Saturday, October 22, 2011

Working Capital Concerns.

The flow of cash through this channel of events gives rise to the working capital requirement for a company. The ability of a company to manage its working capital in all market conditions influences its rate of growth. 


Companies either borrow short-term loans or use internals cash accruals to procure raw materials and to meet day-to-day requirements. These loans are paid once the cash is received from customers. This process is termed as the working capital cycle of a firm. The lesser the number of days in which the company earns back the cash invested in operating activities, better is its working capital management. Companies, which have smaller working capital cycles, tend to deliver better profitability since their short-term borrowing requirement is lower compared with firms that have longer working capital cycles. Working capital efficiency assumes greater significance during tough economic situations. During a low-growth phase, demand for goods and services erodes thereby increasing the amount of average inventory at hand. 

For companies that undertake execution of turnkey projects, investments made to procure materials are blocked until the execution of the projects. When the implementation of such projects is delayed, the short-term borrowing requirement of such players shoots up. When working capital remains tied up in receivables or inventory for longer than the average period, the company will have to borrow additional capital to meet daily expenses. Given the current scenario of rising interest rates, higher borrowings will increase interest outgo thereby putting pressure on net margins. When working capital cycle deteriorates, the company would either have to slow down its operations or increase borrowings. In either case, it will not be able to meet its profit targets. Let's look at companies whose working capital requirement has increased in the past one year. 

Patel Engineering
Patel Engineering is a construction and engineering company operating in hydropower, roads and irrigation segments. The working capital requirement of Patel Engineering has increased due to a delay and stoppage of work in a few of its projects. The company's largest irrigation project in Andhra Pradesh worth more than Rs 1,500 crore was delayed due to political turmoil in the state. The hydropower project at Loharinag Pala in Uttarakhand, where work had commenced and which was expected to be a major contributor to revenue growth was cancelled by NTPC due to environmental issues. Work at two big hydro electric projects had to be stopped for a certain period in the last financial year due to floods. However, work on the projects has commenced since the last quarter of FY11. 

Excluding the delayed projects, the company's current order book stands at Rs 6,500 crore which is nearly two times its FY11 revenues. It has failed to receive any major orders since the last two quarters. This gives a low revenue visibility for the company. The pace of execution and clearances for the delayed projects will be the points to look out for in future. 


The country's largest transfer of development rights (TDR) player has high working capital requirement as close to half its exposure is to slum rehabilitation projects. Even though the company has lower debt as compared to its peers, the high gestation period of its projects poses a risk for earnings. 

On the flip side, income from the TDR, which has relatively insulated cash flows can provide a cushion to the company's earnings. The company will take at least 2-3 years to record reasonable cash flows since it's expanding in the mid-housing segment to diversify its earnings mix. 


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