Making a splash

A strong balance sheet and cheap valuation seem to work in favour of water treatment major, VA Tech Wabag

In 1996, Rajiv Mittal left London and came to Chennai to set up the Indian office of the company he worked for. Eight years later, when the Indian operation was put on the block, Mittal and three executive directors of the company decided to make a bid. Management buyouts are still a rare occurrence in India — and buyouts of Indian arms of MNCs almost unheard-of. But, in September 2005, with some help from ICICI Ventures, the quartet bought 75% of the company they worked for, paying ₹60 crore. A year after Mittal decided to try his hand at the unthinkable — he made a bid to acquire the parent company in Austria. Again helped by the PE firm, he succeeded and the deal was completed in 2007.

Just what company are we talking about? It’s the Chennai-headquartered VA Tech Wabag, a ₹1,400-crore tech firm that’s carving a niche for itself in the water treatment business, offering solutions for sewage treatment, industrial waste water treatment, drinking water treatment, desalination and water reuse, to clients across government and industry. It also has ambitions of establishing itself as one of the top three players globally in the water business (currently, VA Tech is in the top eight). The company has given a guidance of growing revenue to €1 billion (₹ 7,100 crore) by 2017 — a four-fold increase in as many years. Of this, nearly half will come from the Indian market, 25% from overseas business and the rest through acquisitions. Can it achieve all that? That’s the billion-euro question.

At home and abroad

According to EverythingAboutWater, the total Indian water market is estimated at about $15 billion, while the water and wastewater treatment market size is about $420 million; both are growing at 18% a year. Another report, this one by the Water Resource Group, estimates that about half the country’s water demand will go unmet by 2030 if existing conditions continue. Nearly 75% of India’s population lives in water-stressed areas. So, it comes as no surprise that the Indian government is focusing on improving water infrastructure through its landmark schemes under the Jawaharlal Nehru National Urban Renewal Mission (JNNURM), where 20% of the total spend is earmarked for capacity addition. VA Tech, with a presence across the water spectrum, is in a position to take advantage of this. At home, the company competes with domestic players such as Thermax, Ion Exchange and Hindustan Dorr Oliver, as well as international rivals such as Veolia, Suez and Degremont. But it does have a couple of advantages. 

First, the takeover of its parent gave VA Tech access to cutting edge technology, with over 100 patents. “This is one of the clear differentiators,” agrees Mittal, the managing director. Also, the company is present across the water spectrum unlike, say, Thermax, Ion Exchange and Driplex, which compete only in the industrial water segment, while Degremont and Enviro Control are present mainly in the waste water segment. That’s helped the company increase the contribution to total revenue from Indian business from 58% to 66%, between FY09 and FY12. 

On the international platform, its pedigree has helped the company win projects in over 20 countries across North Africa, Europe and Asia where it can play the low-cost advantage card (see: World wide wet). VA Tech consciously follows an asset-light model, focusing on design and engineering in the projects it undertakes while outsourcing the majority of its construction jobs. About 81% of its business comes from engineering-procurement-construction (EPC) services, while operations and maintenance (O&M) accounts for the balance.

A salt-free diet

Now, the biggest opportunity, believes the management, lies in desalination. By 2018, VA Tech estimates, desalination capacity in India will be around 5,350 million litres a day (mld) having grown at 30% a year from the current 900 mld. It recently completed its biggest desalination project till date, the ₹1,100-crore Nemmeli plant in Chennai, which will supply 100 mld every day to Chennai residents, taking care of 10-12% of the city’s requirement. While VA Tech has earned ₹530 crore for the design and construction of the project, it also has an O&M contract for the plant, which will generate another ₹500 crore over a seven-year period. 

Although there were some delays in the Nemmeli project, the company has been able to use it to springboard its way to more projects. In 2010, VA Tech entered into an alliance with Sumitomo Corporation to compete for large water infrastructure projects. The consortium won a $350 million project to build a 192 mld desalination plant in Muscat, Oman. VA Tech’s share of the project, which is likely to be completed in the next two years, will be around ₹400 crore.

Recently, the Tamil Nadu government also announced two more desalination plants. While a 150 mld plant will come up next to the existing one at Nemmeli, another will be set up at Pattipulam near Chennai with a capacity of 200 mld that can be increased to 400 mld. Analysts believe VA Tech will be at an advantage when bidding opens on the projects, since it has already built the largest plant in the country. In fact, the company is likely to be one of the major beneficiaries of even the central government’s increasing investments in water supply and waste water treatment  (see: The fourth wave). “The sector is so attractive and it is up to us and our ability to harness the growth opportunities,” says Mittal.

Order, order

At the end of December 2012, VA Tech had an impressive order book of ₹4,269 crore, but the slowdown has had an impact, with orders taking longer to come by. “There has been some slowdown but we have managed to get our share of the pie. We may have had to work harder for it but we will achieve the order book growth we had promised for FY13,” says Mittal confidently. At the beginning of FY13, the company has indicated an order book growth of 20% for FY13. It is looking at a similar growth for FY14. The company is also confident of achieving its full-year revenue guidance of ₹1,650-1,700 crore with operating margins of 9-9.5%. That’s lower than the industry average of 10-10.5% and in defence, the company points to high-cost overseas subsidiaries, which it says it has since turned around. Now, VA Tech is looking to build up volumes for margins to improve further. Besides, Mittal points out, margins on the standalone business are at 12.5-13%. 

Delays are a concern but they are also all too common in the project business. Where projects involving the government may at times run into hurdles in getting approvals or funds released, even natural phenomena such as a heavy monsoon can stop work for up to a couple of months at a time. In some cases, VA Tech has itself funded the project to ensure timely completion — the Nemmeli project is a case in point, although now some 70% of the design and construction cost has been paid to the company by the Tamil Nadu government. “Delays lead to cost escalation, resulting in lower margins. Our customers have the willingness to pay but, at times, may not have the ability. So, we put in our cash to complete the projects,” explains Mittal.

This is where the company’s strong balance sheet and cash reserves of about ₹350 crore come to its aid. “Unlike many EPC companies that come with stressed balance sheets, VA Tech’s asset light business model ensures that the company remains cash rich and that works to its advantage,” points out Nitin Bhasin, infrastructure analyst at Ambit Capital.

VA Tech is also becoming careful in the kind of projects it chooses. Since chances of delay in execution as well as payment are higher in municipal and state government projects, it prefers multi-laterally funded and central government initiatives. “The company works in a space where most of the payments are made by the government or government entities and dealing with them can be very challenging. But it has done well on that front,” praises Jerry Rao, founder of Mphasis and a director on the VA Tech board. Indeed, as there has been some lag in government spending in India, the contribution of the domestic industrial business is now about 45-50% of revenue, while the government business contributes 50-55% compared with earlier when government business contributed about 75%. 

Meanwhile, when there has been a slowdown of orders in some of VA Tech’s otherwise-strong markets, such as Libya and Algeria, due to political unrest in 2011, the company has turned its focus to newer markets such as Turkey, Sri Lanka and West Asia. “Having a diverse presence across countries works in its favour because when one economy is a facing a downturn, you can focus on other markets to generate growth,” says Sumit Chandwani, managing partner, Arth Capital. Chandwani was with ICICI Ventures when it invested in VA Tech and played an instrumental role in both its takeovers. He continues as an independent director on the company’s board.

Over a five-year period (2007-2012), the company’s revenues have grown by an average 34% and profits have grown by 61%. During the nine months ended December 2012, revenues grew by 20% to ₹925.5 crore and profits more than doubled to ₹29.6 crore. Ambit’s Bhasin feels that, given the growth trajectory of the company, its current valuations are attractive. “The company’s revenue growth trajectory from mid-teens is likely to shift higher to 20% during the next two years. Given that the stock trades at 11-12x its FY14 earnings, we think it is very attractive,” he adds.

Over the past one year (as April 22, 2013), VA Tech’s stock has gained 16%, outperforming the Sensex during that period. The company is also well-poised to gain from the increased spending in water infrastructure, sewage and waste water management in emerging markets. With Mittal eyeing €1 billion in revenues in the next four to five years, most analysts are bullish on the stock on account of the strong management team, increasing investments in the sector and execution track record of the company. Bhasin has a price target of ₹750 on the stock, which currently trades at ₹492. With the odds in its favour, it definitely seems worth a bet.