Construction Companies......Evaluation???????????

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Construction Sector, the back bone of
Infrastructure revolution, is the promising area to find multi-baggers but
there are few limitations in evaluating companies in this sector. One may find
a wide spectrum of ratios. From single digits to three digit returns. Carrying
out peer comparisons are entirely ruled out due to the fact that construction
and infrastructure companies are found to apply different accounting techniques
while preparing their annual accounts. Absence of any sector index rules out
industry movement gauge.

Following Different Accounting Techniques have
been observed and I request other forum members to contribute by highlighting
other such practices they might have come across

1.      Income:
Some companies include work in progress in their income bracket while others charge
it to expenses. Here the catch is if the company is following completed project
methods of accounting or is employing running payment/income method. Normally
for a big project with outlay of few hundred crores and time frame of few years
the running payment method is used by the client and the executor of the
project. Most of the times the client is a state or central Govt. entity with
annual budgets that have to be exhausted in current financial year only. CCCL,
C&C Constructions JP Associates follow running payment/ income method
whereas HDIL follows completed project method of accounting

2.      Inventory:
Some developers, construction companies account for their work in progress in
inventories resulting in high level of inventory base. Most of residential
builders adopt this strategy.

3.      Carried
Forward Expenses: Some companies reflect their project development costs in Carried
Forward Expenses.  Companies incur a
substantial cost including borrowing costs for big projects. They defer booking
of expenses to subsequent years taking the legal, accounting shield of complete
project method.

4.      Net
Asset Value: Some companies, in order to show healthier bottom lines value
their land bank at different values. An example to this effect has been quoted in
The Economics Time dated 4^th July 2009. I reproduce the same exactly
as follows:
      ,”A real estate industry
expert cited an example of a company with an 8-acre agriculture land in Maharashtra, whose actual value was Rs 3 lakh per acre.
But the company chose to value the land at Rs 500 crore on the presumption that
it would convert it into a software park, which would result in the doubling of
FSI or floor space index.”

5.      Income
from Other Sources: Since most of the construction companies are diversified
into different sectors like infra, reality, power, cement production and even
IT.  It is pertinent to see stand alone
income of the construction arm to have head to head comparison of different players
in the field. Also, since most companies have their own ready concrete mix
plants and they all sell the spare capacity ready-mix in the markets peripheral
to their project sites. It is interesting to note how much of this type of business is accounted for and if at all it has been separately
accounted or has been clubbed under income from operations.

I am sure forum members will help
in pointing out similar variations so that we can later turn to the aspect of
how fair valuation of construction companies can be done.

To Read Above Quoted News Item Click Here
http://economictimes.indiatimes.com/Markets/Stocks/Market-News/Market-now-takes-a-realistic-view-of-realty-cos-value/articleshow/4736089.cms

Edited by vsb2pwn - 24/Jul/2009 at 6:42am