SREI Infrastructure Finance Ltd

PRICE : RS.129 RECOMMENDATION : BUY

TARGET PRICE : RS.200 FY10E PE : 7.8X; P/ABV : 1.3X

Sarika Lohra

sarika.lohra@kotak.com

+91 22 6634 1480

Srei Infrastructure Finance (Srei) is well placed to leverage on the robust

capex requirement for infrastructure development. Srei caters to SME

project developers. The NBFC has created a niche for itself in the

infrastructure financing segment. This has helped Srei in capturing a

share of around 30% of the infrastructure equipment financing space.

The sale of the asset financing business to a 50:50 JV with BNP Paribas is

expected to help the company in ramping up its other business. Srei

Infrastructure would largely focus on large ticket equipment financing

projects worth Rs.150 mn and the project financing business. We expect

the business of the NBFC to grow at a CAGR of 46% over FY07-10 to

Rs.111 bn.

We are extremely positive on Srei's business growth prospects. We opine

that this will drive the NBFC's revenue growth, going forward. We have

valued the company on an SoTP methodology to arrive at a fair price

target of Rs.200. At the current price, the stock is trading at around 1.3x

its FY10 ABV of Rs.97. At our price target of Rs.200, the stock offers an

attractive upside of 55%. We recommend BUY on the stock with a 12-

month price target of Rs.200.

Investment rationale

q Substantial spend on infrastructure development: Following the

Government's thrust on infrastructure development, the Eleventh Five Year

Plan (FY2007-12) has laid out expenditure of $500 bn on the infrastructure

sector. This offers huge potential to infrastructure project developers and

contractors. In the backdrop of considerable construction activity, the demand

for construction equipment is also likely to grow. Construction equipment

cost accounts for approximately 20% of the total construction cost of a

project. Thus the demand for construction equipment is expected to increase

fivefold by 2015 from the current US$2.3 bn to about US$12-13 bn.

q Vital presence in the niche segment Srei provide services to small and

medium scale contractors and project developers. The NBFC has efficiently

capitalized on its strong relationship with its customers and created a

significant place in the segment. Around 85-90% of the company’s orders are

repeat orders, which has helped the company create a niche for itself.

Currently, Srei controls significant market share of close to 30% of the total

equipment financing segment.

q Higher business growth amid robust capex in infrastructure sector:

There would be substantial infrastructure spending of $500 bn in the Eleventh

Five Year Plan (FY07-12). Of this, over 65% would be in the construction sector

alone. This, we believe, offers huge potential to construction contractors

and project developers. In light of this, the overall financing assets of the

NBFC are expected to grow at a CAGR of 46% over FY07-10 to Rs.111 bn.

q Capitalizing on BNP Paribas JV to boost business growth: Srei has

entered into a 50:50 JV with BNP Paribas for the equipment financing and

leasing business. BNP Paribas has invested Rs.7.8 bn while Srei has invested

close to Rs.250 mn in the JV - SREI Infrastructure Development Finance. The

new JV has commenced its operations from April 2008. With the 50%

holding in the JV, Srei (the parent company) would get additional funds worth

Rs.4 bn to capitalize on. This would facilitate rapid business growth for the

company.

q Project financing and advisory to be key growth drivers: Post capital

infusion by BNP Paribas, Srei (the parent company) would focus mainly on the

large scale infrastructure projects above Rs.150 mn, and the project financing

business. The NBFC has bid for various projects in consortium partnership with

companies engaged in the development of roads, ports and SEZs. Moreover,

Srei also gets the advantage of working successfully on Government projects,

and has been chosen as a preferred partner under PPP for various Government

projects for advisory and execution.

q Buoyant financials supported by considerable business growth: We

expect the earnings growth for the NBFC to continue to witness traction

following the rapid business growth. NII of the NBFC is expected to grow at a

CAGR of 38% over FY07-10E to Rs.3.97 bn, while we expect net profit of the

company to grow at a CAGR of 37% over FY07-10E to Rs.2.17 bn.

Valuation and recommendation

We have a positive outlook on the stock given the favorable macro-economic

factors. Robust business growth of the company would be the key revenue driver.

We have valued the company on a sum of the parts (SoTP) basis, and valued the

core business of the parent company Srei Infrastructure Finance (consolidated) on a

dividend discount model. We have also valued SREI’s investment in its subsidiaries

SREI Capital Markets, SREI Venture Capital and Quipo Infrastructure.

At the current market price of Rs.129, the stock is currently trading at a P/E of 7.8x

its FY10 EPS of Rs.16.1 (post equity dilution-warrant conversion), and 1.3x its FY10

P/ABV of Rs.97. Based on our SoTP valuation method, we have arrived at a fair

price target for the company of Rs.200. At our target price, the stock offers a

potential upside of around 55%. We recommend BUY on the stock with a 12-

month price target of Rs.200.

Risk and concerns

q Competition with Banks and FIs: With banks increasing their focus on

lending to the SME segment, particularly to small and medium size contractors

and project developers, the competition for NBFCs like Srei has increased.

However, the NBFC has an advantage in that it offers varied and customized

services to customers. This has also facilitated in developing a cordial

relationship with them.

q Risks of non-execution/delays in project implementations: Any delay in

the execution of projects pertaining to roads, ports and SEZs following the

NBFC's capital constraints can affect the project development related income of

the company.

INFRASTRUCTURE DEVELOPMENT IN INDIA:

AN OVERVIEW

Robust capex requirement for infrastructure development

The Eleventh Five Year Plan has outlined a massive capex requirement for infrastructure

development in the country. During the Eleventh Five Year Plan the total

investment in infrastructure sector is estimated to be around 7.5% of GDP. Capex

for infrastructure development - which includes roads, airports, port, power oil &

gas and telecom - has been pegged at around $500 bn or Rs.20,272 bn over

FY07-12. The Eleventh Plan lays emphasis on attracting private investments

through public private partnerships or PPP. Estimated investments under the Eleventh

Five Year Plan are inclusive of both public and private investments for infrastructure

development.

Construction

The construction sector has been the biggest beneficiary of infrastructure expansion.

The structural infrastructure construction in all sectors together requires a

capex of approximately Rs.14,500 bn in the 11th Five Year Plan. The major growth

drivers in the construction sector are housing construction and surface transportation

(roads). Considering the monetary requirement, particularly for the construction

space, which has been detailed below, over 65% of investments would be directed

to the construction sector.

Roads

Under the Eleventh Five Year Plan, the committee of members has suggested a

capital investment requirement of Rs.3118 bn, by both public and private entities.

The planned expansion includes development of national highways, state roads,

expressways and widening of national highways.

Ports

The Government of India (GoI) has planned a capacity addition of 485 MMT in

major ports and 345 MMT in minor ports, under the Eleventh Five Year Plan. On

the back of the robust expansion, the Government has laid down a total investment

of around Rs.739 bn over the Eleventh Five Year Plan.

Power

The power sector accounts for the largest share of the total investments required

to be made in infrastructure development. Under the power for all program, the

Government has targeted an addition of around 70,000 MW of power generation

capacity. The Government has earmarked the upgradation and development of the

transmission and distribution facility for rural electrification through the Rajiv

Gandhi Grameen Vidyutikaran Yojana (RGGVY).

Airports

The Government has also finalized plans for the development and modernization

of the four metro and 35 non-metro airports for the Eleventh Five Year Plan. The

airport development also includes construction of seven greenfield airports and

three airports in the North East. Based on the working committees' report, the total

investment required for the development of airports in India would be close to

Rs.347 bn.

Railways

For railway infrastructure development, GoI has planned the construction of dedicated

freight corridors between Mumbai and Delhi and between Ludhiana and

Kolkata. The railway infrastructure development plans also include construction of

10,300 km of new railway lines, gauge conversion of over 10,000 km and modernization

and redevelopment of 21 railway stations. The Government also indicated

the introduction of private entities in container trains for rapid addition of

rolling stock and capacity.

Gas

In the Eleventh Five Year Plan, an investment of around Rs.205 bn is required for

setting up gas distribution infrastructure, which comprises LNG terminal, gas transmission

lines and city gas distribution.

Telecom

Of the $500 bn of planned expenditure over FY07-12, around 13% would be

spent on the telecom sector, which amounts to around Rs.2670 bn. Under the

Eleventh Five Year Plan, GoI plans to achieve a telecom subscriber base of 600 mn,

with 200 mn rural telephone connections.

Infrastructure equipment requirement

With the intense need for faster implementation of infrastructure projects resulting

in increased mechanization, the demand for hi-tech construction equipment is rising.

Given the substantial infrastructure spending, the requirement for

infrastrastructure related equipment would be significantly higher in the Eleventh

Five Year Plan.

In view of the sizeable construction activity, the construction equipment industry is

poised for a big leap. The domestic equipment market is all set to expand five-fold

to around $13 bn by FY15 from around $2.3 bn in 2007 (Source: CII). Considering

the following table, this indicates that the cost of infrastructure equipment would

account for approximately 20% of the total construction cost under various

projects.

COMPANY BACKGROUND
Srei Infrastructure Finance (Srei) is a Kolkata-based infrastructure equipment
financing and infrastructure project financing company. The company
is owned by the Kanoria family, headed by Hemant Kanoria. The NBFC is
India's leading player in the infrastructure equipment financing segment
with a market share of around 30%. Srei's unique business matrix includes
financing infrastructure, construction and mining equipment, infrastructure
projects and renewable energy systems.
The NBFC has also developed strong expertise in the areas of investment
banking and venture funds, besides insurance broking. Srei operates across
the country with a network of 51 offices and has expanded its operations
overseas in Russia. In addition, through its associate concern Quipo Infrastructure
Equipment Ltd (QIEL), Srei has pioneered the concept of renting
of construction equipment in India under the brand name of Quipo.
Leader and niche player; well poised to capitalize
Srei is largely catering to the financial requirement of small and medium size construction
and infrastructure developers. The NBFC provides financial assistance to
these contractors to help them to scale up to project developers. Srei provides asset
financing services to companies engaged in varied infrastructure development
activities like construction, mining, oil & gas, power, ports, telecom, railways, aviation
and renewable energy.
Besides this, the NBFC also offers auxiliary services to its customers along with infrastructure
equipment financing. Srei provides customized solutions across various
verticals to its customers. Project advisory, investment banking, debt funding and
insurance advisory services are various services that the NBFC offers. This makes
Srei a one-stop shop for its customers.
Srei has efficiently capitalized on its strong relationship with its customers and created
a niche for itself in this segment. This has facilitated Srei in capturing close to
30% market share of the total equipment financing market. Currently, around 85-
90% of the company’s orders are repeat orders, which has helped the company in
creating a niche for itself.
Recording strong growth in key business segments
Srei is operating largely in three segments, which includes asset financing (financial
and operating lease), project financing, and advisory and fee-based services. The
asset financing business of the company contributes to around 90% of the total
revenues. However, going forward, with the revamping of its business model, the
project financing and advisory business would also start contributing a significant
share to the total revenues of the company. Meanwhile, the asset financing business
would continue to be the revenue growth driver for the company.
After transferring the financial leasing business to Srei Infrastructure Development
Finance, a 50:50 JV with BNP Paribas, the parent company would focus largely on
big ticket equipment financing projects above Rs.150 mn. Moreover, the parent
company would also concentrate more on the project financing and project advisory
business.
Asset financing business remains major revenue driver
Srei's equipment lease financing business consists of financial lease and operating
lease. The major part of the NBFC's business consists of financing lease, which accounts
for close to 90% of the financing assets.
With the commencement of the partnership with BNP Paribas, the proportion of
income from infrastructure equipment financing would continue to be larger revenue
contributor, as the management would increase its focus on the project financing
business and advisory and fee-based services would result into increase in
contribution by these segments as well.

BNP Paribas JV to lead to significant business transformation
Srei has sold its equipment financing business to a 50:50 JV company with the
world's leading leasing finance company BNP Paribas Lease Group, which is a subsidiary
of BNP Paribas Bank. The new JV is called Srei Infrastructure Development
Finance. Srei Infrastructure Finance (the holding company) would continue to hold
50% stake in the JV.

BNP Paribas would pay a total consideration of Rs.7.8 bn for the equipment lease
financing business. The JV company Srei Infrastructure Development Finance
would largely concentrate on infrastructure equipment financing projects valued at
less than Rs.150 mn and also on the insurance broking business under its umbrella.
The JV would have networth of Rs.8 bn, of which BNP contribute Rs.7.8 bn and
the balance is contributed by Srei.
Benefits from 50:50 JV with BNP Paribas

n The 50:50 JV with BNP Paribas would give Srei (the holding company) access to
the business know-how and expertise of the BNP Paribas management on the
board. This would facilitate rapid business growth for the infrastructure financing
business.

n With the receipt of Rs.7.8 bn from the sale of 50% of the equipment financing
business to BNP Paribas, this has also provided Srei (the holding company) with
capital, which enables the NBFC in expanding its business.
n The new JV with BNP Paribas would support speedier growth in the asset financing
business. This would lead to higher earnings visibility and superior returns
for investors.

Robust business growth following positive macroeconomic environment,
additional funds from BNP Paribas

The strong growth in infrastructure development would continue to boost demand
for infrastructure equipment financing. The total investment requirement for the
infrastructure development sector has been pegged at $500 bn during the Eleventh
Five Year Plan. These investments are mainly focused on power, transportation
and road development. Infrastructure equipment cost would account for
around 20% of the such project cost.

Over FY04-07, the NBFC's disbursements to infrastructure equipment finance has
seen a sharp surge of 53% to Rs.36.23 bn, Financial leasing would comprise
Rs.31.65 bn. The innovative product offering in the operating lease business would
lead to multifold growth in the NBFC's operating lease assets.
There would be substantial infrastructure spending of $500 bn in the Eleventh Five
Year Plan (FY07-12), of which over 65% would be in the construction sector alone.
This, we believe, offers a huge potential to the construction contractors and
project developers. In light of this, the overall financing assets of the NBFC are expected
to grow at a CAGR of 46% during FY07-10 to Rs.111 bn.

Scaling up project financing biz, key driver for revenues growth

The project financing business of the NBFC has recorded significant growth. Srei

has leveraged upon its strong relationship with small and medium enterprises and

customized its disbursals. Currently, the share of revenue contribution from the

project financing business is lower than the asset financing business. However,

with the increase in the NBFC's focus on the project financing business the contribution

will increase significantly. Srei Infrastructure as a consortium partner in various

project developers has been awarded the following projects:

n Road development projects: SREI has recently bagged around seven NHAI/

Annuity Road Projects on build-operate-transfer (BOT) basis worth more than

Rs.30bn. SREI in partnership with several leading construction companies

throughout India will complete these projects. These BOT road construction

projects will be completed over the next 18-36 months.

Road Projects

Capex required Equity SREI's Other major

(Rs mn) (Rs mn) stake (%) partner

Trissur-Angamalli 5509 1470 49 KMC Construction

Bharatpur-Mahua 2905 596 26 Madhucon Projects

Madhurai-Tuticorin 8970 1404 39 Madhucon Projects

Karur-Dindigul 3640 728 26 Madhucon Projects

Nagpur Seoni 4723 1181 49 Saddbhav Engineering

Nagpur-Kondhali 1760 330 26 Atlanta

Jaora-Nayagaon 4144 1243 28 Viva Infrastructure

Source: Company

n Consortium to develop two ports. SREI has participated in 2 consortiums for

development of Deep water sea ports on BOOT basis. A consortium of companies

headed by Maytas Infrastructure along with SREI Infrastructure, NCC and

SEC has been allotted the Machilipatnam Port and SEZ project in Andhra

Pradesh. The project has already achieved financial closure and would cost

close to Rs 12.5bn and is likely to be commission by Sept. 2011.

The second port development project is in the state of Orissa, located in the

hinterlands of Subarnarekha River. The project would cost close to Rs 17.4bn

and is likely to be commissioned in three phase's over2010, 2020 and 2032 respectively.

SREI holds ~70% equity in the SPV.

Port Projects

Capex required Equity SREI's stale Other major

(Rs mn) (Rs mn) (%) partner

Machilipatnam-Andhra Pradesh 12546 8856 38 Maytas, NCC & Sarat

Chaterjee

Subaranrekha Port - Orissa 17425 5125 70 -