Gammon India has recently restructured and refurbished its portfolio of offerings through merger (via share swap) and acquisitions (via debt).
It has merged its associate - Associated Transrail Structures (ATSL, which is into the Transmission Line business) and acquired three Italian companies in the power space. This is in line with the company’s strategy of setting up a complete power vertical.
No doubt these acquisitions make business sense, but we have concerns with regards to the ’size’ (vis-à-vis established players like BHEL, ABB) and ’impact’ of these acquisitions.
The company has a modest order book of Rs8,300 crore of which 65-70% is WPI linked, while 10-15% is star rated and the rest constitutes fixed price contracts.
Outlook and valuation
We expect Gammon to post CAGR of 21% in topline over FY2008-10E to Rs3,426 crore on a standalone basis for its core construction business. We have factored in additional intake orders of Rs1,200 crore in the order book for FY2010E.
This addition of a mere Rs1,200 crore worth of orders is on the basis of past trend in order intake for Gammon, high level of competition expected going ahead and slow down in order inflows. As a result, FY2010E order book to sales ratio is alarmingly low at 1.8x.
We have assigned P/E multiple of 6x FY2010E EPS of Rs13.6 to the construction business. We have valued the company’s stake in GIPL and investments in Sadbhav Engineering on holding company discount basis contributing Rs39.9 and Re1, respectively.
We have not assigned any value to the Italian companies due to lack of clarity on the revenue front and concerns about Gammon’s ability to turn them around. However, we have factored in interest costs arising from the acquisitions. We have arrived at a fair value of Rs123, translating into an upside of 70%.
However, we are cautious about the profitability of the Italian companies, as the firms posted a loss of Euro101 million at PBT level in CY2007.
Though management expects the companies to turn-around in the near future, we would ’wait and watch’ especially considering that the companies would be competing with majors like BHEL, L&T, etc.
We initiate coverage on the stock with a NEUTRAL recommendation.