Road to success

GUEST COLUMN

Mudar Patherya finds Gayatri Projects a good investment.

All the curious coincidences of life only happen in a bull market. It is only when the Sensex is north of 18,000 do you run into a Godavariben, who is unexpectedly overflowing with the milk of human kindness when she encounters you at a wedding reception; while you are straightening your tie for a politically correct pose with the couple on the dais, she impatiently interrupts, "Ek minute," leads you by the arm and whispers conspiratorially: "Khaangi raakhjo... our neighbour has made us a big offer to sell his flat, we are in need of some really big money, koi tip-ship chhey that will enable us to treble our money in ek-bay months?'

Godavariben, this column is dedicated to you.
I know that while you are reading this, the dal is on the boil and Ramu at the door wants to know what else he should cook for the day, so I will be quick.

This is my argument: buy into the construction and infrastructure story as that will drive growth year after year for the next few years; buy into a related play with the biggest ratio between order book and market capitalisation (assuming an OPM in excess of 12 per cent and a net margin in excess of 3 per cent) because when that anomaly corrects, you could buy out the whole building.

Godavariben, don't reach for your pen and paper. I have already done the filtering for you. The company that survives my stringent filter is Gayatri Projects. Its ratio of 11.7 between order book and market capitalisation indicates that it has been deeply discounted ('paani no bhaav'); its EBIDTA margin of nearly 16 per cent and a net margin of around 5 per cent indicates that the fundamentals are fairly credible.

If you have the time, stay on.
I like Gayatri's business and positioning for the following reasons:

The promoters of Gayatri Projects have been in the business of construction and infrastructure creation for more than four decades; more than 100 Gayatri-ites have been with the company for more than 15 years. Gayatriben, sorry Godavariben, I think this is important as it indicates that these people have seen a number of industry cycles and know their business thoroughly.

Gayatri is in the business of roads, power and irrigation. Presently, a third of the company's revenues are derived from irrigation projects (value rich) and nearly two-thirds from roads (volume heavy) and a negligible proportion from industrial projects. Spending in these areas will have a positive rub-off on its prospects.

Gayatri is one of the leading EPC (engineering, procurement and construction) contractors in India; 'EPC' indicates that they manage turnkey projects with single-point responsibility; if you ask me, this can be a profitable business strategy as long as the company enjoys a superior sourcing strategy and can pass off cost escalations.

Gayatri has been working for some brand-enhancing customers. In the road sector, its principal customer is the NHAI for which it has executed 250 km of national highways and 1100 km of state highways over the last few decades. Its irrigation clients comprise the state governments of Andhra Pradesh, Madhya Pradesh, Chhatisgarh, Karnataka, Tamil Nadu and Orissa. Its industrial customers include RIL and JSW among others.

Gayatri has entered the attractive prospects coming out of the BOT (build operate transfer) segment with an investment outlay of Rs 167 crore across five projects, of which Rs 120 crore has already been deployed and the rest will come from accruals. According to an estimate these projects will generate an IRR (internal rate of return) of around 14 per cent on the invested funds. After seven years, it is clean profit.

Gayatri's five BOT projects will generate EPC assignments worth Rs 1000 crore, in addition to which the company has an order book of around Rs 2500 crore from external customers. This consolidated order book is expected to keep the company busy for the next 30 months (calculated up to the end of the financial year 2009-10).

Gayatri has over the years invested in equipment worth Rs 230 crore, which has progressively reduced its dependence on external vendors. Not only has this enabled the company capture a sizeable value addition, it has also facilitated a quicker turnaround of projects.

Gayatri is entering the water treatment, desalination and urban infrastructure verticals, each of which will continue to grow sustainably over the coming years.

Godavariben, in all honesty I must keep you posted on some lurking investor concerns which have perhaps contributed to the deep discount.

One, the company's founder chairman is a MP and there is a worry about a loss in orders should he lose his seat. My answer is that Gayatri's competencies are distinct from the personality of T Subbarami Reddy; repeat customers come to the company for its professional delivery and not because of a sifaarish connection.

Two, IJM Gayatri, a joint venture that embarked on NHAI projects, suffered a cost overrun of Rs 130 crore on an EPC contract; Gayatri's share of net liability would be Rs 38 crore should it materialise. However, the company is convinced that it has a good case, has represented its argument to the government and expects a favourable ear.

Three, the company's biggest strength "� the size of the order book "� is being perceived as its weakness. The big question: will it be able to execute? The company's track record indicates that it will.

Four, I do not like the look of the company's interest cover at 2.8. However, two interesting developments have enhanced my optimism that this will correct "� the cost of working capital loans of an average 13.5 per cent is being replaced with FCNR-B loans at 9.75 per cent (including hedging cost); the company issued Rs 100 crore of FCCBs at zero per cent coupon rate to be converted at Rs 378 per share within five years. The twin impact could enhance interest cover to around 5.

Five, I will appraise the bottom line of a construction company with a trace of suspicion following the application of Section 80-IA, which stipulates that while profits from the earnings of infrastructure projects will be tax-exempt for 10 years, this does not include EPC contracts.

So some construction companies have factored in this tax shelter even as there is a case that they are not permitted. I checked; Gayatri has provided for the complete tax on protest on this account for 2006-7, so the numbers may be considered to be conservative.

Gayatri expects to liquidate its order book in the following manner: Rs 700 crore top line in 2007-08, Rs 1200 crore in 2008-09 and Rs 1600 crore in 2009-10. Apply the 5 per cent net margin yardstick (yet to be achieved but with interest savings, this could well be a reality) and you get Rs 175 crore of consolidated profit and a cash profit of Rs 215 crore for the next three years. Your cost: Rs 310 crore today (the equity dilutes to Rs 12.6 crore over the next three years so I am not bothering you with that at the moment).

Godavariben, I have only this to tell you. If Gayatri were to have gone public there is no way it would have done the IPO at less than Rs 500. And if you are getting back more than the money you invested in less than six years plus dividend plus capital appreciation, then stop bickering about Ramu not coming back from his des on the promised date or Ramu keeping a small profit for himself each time he goes to buy the farsaan.

Mudar responds with speed at mudar@trisyscom.com. He has bought the Gayatri stock for the Godavariben in his life - his wife!