrics that is used to determine a company's ability to pay off its short-terms debts obligations. Generally, the higher the value of the ratio, the larger the margin of safety that the company possesses to cover short-term debts thus making it credit worthy; however too high a value is also bad as idle assets earn nothing. Therefore it is essential to strike the right balance. The following are different types of Liquidity ratios: 1. CURRENT RATIO = CURRENT ASSETS/CURRENT LIABILITIES It is a measure of firms short term solvency & a conventional healthy ratio of 2:1 is to be maintained. As can be seen apart from Punj Lloyd, none of the companies maintain that ratio. This can also be due to the fact that infrastructure companies are involved in high investment projects, where they generally borrow huge amount of cash. 2. QUICK RATIO = CURRENT RATIO-INVENTORIES/CURRENT LIABILITIES Sometimes inventory isnt fast moving. To evaluate the immediate solvency position of such firms, this ratio can be used. Generally ideal is assumed to be 1:1. As can be seen it is no different than the previous graphs as the inventory in Infrastructure Company is mostly absent.

2. Activity Ratio: These ratios measure a firm's efficiency in utilizing its assets. They measure the firms ability to convert different accounts within their balance sheets into cash or sales. Such ratios are frequently used when performing fundamental analysis on different companies. The following are different types of Activity ratios: 1. DEBTOR TURNOVER RATIO = NET CREDIT SALES/AVERAGE DEBTORS 2. DEBTOR VELOCITY = 365/DEBTOR TURNOVER RATIO Normally higher the debtors turnover ratio, the better it is. Higher turnover signifies speedy and effective collection. Lower turnover indicates sluggish and inefficient collection leading to the doubts that receivables might contain significant doubtful debts. Receivables collection period is expressed in number of days. It should be compared with the period of credit allowed by the management to the customers as a matter of policy. Such comparison will help to decide whether receivables collection management is efficient or inefficient. Being infrastructure companies, a high amount of debt needs to be provided to the customers as the customer financial involvement is huge. DLF again tops the chart with a higher efficiency. 3. FIXED ASSET TURNOVER = NET SALES/FIXED ASSETS It measures the firm's ability to utilize its assets to generate sales. It is an indication of the firm's operational efficiency. A lower ratio means inefficient utilization of assets. The lower the total asset turnover ratio, as compared to historical data for the firm and industry data, the more sluggish the firm's sales. GMR has the highest ratio however has declined over the years. This can be due to the evolving technology in the field of infrastructure. 4. TOTAL ASSET TURNOVER = SALES/NET ASSETS Assets are used to generate sales & this ratio tells us how efficiently we can use assets to maximize sales. L & T has the highest asset turnover ratio which is higher than the industry average as well thus inducing the reason of high sales generated.

3. Leverage Ratios: A ratio used to measure a company's mix of operating costs, giving an idea of how changes in output will affect operating income. Any ratio used to calculate the financial leverage of a company to get an idea of the company's methods of financing or to measure its ability to meet financial obligations. The following are different types of leverage ratios: 1. DEBT EQUITY RATIO = DEBT/EQUITY A firm with high debt equity ratio implies its credibility with the creditors. A good credit rating is highly essential in infrastructure sector owing to the huge amount of investment required. Punj Llyod has a high credit rating in form of high debt to equity ratio over the years apart from 2008 (which can be attributed to recession).

2. PROPRIETARY RATIO = NET WORTH/TOTAL ASSETS It draws a comparison between the amounts of net worth in comparison to total assets. Herein we can see that GMR has high proprietary ratio.

4. Profitability Ratios: These are a class of financial metrics that are used to assess a business's ability to generate earnings as compared to its expenses and other relevant costs incurred during a specific period of time. This provides a measurement of the overall performance & effectiveness of firm. The following are different types of profitability ratios: 1. NET PROFIT RATIO = PAT/SALES This shows the portion of sales available to owners after all expenses. A high profit ratio is higher profitability of the firm. This ratio shows the earning left for shareholder as percentage of Net sales. Net Margin Ratio measures the overall efficiency of production, Administration selling, financing and pricing. DLF has the maximum net profit ratio which shows their high efficiency level. On the other hand Punj Lloyd has the minimum net profit margin.. 2. OPERATING PROFIT RATIO = OPERATING PROFIT/SALES This ratio helps in determining the ability of the management in running the business, wherein all others except GMR are consistent performers. DLF has the highest operating profit ratio. 3. RETURN ON CAPITAL EMPLOYED = PBIT/CAPITAL EMPLOYED L & T has the highest return on capital employed ratio i.e. 24.421 which is consistent over the years. This implies that they are able to generate revenue in proportion with the money employed on equity and debt. 4. RETURN ON NET WORTH = PAT/EQUITY The net worth ratio states the return that shareholders could receive on their investment in a company, if all of the profit earned were to be passed through directly to them. Thus, the ratio is developed from the perspective of the shareholder, not the company, and is used to analyze investor returns. Punj Lloyd has the lowest ratio among the other four.

DU PONT Analysis
It is a method of performance measurement that was started by the DuPont Corporation in the 1920s. With this method, assets are measured at their gross book value rather than at net book value in order to produce a higher return on equity (ROE). It is also known as "DuPont identity". DuPont analysis tells us that ROE is affected by three things: Operating efficiency, which is measured by profit margin

Asset use efficiency, which is measured by total asset turnover Financial leverage, which is measured by the equity multiplier

The formula for calculating Return On Equity (ROE) is: ROE = Profit Margin (Profit/Sales) * Total Asset Turnover (Sales/Assets) * Equity Multiplier (Assets/Equity) More explicitly,

This decomposition presents various ratios used in fundamental analysis:

The company's tax burden is (Net profit pretax profit). This is the proportion of the company's profits retained after paying income taxes. [NI/EBT] The company's interest burden is (Pretax profit EBIT). This will be 1.00 for a firm with no debt or financial leverage. [EBT/EBIT] The company's operating profit margin or return on sales (ROS) is (EBIT Sales). This is the operating profit per dollar of sales. [EBIT/Sales] The company's asset turnover (ATO) is (Sales Assets). The company's leverage ratio is (Assets Equity), which is equal to the firm's debt to equity ratio + 1. This is a measure of financial leverage. The company's return on assets (ROA) is (Return on sales x Asset turnover). The company's compound leverage factor is (Interest burden x Leverage).

ROE can also be stated as: ROE = Tax burden x Interest burden x Margin x Turnover x Leverage ROE = Tax burden x ROA x Compound leverage factor The Profit margin is (Net profit Sales), so the ROE equation can be restated:

From the analysis carried on the five companies taken, it is observed that the ROE of GMR and Punj Llyod is very low. On further analysis, it can be seen that, 1. The tax burden is more on L&T when compared to the other four companies. Therefore, the profit retained after paying taxes is less in this company. 2. The interest burden is highest on Punj Llyod when compared to the other companies. This may be because the company is more financially levered. But still, the ROE has decreased. It is because if the company has a high cost of borrowing, its interest expenses on more debt could mute the positive effects of the leverage.

3. The operating leverage for GMR group is the highest i.e. it is able to generate more profits for one unit of sales in comparison to the other companies. 4. The asset turnover ratio is the highest for L&T. This implies that it is able to generate more sales on its assets employed than the other companies. As observed, the source of ROE for all the companies is the equity multiplier i.e. the leverage is highly determining the ROE. In case of L&T, the asset turnover is the major source for rise in the ROE. If a company's ROE goes up due to an increase in the net profit margin or asset turnover, this is a very positive sign for the company.

External Funding Requirement

Funding that a company raises from any source other than itself. Two common types of external funding are bond and stock issues. A company seeks out external funds when it wishes to expand its operations or other activities, but lacks the cash flow to do it independently. Providers of external funds almost always expect to receive something in return; for example, bondholders expect interest and principle repayment, while stockholders expect to receive a portion of the ownership of the company. Here in our analysis we will see what amount of EFR does a company require, if it is positive or negative, if negative then what is the reson for the same and if positive then what can be the sources of raising it(debt or equity).

Where,

S0 = Current Sales, S1 = Forecasted Sales = S0(1 + g), g = the forecasted growth rate is Sales, A*0 = Assets (at time 0) which vary directly with Sales, L*0 = Liabilities (at time 0) which vary directly with Sales, PM = Profit Margin = (Net Income)/(Sales), and b = Retention Ratio = (Addition to Retained Earnings)/(Net Income). Company GMR Group Reliance Infrastructure L&T Punj Lloyd DLF EFR -127.5643254 -1237.62063 -4978.041415 -15.70814652 7.1

As per the calculated EFR of above mentioned infrastructure companies, L&T has the highest volume of retained earning with it. Here the negative sign indicates that the company does not require external funds to finance any upcoming projects to the extent of the negative value of each company.

Here, L&T > RELIANCE INFRASTRUCTURE > GMR > PUNJ LLOYD > DLF L&T has the highest available fund while DLF requires external funding. Amount of external financing depends on the firms projected growth in sales. The faster the firm grows, the more it needs to invest and therefore the more it needs to raise new capital. A firm with a high volume of retained earnings relative to its assets can generate a higher growth rate without needing to raise more capital.

CAPITAL STRUCTURE

CAPITAL STRUCTURE The Capital structure of a company is referred to the mix of the long term finances used by the firm. Generally, Equity and Debt capital are the two main sources of long-term finance for a firm. Their optimal mix depends on the relationship between financial leverage and firm valuation or cost of capital. The approach that we have taken for the valuation of the firm is The Net Income Approach. All the three companies that we have chosen in Infrastructure Industry are levered firms i.e. they have financed their assets by equity and debt both. The Debt/Equity ratio of each firm i.e. DLF, GMR, L & T, Reliance Infrastructure and Punj Lloyd is 1.09, 0.331, 0.327, 0.224 and 0.929 respectively. This approach to capital structure of company tells us that a company can increase its value or may reduce the entire cost of capital by increasing the percentage of debt in its capital structure. The fundamental assumptions considered here are given below: As the use of debt does not alter the risk element, the equity capitalization rate and debt capitalization rate will remain unchanged. The debt capitalization rate is less than the equity capitalization rate. Income-tax considerations are ignored.

This approach basically tells us that as and when the debt/equity ratio increases the cost of debt which is lower than the cost of capital receives a higher weight in the calculation of the weighted average cost of capital, hence the WACC decreases.

DIVIDEND POLICY
There are basically two options which a firm has while utilizing its profits after tax. Firms can either plough back the earnings by retaining them or distribute the same to the shareholders. The returns to the shareholders either by way of the dividend receipts or capital gains are affected by the dividend policies of the firms. The dividend policy gains importance especially due to unambiguous relationship that exists between the dividend policy and the equity returns. Few models which studied this relationship are Traditional Position, Walter Model, Gordon Model,

Miller & Modigliani Position and Rational Expectations Model. We have considered only Walter Model and Gordon Model for our analysis. For our calculations, we have considered ROE=IRR as mentioned in the exhibit on page number 426 of the book Financial Management by I.M. Pandey. r has been taken as the average ROE of last 5 years. Cost of Equity has been calculated by using CAPM model. Both Walters & Gordons Model suggest that a firms share value is positively correlated with the dividend pay-out ratio when r < ke and is negatively correlated when r > ke. This can be proved by our calculations. In case of Reliance, Punj Lloyd and DLF, r < ke. Hence, as the DPR is increased, the share prices increase. While in case of L & T r > ke. Hence, as the DPR is increased, the share prices decrease.

FUND FLOW STATEMENT

A fund flow statement explains the various sources from which funds are raised and uses to which these funds are put to in a particular year within a company. Fund flow statement can be prepared on total resources basis, cash basis or working capital basis depending upon the requirement of the user. Fund flow statements are very helpful in detecting any imbalances in inventory management, assisting in appraisal of divisional performance, evaluating the firms financing options and planning for future financing. Analysis of statement of changes in working capital With the help of this statement we can infer the increase or decrease in working capital. Major changes in increase in working capital are seen for DLF that are 2,428.99, followed by L & T (18919.99) and then GMR (285.73) while there is decrease in working capital for Reliance Infrastructure. It states that current assets of DLF have increased with major increase in cash and bank balances. Analysis of statement of changes in funds from operations Here the non-fund and non-operating items which have been already deducted to profit and loss account are added back. L & T has maximum funds from operations that is 3683.21since it has maximum net profits with it. It shows that L & T have the major ability to earn profits. Since profit and loss account contains certain items that do not affect working capital .therefore in determining the amount of working capital from operations, the figure of net profit as shown in the profit and loss account is adjusted.

FINANCIAL FORECASTING
Financial forecasting is a planning process with which the companys management position the firms future activities relative to the expected economic, technical, competitive and social environment.

In our project, we have used sales method for forecasting. Here we have used CAGR to forecast the projected sales. For all calculation including CAGR, we have used data of previous 5 years for these companies. Once the net sales have been projected, we have considered net sales as 100. All expenditures forecast have been calculated as they are done in sales method including depreciation and interest. Number of outstanding shares has been assumed to be same as in the previous year. Equity Dividend percentage have been assumed to be an average of the periods of which the data is considered.