Weak pillars

Last week’s tragic accident at the construction site of Delhi Metro Rail Corporation (DMRC) has raised questions about the role of its contractor, Gammon India, in the mishap. The movement in Gammon’s share price reflects the market’s concern, given that it has underperformed the broader markets since the accident. While the share price took a severe beating as it plunged nearly 20 per cent intra-day on last Monday (July 13) after the accident (which occured on July 12), it later recovered during the day. However, through the week, the stock was down 7.5 per cent as against the 9.2 per cent rise in the BSE Sensex and 5-8 per cent rise in the share price of other construction companies.

What’s at stake?
Gammon India, which has a long history spanning close to 90 years in the infrastructure and engineering space and having executed some of the prestigious projects including the foundation work for the Gateway of India in 1919, is now in the news for the wrong reasons. After a part of the bridge the company was constructing for the DMRC fell and killed six people, analysts are concerned about the prospects of the company. More importantly, if the company is found to be at fault it would be its second incident--- the first one was also a similar incident (a part of the under-construction flyover collapsed) which occurred in 2007 in Hyderabad and where the company was found guilty; and could have an impact on its reputation.

While DMRC has formed a committee to investigate into the incident, wherein the findings are expected to be presented by July 22, here’s what some of the market experts think about the possible consequences. “Though we do not know the implication of this incident since the committee report is awaited, the chances are high that the company might have to suffer some setback due to this mishap. This is because E Sreedharan, DMRC’s chief, has said that the causes of the accident could have been due to the faulty design or inferior material,” says Gautam Bafna, who tracks the infrastructure sector at B&K Securities.

Some others believe that it may be a little early to arrive at any conclusion or figure out the charges. “It is too early to make any guess as to what and how much would be the impact of this incident on the company. But definitely, if post-investigation the company is found to be guilty because of the issues related to the design or material it will have an impact on the company’s future business and its reputation,” says Raj Kamal Bajaj, head, Bajaj Consultants.

In terms of immediate financial losses, analysts believe that the damage (to restore the collapsed bridge) could be in the range of about Rs 5-6 crore (or about 5 per cent of Gammon’s standalone net profit of 2008-09) due to this incident. Also, if the charges are proved, there could be additional expenditure on account of penalties, delays and other clearing charges.
 

STEADY, FOR NOW
in Rs crore	FY07	FY08	FY09
Net Sales	1,851.70	2,344.90	3,657.90
Total Expenditure	1,679.50	2,131.60	3,327.50
EBIDTA (%)	10.4	9.3	10.2
Interest	13.6	32.2	99.4
Net profit	44.5	86.2	114.5
EPS (Rs)	5.1	9.9	16.2
Source: Capitaline Plus, Standalone financials

Italian woes
Gammon is one of the few old infrastructure companies in India having presence across different verticals such as transport, energy, factory and commercial buildings, hydro power, tunnelling and irrigation projects. The company is well placed within the infrastructure space and has a strong order book of Rs 8,000 crore, which is almost two times its 2008-09 revenues. The company however, is facing tough times with the international acquisitions it had done last year.

Gammon India, through its international subsidiary had acquired three Italy-based companies to fill in the gap in its power vertical. These companies reported losses of about 100 million euro in calendar year (CY) 2007. Analysts expect these companies to continue to report losses in CY 2008 (financial details are yet to be published) as well.

“We believe its Italian subsidiaries still remain a drag on the company's financial performance as the acquisition, which was worth over Rs 600 crore, was funded through debt,” says Bafna. This is also a reason that the company’s debt is expected to have increased almost three-fold from Rs 377 crore in 2007-08 to about Rs 920 crore in 2008-09. While its standalone interest outgo was up 208 per cent to Rs 99.35 crore in 2008-09, the company is expected to report higher interest outgo on a consolidated basis as well. It could however, find some respite if it is able to raise funds to reduce the debt levels in a meaningful manner----on July 9, it allotted 1.6 crore warrants to promoters (conversion price of Rs 90.20 per share), which will result in an inflow of about Rs 145 crore if these are converted into equity shares.
 

ACQUISITIONS: IN THE RED
In Euro million	Gammon's Stake (%)	CY07		CY08E
		Sales	Net profit	Sales	Net profit
Sofinter	50.0	522.0	-54.0	508.0	-7.0
Franco Tosi Meccanica	75.1	87.0	-46.0	113.0	-18.0
Sadelmi	50.0	120.0	-0.1	169.0	1.4
E: Analyst estimates

Outlook
Overall, the concerns remain for the company on many counts. Regarding the recent incident, should the investigating committee absolve Gammon India of being at fault, it should prove positive for the company in terms of further liabilities and future business prospects.

Meanwhile, analysts believe that the stock is worth skipping. "We are not advising investors to buy Gammon India’s stock primarily due to the weak fundamentals of the company apart from the recent incident. The stock is still trading at higher valuations and additionally its Italian subsidiaries are running into losses. We would suggest investors to look at other stocks in the infrastructure space,” says Shailesh Kanani, analyst, Angel Broking. At the current market price of Rs 149.15, the stock is expensive at 1.2 times its book value and 13 times its earnings based on estimated numbers for 2009-10.