The Hindu Business Line : Gammon India: Buy

INVESTORS with one/two-year horizon can consider taking exposure to the Gammon India stock. A bulging order-book, improving margins and a well-diversified order-mix lend optimism, despite the stock trading at a rich valuation.

Gammon is negotiating with foreign investors for an equity stake in its subsidiary — Gujarat Infrastructure Projects (GIPL).

Such an event, coupled with the possibility of a public offer by the subsidiary, may also lead to a re-rating of the stock. At the current price of Rs 379, the stock trades at 5.4 times its expected CY-05 book value, which is comparable to industry leader Larsen & Toubro.

Gammon is executing transportation, hydro energy, pipeline, tunnel and irrigation projects. Diversity of operations has given the company the advantage of pre-qualification in almost every infrastructure project.

Joint ventures with overseas companies have also enhanced Gammon's technical expertise.

Robust order-book position

Gammon has an order backlog of more than Rs 5,200 crore, which is 4.5 times its 2004 calender year. This is similar to the order book-to-sales ratio of companies such as Hindustan Construction and Nagarjuna Construction.

With the bulging order-book, the current growth rate in revenues is likely to be maintained, if not improved; revenues have risen by about 30 per cent annually over the past three years.

Gammon, like most other leading players, has expanded its equity base to qualify itself as an EPC engineer-procure-construct) contractor and also capitalise on opportunities in public-private partnership projects. Thus, the company bagged five build-operate-transfer (BOT) projects worth Rs 1,650 crore through its 100 per cent subsidiary.

The company's recent plan to further raise up to $100 million (approx Rs 450 crore) through foreign currency borrowings or global depository receipts give it an edge vis-a-vis its competitors to bid for large BOT projects.

Diversification and risk mitigation

Hydel and pipeline projects have been Gammon's forte. The company has also taken advantage of the tremendous opportunity in the country's road and transport segments; now, 34 per cent of its order-book is from this space, the rest from a variety of civil works.

International projects account for about 11 per cent of the order-book. The operational and geographical diversification is likely to protect the company's operating margins.

Gammon's wholly-owned subsidiary, GIPL, has facilitated the company's foray into BOT projects, which are capital-intensive and offer sizeable returns. This strategy is likely to protect its core business from the risks of infrastructure business. BOT projects such as the Rajahmundry and Andhra Expressways offer annuity-based returns.

Such models assure the company stable revenues for 15-20 years. These projects offset the risks arising from purely traffic-based revenue models.

Gammon has a track record of steady operating margins. For the quarter ended September 2005, the margins improved by close to two percentage points to 15.5 per cent, as a result of lower material costs.

The company has a healthy debt-equity position and a return on equity that is superior to peers. The substantial order-book can be expected to yield superior returns.

A decline in raw material costs for the latest quarter offers some comfort but does not mitigate the risk of rising raw materials costs cutting into the margins.

Increasing competition in the sector may force the company to compromise on the returns arising from projects.

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