After our downgrade to Sell (3M) in January 2010 at Rs 223, the Punj Lloyd stock has corrected about 50%. Under normal circumstances, we would be working out stress-case scenarios and looking to bottom-fish. But in this case, we believe discretion is the better part of valour. We cut our target price to Rs 115 (from Rs 179 earlier) to factor in our 30-48% earnings cut and roll forward of our target PE (price-to-earnings) multiple of 14x to Sep11E (from Jun11E earlier).

And the reasons for maintaining sell rating are: (1) losses in Simon Carves could continue for a couple of more quarters; (2) two more pending orders in Simon Carves; (3) 35% of the Rs 278 bn backlog consists of delayed Libyan orders; (4) Rs 25 bn Sabah Sarawak pipeline and two of five Assam roads are delayed; (5) the recent top and middle management departures; (6) balance sheet deterioration?increase in leverage and working capital intensity; and (7) Rs 2.5 bn of FCCBs (foreign currency convertible bonds ) with a conversion price of Rs 273 due in late FY11E are deep out-of-the-money, implying redemption pressure.

Crisis of confidence: This stems not from the Rs 6.1 bn loss in Q4FY10, but from the Rs 1.3 bn of unexpected losses in the Ensus project [other than Rs 1.65 bn of LDs (liquidated damages)]. Since the time of the IPO (initial public offering), Punj Lloyd has ended all the past five years with auditor qualifications and more often than not, has written off the same in the profit-and-loss statement subsequently.

As a consequence, it is very difficult to assume that the Rs 3.7 bn of auditor qualifications would be recouped from clients. It is a fact that Sabic was a legacy order, but Ensus and ONGC?s Heera projects might be the result of aggressive bids not paying off.

Losses of Rs 6.1 bn in Q4FY10: Punj Lloyd had a Q4FY10 loss of Rs 6.1 bn on account of Rs 1.6 bn of LDs and Rs 1.3 bn of further losses on the Ensus project. Punj Lloyd has won Rs 168 bn of orders in FY10 up 30% YoY (year-on-year) to end the year, with an order backlog of Rs 278 bn up 34% YoY.

We revise down earnings estimates by 30-48% over FY11E-12E to factor in ?23-27% lower sales on delays in Libyan, Petronas and Assam orders, 80-150 bps lower margins on ONGC and pending Simon Carves orders.

Working capital, debt and consequent interest costs: Our estimates are 17-32% below consensus estimates over FY11E-13E. Losses of Rs 6.1 bn in Q4FY10: Punj Lloyd had a Q4FY10 loss of Rs 6.1 bn on account of Rs 1.6 bn of LDs and Rs 1.3 bn of further losses on the Ensus project. Punj Lloyd has won Rs 168 bn of orders in FY10, up 30% YoY, to end the year with an order backlog of Rs 278 bn, up 34% YoY.

Balance sheet risks remain: The Ensus project losses have taken a significant toll on Punj Lloyd?s balance sheet, which is apparent from these facts: (1) net debt-to-equity ratui deteriorating from 1.09x at the end of FY09 to 1.25x at the end of FY10, and (2) working capital intensity (NCA- cash)/ sales moving up from 22% to 41%. Furthermore, Rs 2.5 bn of FCCBs, with a conversion price of Rs 273 due in late FY11E, do not give us any comfort on the balance sheet. Ensus project losses has mounted to Rs 5.3 bn. More losses are likely in 1QFY11E. At the end of 3QFY10, the Punj Lloyd management had communicated that the Ensus project has been completed in late January 2010 and the client had obtained the ?take over? certificate in March 2010. Punj Lloyd wrote off Rs 300 m in Q1Y10, Rs 1 bn in Q2FY10 and Rs 1.1 bn in Q3FY10 on this project. Further, the client levied LDs for delay in completion of the project to the tune of 15% of contract value of ?161 m = ?23 mn (Rs 1.65 bn), which was to be booked in Q4FY10.

The big negative surprise in Q4FY10 was that the company booked an additional ?18 m (Rs 1.3 bn) of losses on the Ensus project. Under the contract, the plant was supposed to achieve a minimum level of capacity utilisation for the contract to be considered complete. However, this could not be achieved in Q4FY10.

The company had tried to complete the project within agreed timelines and parameters, but faced several challenges, which included: (1) extremely low productivity from the UK labour/ subcontractors, (2) adverse weather conditions (causing three-four weeks of delay), (3) leakage in heat exchangers bought from Spain (causing a one-week delay), (4) local management failure to influence the union, (5) some cases of deliberate sabotage, and (6) the failure of the company to understand the complexity of construction management in the UK.