construction and engineering by abn

7/28/2019 Construction and Engineering by ABN

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Widening scope of operations

IVRCL is racing ahead of its peers to build scale and sustain

profitability. With relatively better profitability and a better growth

ratio than its peers, it's still our top pick. We upgrade Gammon to

Buy on our EPS upgrade and attractive valuations.

Key recommendations and forecasts

Reuters

Year-end

Recom

Price

Target

price

09F

EPS

09F

PE

IVRCL IVRC.BO Mar 2009 Buy Rs363.00 Rs473.90& 20.90 17.4

Nagarjuna Cons NGCN.BO Mar 2009 Buy Rs180.55 Rs231.00& 8.96 20.1

Gammon India GAMM.BO Mar 2009 Buy% Rs334.85 Rs486.80& 18.00 18.6

Hindustan Construction HCNS.BO Mar 2009 Hold Rs116.75 Rs127.40& 3.83 30.4

1 Normalised EPS - Post-goodwill amortisation and pre-exceptional items.Source: Company data, ABN AMRO forecasts

Increasing our sales forecasts for IVRCL and Gammon

Within our construction coverage universe, order inflow has clearly exceeded our

expectations. IVRCL continued to lead the pack with an 80% increase in order

backlog in 2008. This extends visibility for better sales momentum for the coming

years. Hence we increase our FY09-10 sales forecasts for IVRCL and Gammon by

about 5% and 10%, respectively. We expect National Highways Authority of India

(NHAI) Phase V to be awarded and industrial capex to provide better visibility for

FY08-10F order inflow. We expect companies to widen their scope of operations to

tap the increased size of orders in the traditional areas or expand into new areas such

as railways, oil & gas, etc.

Our EPS forecasts revisited

Due to sharp increases in input material costs, such as steel, cement and bitumen,

we have re-examined our EPS forecasts for our coverage universe. We increase our

EPS forecasts for Gammon by 5-12% for FY09-10, driven by a sales upgrade,

whereas we marginally adjust our EPS forecast for IVRCL. However, we cut our FY09-

10 EPS forecasts by a steep c19% for Nagarjuna and 35% for HCC, as a result of

execution slippage in FY08 for Nagarjuna and increasing funding costs for HCC.

Our subsidiary values trimmed sharply

Considering the sharp correction in some of the listed subsidiaries (especially real

estate subsidiaries) and the building impact of a higher cost of capital on BOT (build-

operate-transfer) projects, we trim our subsidiary values by a sharp 18-41% across

the board for stocks in our coverage universe, led by IVRCL and Nagarjuna.

IVRCL and Nagarjuna are our top picks; we upgrade Gammon to Buy

High organic growth coupled with a relatively better ROE and expansion into new

growth avenues keep IVRCL and Nagarjuna ahead of the pack, in our view. We

maintain IVRCL as our top pick as it accelerates to gain size over its peers. We

upgrade Gammon to Buy from Sell given our EPS forecast upgrade and considering

an attractive valuation of 6.6x FY09, based on our forecasts.

www.abnamrobroking.co.in

Researched byABN AMRO Institutional

Equities Team

Mafatlal Chambers C Wing, Ground Floor, N.M. Joshi Marg, Lower Parel (E),Mumbai 400 013, India. Tel : +91 022 6754 8411 Fax : +91 022 6754 8420

Priced at close of business 18 June 2008

India

Thursday 19 June 2008

Construction & Engineering


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Contents

C O N S T R U C T I O N & E N G I N E E R I N G 1 9 J U N E 2 0 0 8 2

I N V E S T M E N T V I E W

Enough order backlog to extend visibility 3

Except for IVRCL, Tier 2 construction companies in our coverage universe slippedon FY08 sales and PAT. Given building cost pressure, we cut our EPS forecasts.IVRCL remains our top pick and we upgrade Gammon to Buy.

IVRCL overtakes peers in sales with big leap in FY08 3

Profitability came under marginal pressure 3

Order inflow has been impressive in FY08 4

NHAI and industrial capex to drive FY09F order inflow 4

Steep increase in input costs leading to margin concerns 5

We adjust our EPS forecasts across the board 6

Trimming our subsidiary values to adjust for CMP or comparables 6

Maintain Buy for IVRCL and Nagarjuna, upgrade Gammon to Buy 7

S E C T O R D Y N A M I C S

Input prices: throwing a spanner in the works? 8

A steep increase in prices of key inputs and the ineffectiveness of inflation indicescould upset the apple cart for construction companies. Companies want star-ratedcontracts, but questions remain regarding BOT...

Hefty increase in input costs; indices napping 8

Roads: need for speed 10

After a deluge of contract awards in FY06, there was a moderation in the twosubsequent years. However, with NHAI floating RFQs for more than 3,300kmsrecently, the roads and highways sector seems back in action.

NHAI gearing up for large awards 10

Water and irrigation 12

A need to increase irrigated areas and cater to a growing urban population isdriving investments in water infrastructure. Water being a state subject, we focusour attention on states that have taken the lead on this...

Thirsty for more 12

Urban infrastructure 14

Urban India, due to its large contribution to GDP, is occupying prime space on thepolicy radar. Programmes such as JNNURM, which links central grants to locallevel reforms, bode well for the urban infrastructure space.

Focus on urban areas change in policy paradigm 14

Railways 16After reaping the benefits of better utilisation, Indian Railways is banking onaggressive capacity expansion to ride the next growth wave. We focus on anambitious dedicated freight corridor project and the opportunity...

C O M P A N Y P R O F I L E S

Company profiles 18

Gammon India 19

Hindustan Construction 29

IVRCL Infrastructures & Projects 37

Nagarjuna Construction 46


3/54



Enough order backlog to extendvisibility

Except for IVRCL, Tier 2 construction companies in our coverage universe

slipped on FY08 sales and PAT. Given building cost pressure, we cut our EPS

forecasts. IVRCL remains our top pick and we upgrade Gammon to Buy.

IVRCL overtakes peers in sales with big leap in FY08

With a robust 59% increase in sales in FY08 coupled with a consistent increase in

sales recorded within the past few years, IVRCL was able to overtake its peers to

emerge as the leader in sales in FY08. We expect it to widen its lead over FY09-10F

because its average order execution period is relatively low and it relies upon arelatively higher proportion of subcontracting to increase its size. We believe

Nagarjuna Construction, which lost its leadership position in FY08, will continue to

challenge IVRCL in the coming years as Nagarjuna increases its exposure to the

industrial capex cycle. We believe HCC and Gammon, which are being selective in

types of orders, will lose their size advantage.

Chart 1 : Sales trend for construction peers (Rs m)

10,000

20,000

30,000

40,000

50,000

60,000

70,000

FY05 FY06 FY07 FY08 FY09F FY10F

Gammon India HCC IVRCL Nagarjuna Construction

Source: Company data, ABN AMRO forecasts

Profitability came under marginal pressure

The profitability of Tier 2 construction companies clearly came under attack as they

faced land-acquisition delays, a steep increase in input costs within the past few

months, and reliance upon build-operate-transfer (BOT) projects. Even though

Nagarjuna bucked the trend with an improved sales mix and significant equity

funding, IVRCL has been able to maintain its leadership position, being flat on PBT

(profit before tax) margins. HCC was specifically affected by rising interest and

depreciation costs.

IVRCL has beaten

Nagarjuna in terms of sales

to emerge as the largest

tier-2 construction company

in India

HCCs profitability has been

on the slide, while

Nagarjunas has improved


4/54



Chart 2 : PBT margin trend

3%

4%

5%

6%

7%

8%

9%

FY05 FY06 FY07 FY08 FY09F FY10F



Order inflow has been impressive in FY08

Order inflow has been robust for companies in sectors such as water, buildings and

industrial capex. IVRCL again scored an edge by expanding its order book by a steep

80% in 2008, followed by Nagarjuna at 28%. Orders from roads or hydro power have

been slow to flow through and were concentrated in the BOT space.

Chart 3 : Order book status, end-March 2008 (Rs m, x)

70,000

80,000

90,000

100,000

110,000

120,000

130,000

140,000


2.0

2.2

2.4

2.6

2.8

3.0

3.2

3.4

3.6

3.8

4.0

Order Book (Rs.m) Order Book to Average sales

Source: Company data, ABN AMRO estimates

NHAI and industrial capex to drive FY09F order inflow

For FY09 onward, we expect new orders from the National Highways Authority of

India (NHAI) and we expect the industrial capex cycle to be robust, whereas buildings

and airports may take a breather. Railways and JNNURM (Jawaharlal Nehru National

Urban Renewal Mission) projects could surprise by gaining momentum just prior to

the 2009 General Election.

NHAI has already called for RFQs (Requests for Qualification) for about 35 packages,

of 3,300kms in length, under the Golden Quadrilateral road-widening programme, for

which bids may be awarded as early as September or October 2008. This is much

better than the average award of around 1,500kms pa for the past two years.

NHAI plans to award more

than double the length of

road contracts awarded in

FY08


5/54



With regard to industrial capex, except for a rising interest rate trend noticed in

recent months, we believe the fundamentals seem to support ambitious capacity

expansion across segments.

Table 1 : XI plan infrastructure investment details

(Rs bn)Construction

component

Infrastructure

investment

% X plan XI plan Growth %

Airports 40 40 350 775

Irrigation 60 1,320 1,720 30

Ports 50 30 740 2,367

Power 40 2,890 5,650 96

Railways 42 830 2,550 207

Roads 100 1,300 3,330 156

Telecom 10 920 1,820 98

Urban infrastructure 60 640 1,060 66

Gas 20 90 210 133

Storage 30 90 150 67

Total 8,150 17,580 116

Source: Cris INFAC, company data, ABN AMRO

Table 2 : Total construction industry investment

(Rs bn) FY02-06 FY07-11F TAGR

Real estate 10,218 18,517 12.6%

Housing 9,810 17,338 12.1%

Commercial real estate 408 1,179 23.6%

Infrastructure 3,213 6,129 13.8%

Industrial 612 1,826 24.4%

Total 14,043 26,472 13.5%

Source: CRISIL Research, ABN AMRO forecasts

Steep increase in input costs leading to margin

concerns

The construction sector as a whole is struggling to find an answer to rising input

costs, particularly for steel, cement and bitumen. These three inputs contribute a

sizable chunk of overall project costs eg up to 40% of total costs in the case of road

projects. Although most cash contracts have escalation clauses, the company

undertaking the project is still exposed to a price hike to the extent that the

underlying index fails to reflect the actual price increase. This steep increase in the

prices of key inputs, coupled with the ineffectiveness of inflation indices, threatens to

upset the apple cart for construction companies. Companies have begun to insist on

star-rated contracts (prices of key inputs are specified and any variation thereon is

borne by the contractee) for cash contracts. However, questions remain regarding

BOT contracts. Companies such as IVRCL and Nagarjuna have indicated that 65% of

their order books include price-escalation clauses pertaining to either star or the WPI

(wholesale price index), which may limit the damage.

The builders association representations to state and central departments for

compensating their increased costs have just begun to yield results, as Andhra

Pradesh recently issued a notice that its state projects will be star-rated. That

announcement may be followed soon by similar moves by Maharashtra and

Rajasthan. The NHAI may take longer to accommodate the builders demand, as itmay be routed through a parliamentary bill.

Builders lobby helping

compensate on cash

contracts


6/54



We adjust our EPS forecasts across the board

Except for Gammon India, where we raise our FY09 EPS forecast by 5-12%, we trim

our EPS forecasts for all other construction companies in our universe by 5-35% for

FY09-10 as a result of execution risks, a steep hike in input material costs, a weak

pricing environment and rising funding costs. Among our EPS cuts, HCC leads the

pack with a nearly 35% cut, whereas there is little impact on IVRCL.

Table 3 : Our EPS revisions at a glance

FY09F FY10F

EPS (Rs) Chng EPS (Rs) Chng

Gammon India 18.0 5.2% 24.4 12.4%

HCC 3.8 -35.1% 5.3 -31.8%

IVRCL 20.9 -0.9% 26.9 -4.8%

Nagarjuna Construction 9.0 -19.3% 11.5 -18.8%

Source: ABN AMRO forecasts

Trimming our subsidiary values to adjust for CMP orcomparables

Since almost all of the construction companies in our coverage universe have real

estate subsidiaries, the recent weakness in this sectors stocks has a bearing on

subsidiary values. This is more pronounced in the case of IVRCL, whose real estate

subsidiary is listed, vs HCC, whose real estate subsidiaries are privately owned.

Across the companies, we trimmed the BOT subsidiary value to 1.5-2x price to book

value from 3x previously. As a result, there is a severe impact on Nagarjuna and

IVRCL.

Table 4 : Subsidiary values reduced (Rs per share)

New Old Change

Gammon India 216.8 289.8 -25.2%

HCC 69.9 84.9 -17.7%

IVRCL 97.4 158.1 -38.4%

Nagarjuna Construction 51.7 88.3 -41.4%

Source: Company data, Bloomberg, ABN AMRO estimates

We cut our EPS forecasts

for HCC and Nagarjuna

significantly

Maximum reduction for

Nagarjuna and IVRCL


7/54



Maintain Buy for IVRCL and Nagarjuna, upgrade

Gammon to Buy

Construction and engineering sector stocks across the board have recorded a severe

slide in the past six months. Many of the stocks are 50% below their recent peaks.

While our cautious outlook on HCC (Hold) and previous Sell recommendation on

Gammon India appeared appropriate in this environment, even high-growthcompanies such as IVRCL and Nagarjuna, which we rated Buys, experienced steep

corrections in their PE multiples.

Chart 4 : Share-price performance (Rebased chart of Construction companies)

50

100

150

200

250

300

May-07

Jun-07

Jun-07

Jul-07

Jul-07

Jul-07

Aug-07

Aug-07

Sep-07

Sep-07

Oct-07

Oct-07

Nov-07

Nov-07

Dec-07

Dec-07

Dec-07

Jan-08

Jan-08

Feb-08

Feb-08

Mar-08

Mar-08

Apr-08

Apr-08

May-08

May-08

Jun-08

Jun-08

Gammon HCC IVRC Nagarjuna Cons

Source: Bloomberg

We upgrade Gammon India to Buy in response to our EPS revision and a steep

correction in the stock price making the valuations attractive, in our view, at 6.6x

FY09F and 4.8x FY10F earnings after adjusting for subsidiary value of Rs216 per

share. The 15% slide in Gammons stock price since it took controlling stakes in two

Italian firms (Franco Tosi Meccanica and Sadelmi Spa) last week seems to us to be an

over-reaction. We believe the acquisition will play well in the medium term because it

reduces the time for Gammon to emerge as a complete solution provider for the

power sector.

We maintain our Buy ratings on IVRCL and Nagarjuna and our Hold on HCC, as the

latter derives 60% of its current market price (CMP) from its real estate subsidiary

and has high equity dilution risk.

Table 5 : Comparative valuations

Company IVRCL Nagarjuna

Construction

Hindustan

Construction

Gammon

India

Larsen &

Toubro

Punj

Lloyd

Current market price (Rs) 364 180 117 337 2,750 267.0

Recommendation Buy Buy Hold Buy Buy Buy

Subsidiary value per share (Rs) 97.4 51.7 69.9 216.8 1,191.4 40.0

EPS -FY09F (Rs) 20.9 9.0 3.8 18.0 90.1 13.6

Adjusted PE post-subsidiary value 12.7 14.3 12.2 6.7 17.3 16.7

EPS -FY10F (Rs) 26.9 11.5 5.34 24.4 109.3 19.8

Adjusted PE post-subsidiary value 9.9 11.1 8.7 4.9 14.3 11.5

EPS CAGR, FY08-10F 30.1% 31.8% 41.7% 33.5% 29.7% 40.0%

Subsidiary value/CMP 26.8% 28.8% 60.0% 64.2% 43.3% 15.0%

All valuations are based on fully diluted equity.Priced at close of business 18 June 2008.Source: ABN AMRO estimates

We upgrade Gammon for its

attractive valuation. IVRCL

and Gammon are high-

growth plays, in our view


8/54



Input prices: throwing a spanner inthe works?

A steep increase in prices of key inputs and the ineffectiveness of inflation

indices could upset the apple cart for construction companies. Companies

want star-rated contracts, but questions remain regarding BOT contracts.

Hefty increase in input costs; indices napping

The construction sector as a whole is struggling to find an answer to rising input

costs, particularly steel, cement and bitumen. These three inputs contribute a sizable

chunk of overall project costs eg up to 40% of the total cost in the case of road

projects. Although most cash contracts have escalation clauses, the companyundertaking the project is still exposed to a price hike to the extent that the

underlying index fails to reflect the actual price increase. For example, between June

2005 and March 2008, prices for steel bars and rods, as quoted by the public sector

entity SAIL, increased 51%, whereas the WPI for bars and rods rose just 26% during

the same period. Other key inputs such as bitumen and cement had similar

experiences, as shown in the next table.

Table 6 : Variation in inflation, WPI vs actual

WPI Actual prices (Rs)

Jun-05 Mar-08 % change Jun-05 Mar-08 % change

Steel** 262.8 330.1 26% 28,760 43,431 51%Bitumen** 264.9 554.7 109% 13,844 29,916 116%

Cement* 163.4 221.1 35% 158 230 46%

*price/bag of 50kg, **price/tonSource: MOSPI, ABN AMRO

Such large variations between actual and WPI-based inflation can have a very

negative impact on margins. The impact is more severe in the case of BOT/annuity

contracts, which contain no provisions for price escalation. In such cases, all the risk

associated with a price increase is borne by the concessionaire. We did a simple

simulation to determine the likely impact of such variations. We considered a project

with Rs100m in project costs, of which 40% is for the aforementioned key inputs. The

concession runs for 20 years, of which two are for construction. Under normal

conditions, the project is supposed to generate an IRR of 15%, translating to an

annuity of Rs17.5m.

Table 7 : A typical annuity-based BOT project

Project cost (Rs m) 100

- Key input cost (Rs m) 40

- Other costs (Rs m) 60

Concession period (years) 20

-Construction period (years) 2

-Annuity period (years) 18

Required project IRR 15%

Annuity (Rs m) 17.5

Source: ABN AMRO estimates

If the prices of key inputs rise 10% more than the level envisioned while signing the

contract, the IRR drops 67bp to 14.3%, while given inflation of 20% it drops 131bp

The rise in the WPI is far

short of actual input cost

increases


9/54



to 13.7%. If the IRR and annuity were maintained at the desired levels of 15% and

Rs17.5m, respectively, the annuity period jumps up by four years for a 10% variance

and a significant 15 years for a 20% variance in cost of key inputs.

Table 8 : Inflation in key inputs planned vs actual

0% 10% 20%

Project IRR 15% 14.3% 13.7%

Shortfall (bp) 0 -67 -131

Required annuity period to attain 15% IRR 18 22 33

Spillover (years) 0 4 15

Source: ABN AMRO estimates

The impact on project IRR and spillover required to compensate for the same can

therefore significantly alter the profiles of projects. As per the new Model Concession

Agreement in the case of BOT toll projects, user charges are linked only to the extent

of 40% to the WPI, exposing companies to a greater level of risk. Moreover, that

agreement also provides for alteration in the concession period to adjust for

variations between projected and actual traffic growth, with an aim to mitigate traffic

risk. Given that the upside from traffic growth is capped, we believe it only fair thatconcessionaires be protected against commodity risks in a similar fashion.

Proposed modifications

To protect their margins, companies and industry bodies have suggested several

changes to contracts through supplementary clauses. However, some of the

suggestions may not go down well with other stake holders. For example, lenders are

generally opposed to increasing the contract term because it increases their risks.

Increasing the concession period or toll charges would similarly not go down well with

the general public.

Many companies have begun to insist on star-rated contracts, whereby the prices ofkey inputs are specified and any variation thereon is borne by the contractee.

Although these clauses increase the complexity levels of contracts, they have become

necessary in light of significant unexpected increases in input costs. However,

government agencies such as NHAI have still not taken a stand on this important

issue and continue to operate with contracts where the escalation is linked to the

WPI. As previously noted, the indices have often failed to reflect the reality. In

addition, with the frequency at which the indices are updated not being up to the

mark, we believe linking escalation clauses to actual market prices is the way

forward. In our opinion, escalation clauses of a similar nature can also be rolled out in

the case of BOT projects, which have no provisions at present to cope with price

escalation.

With regard to state projects, Andhra Pradesh has already issued notice that it will

adopt a star-rated approach for all of its state projects. That announcement is

expected to be followed by similar ones from states such as Maharashtra and

Rajasthan in the coming months. On central public works, Delhi Metro and Indian

Railways are considering whether they should follow suit.

Cash contracts enjoy some

relief, but BOTs may have

to wait


10/54



Roads: need for speed

After a deluge of contract awards in FY06, there was a moderation in the

two subsequent years. However, with NHAI floating RFQs for more than

3,300kms recently, the roads and highways sector seems back in action.

NHAI gearing up for large awards

After awarding stretches of 5,442kms in FY06, NHAI awarded contracts for just

1,791kms and 1,219kms for the next two years, respectively. This trend is now set to

reverse because NHAI recently issued Requests for Qualification (RFQ) for 35 road

projects, mostly falling under NHDP Phases III and V, encompassing more than

3,300kms and with an estimated outlay of more than Rs300bn. NHAI opted to use

the BOT toll model for all of the contracts. In another major shift, the average ticket

size of these contracts has also risen to 95kms (for the 35 RFQs) compared with

44kms from the start of the NHAI programme to date. The fresh round of tendering

activity comes at a time when the industry has notched up implementation of

1,708kms in FY08, from just 807kms in FY06.

Table 9 : NHAI progress report card

Completion during Awarded during

(in kms) FY06 FY07 FY08 FY06 FY07 FY08

GQ 585 292 109 0 0 0

NS-EW 146 219 1,006 3,869 803 43

Port connectivity & others 36 55 214 449 153 1

Phase 3 40 22 379 1124 706 275

Phase 5 0 0 0 0 130 900

Total 807 588 1,708 5442 1,791 1,219

Source: NHAI, ABN AMRO

Even after the award of these contracts, the National Highways Development

Programme (NHDP) will have a backlog of 40% of the stretches, or more than

13,000kms (excluding phases IV and VII). Initial estimates suggest that Phase IV

and Phase VII will cover an additional 20,000kms and cost Rs400bn combined. Hence

we believe there are significant opportunities for construction companies for years to

come.

Table 10 : NHAI programme status

(in kms as of Mar 08) Project scope Completed % completed Under implementation % UI To be awarded %

GQ 5,846 5,663 97% 183 3% 0 0%

NS-EW 7,300 2,101 29% 4,220 58% 979 13%

Port connectivity & others 1,342 657 49% 659 49% 26 2%

Phase 3 12,109 441 4% 1,664 14% 10,004 83%

Phase 5 6,500 0 0% 1,030 16% 5,470 84%

Total 33,097 8,862 27% 7,756 23% 16,479 50%

Source: NHAI, ABN AMRO

Modification in approach

The National Highways Development Programme (NHDP) has evolved and learned

from its experience. To begin with, the mode of delivery has drastically shifted in

favour of BOT toll-based contracts at the expense of cash contracts in the later

phases. Second, the NHDP bidding process is increasingly tilting in favour of larger,

entrenched players due to the rising emphasis on pre-qualification requirements and

increasing average contract size. In the latest round, NHAI is following a two-stage

35 new RFQs; bids to be

decided by October 2008


11/54



bidding process wherein it will select five to six bidders based on pre-qualification

credentials such as financial strength, technical capability, etc. In the second stage,

only these pre-qualified bidders will be allowed to submit financial bids, which will

form the basis of the award. This would require the smaller players to enter into

partnerships to be in the fray. On the positive side, since only five to six financial bids

will be placed, predatory bidding will be reduced, resulting in higher margins for road

projects.

Traffic risk mitigated, still exposed to commodity risk

The new Model Concession Agreement (MCA) for BOT toll projects provides for

adjusting the concession period depending upon actual traffic growth vis--vis

estimated growth. The aim is to cap excess returns due to higher-than-estimated

traffic while simultaneously providing a cushion against lower traffic growth.

However, the other major risk related to increasing commodity prices is not

addressed by the present MCA namely increasing commodity prices. Soaring prices

of inputs such as steel, bitumen and cement can significantly alter the earnings

profiles of projects. We believe NHAI must address this valid industry concern,

especially given the move towards more BOT toll-based projects and steps such as

capping returns from strong traffic growth. However, given the fact that theamendments need to come through a parliamentary bill, it may take a long time to

materialise.


12/54



Water and irrigation

A need to increase irrigated areas and cater to a growing urban population is

driving investments in water infrastructure. Water being a state subject, we

focus our attention on states that have taken the lead on this front.

Thirsty for more

With 16% of the worlds population, India controls only 4% of the worlds total

available fresh water. It not only lags other countries in per capita water availability,

but also falls behind in terms of per capita storage, which stands at 213 cubic metres

(cu m) vs 6,103 cu m in Russia, 4,733 cu m in Australia, 1,964 cu m in the US and

1,111 cu m in China. With nearly 85% of Indias total water demand coming from

irrigation, irrigation outlay assumes high importance. Recognising the need to

improve irrigation facilities, the XIth plan has increased the outlay on irrigation to

Rs2,318bn (for FY08-12F) from Rs1,017bn in the Xth plan.

Another aspect of 21st century India is its 285m-strong urban population, which is

growing at a rate of 2.7% annually and is expected to reach 575m by 2030. Urban

India, which contributes 50% of Indias NDP, is in dire need of investments in civic

amenities. The Ministry for Urban Development estimates that the top 63 cities of

India need a combined investment of about Rs3,353bn over the next seven years to

upgrade their infrastructure with needs of water supply, sewerage, etc forming a

major chunk of the investment. Programmes such as JNNURM, which has a Central

Government outlay of Rs500bn, aim to help state governments and urban local

bodies undertake such investments.

States at the forefront

States such as Andhra Pradesh (AP), Maharashtra and Gujarat have seen significant

ramp-ups in spending for water infrastructure, especially irrigation. The AP

governments ambitiousJalayagnam project is worthy of a special mention in this

regard. TheJalayagnam projectaims to complete 30 major and 18 medium irrigation

projects to provide irrigation for 7.3m acres, drinking water to a population of 12m

and generate 1,700MW power at a cost of Rs460bn over FY05-09. Some of the major

packages underJalayagnam are:

the Tadipudi Lift Irrigation scheme at a cost of Rs3bn; the Sriram Sagar Stage II at a cost of Rs4.3bn; and the Pulichintala Project at a cost of Rs2.7bn.An examination of the fiscal score card of these states reveals very large increases in

outlays for irrigation and water-supply projects. APs irrigation expenditure (capital +

revenue) has increased at a CAGR of 48% during the five-year period beginning FY04

and stands at Rs350bn for FY09. That of Gujarat has increased at a CAGR of 20%

during the same period to reach Rs43bn in FY09.

States driving the spending

in water infrastructure,

with Andhra Pradesh,

Maharashtra and Gujarat

leading the race


13/54



Chart 5 : Budget outlay on irrigation and flood control (Rs m)

0

100,000

200,000

300,000

400,000

FY04 FY05 FY06 FY07 FY08 FY09F

Andhra Pradesh Gujarat

Source: State budget papers

Maharashtras irrigation expenditure on the revenue account has increased at a CAGR

of 37% over FY04-09.

This trend of increased irrigation expenditure in these states will continue as APs

irrigation expenditure on major and medium projects (MMP) during the XIth plan

stands at Rs380.2bn, or 32% of the total India outlay.

Chart 6 : XIth plan major and medium irrigation projects outlay (Rs1,185bn)

Andhra Pradesh

32%Other states

37%

Maharashtra

16%Gujarat

15%

Source: Planning Commission

Behind AP are the states of Maharashtra and Gujarat, with outlays of Rs191bn and

Rs175.8bn, respectively, forming 16% and 15% of the overall outlay. These threestates thus will account for 63% of the irrigation expenditure under the XIth plan and

hence are crucial to the success of the infrastructure companies, in our view.


14/54



Urban infrastructure

Urban India, due to its large contribution to GDP, is occupying prime space

on the policy radar. Programmes such as JNNURM, which links central grants

to local level reforms, bode well for the urban infrastructure space.

Focus on urban areas change in policy paradigm

India is fast recognising the importance and contribution of the urban sector to the

overall economy. As per the 2001 census, its urban population stands at 285m, or

28% of the total population, and is growing at an annual rate of 2.7%. Taking into

account migration from rural areas, Indias urban population is expected to reach

575m by 2030. From an economic perspective, the contribution of urban India to

Indias GDP stands at more than 50%, while from an employment perspective urban

areas corner nearly two-thirds of jobs in trade, commerce and financial services,

manufacturing and the transport sector.

However, almost all Indian cities have inadequate urban infrastructure. For instance,

only 50% of urban households have access to tap water and just 57.4% of

households have sanitation facilities on their premises. There is a huge need for

investments to upgrade urban infrastructure, and government policy is getting

aligned to do the same. The Ministry of Urban Development estimates urban areas

need an investment of Rs8,000bn over the next seven years. We focus our attention

on JNNURM, which we believe is the boldest step taken so far to address

infrastructure needs of urban India.

JNNURM: large grants, but with conditions attached

Jawaharlal Nehru National Urban Renewal Mission (JNNURM) is an incentive-linked

scheme that plans to invest Rs500bn in the form of central government grants aimed

at improving the infrastructure of 63 select cities. Besides the central grants, state

governments and urban local bodies (ULB) are expected to invest a similar sum,

taking the overall scope of JNNURM to Rs1,000bn. The mission has selected 63 cities,

including the four metros and the cities of Hyderabad, Bengaluru and Ahmedabad on

the following basis (see next table).

Table 11 : JNNURM plan

Category Criteria Number of cities

A Population > 4m 7

B Population 1m-4m 28

C Cities of religious/historical/tourist importance 28

Total 63

Source: JNNURM website

JNNURM has been bifurcated into two sub missions: urban infrastructure and

governance (UIG) and basic services to urban poor (BSUP). The former will focus on

infrastructure projects related to water supply and sanitation, sewerage, solid waste

management, and road network and urban transport, etc. The latter will focus on

providing basic shelter and other related services to the urban poor. The funding

pattern for the projects under each of the sub missions is as follows (see next table).

Investments driven by a

combination of state

reforms and the Centres

support


15/54



Table 12 : Financing pattern of projects falling under BSUP sub mission

Category Central grant State/ULB/parastatal agency share

A 50% 50%

B 50% 50%

Cities in North-eastern states 90% 10%

Other cities 80% 20%


Table 13 : Financing pattern of projects falling under UIG sub mission

Category Central grant State govt. ULB/parastatal agency

A 35% 15% 50%

B 50% 20% 30%

Cities in North-eastern states and J&K 90% 10% 0%

Other cities 80% 10% 10%

Desalination plant projects 80% 10% 10%


But the real clincher is that unlike most central government schemes, JNNURM

doesnt simply throw resources at state governments and local bodies. The release of

the funds is subject to specified local reforms that will have far-reaching effects.

Some of the key reforms mandated by JNNURM are:

repeal of the Urban Land Ceiling and Regulation Act (ULCRA); rationalisation of the stamp duty to reduce it to 5% or less; reform of rent-control laws; simplification of procedures for conversion of agricultural land for non-agricultural

purposes and streamlining of the approval process for construction of buildings

and development of sites;

achieving a reduction in headcount through voluntary retirement schemes (VRS)and reductions in future recruitments, etc;

levying user charges to recover full operation and maintenance and otherrecurring expenses; and

Adoption of technology such as a geographic information system (GIS) to improvecollection efficiency and processes such as double-entry accounting in ULBs.

We believe that JNNURM will not only boost urban infrastructure but also result in

reforms that will create a better environment for further investments in urban areas.


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Railways

After reaping the benefits of better utilisation, Indian Railways is banking on

aggressive capacity expansion to ride the next growth wave. We focus on an

ambitious dedicated freight corridor project and the opportunity it extends.

Smart turnaround, aggressive plans

Indian Railways (IR) has over the past five years turned around in a remarkable

fashion, with its surplus increasing more than tenfold from Rs11bn in FY04 to

Rs135bn in FY08. However, much of this is attributable to better utilisation made

possible by some deft tactical moves coupled with robust economic growth rather

than any major capacity-expansion exercise. Against historical elasticity of rail freight

to GDP of 0.6 to 0.75, the 10th plan period (FY02-07) experienced an elasticity of

greater than 1, thereby helping IR to post handsome gains. This is in line with

empirical studies conducted in other rapidly growing economies and hence the

Planning Commission of India estimates a higher transport elasticity of 0.8 going

forward.

Buoyed by very large surpluses and to keep pace with growth experienced within the

past few years, IR has increased its annual investment plan to Rs375bn for FY09, its

highest ever. Track renewals (Rs36bn), laying of new lines (Rs17bn), gauge

conversion (Rs25bn), and roads and bridges (Rs13bn) will be the key thrust areas

under the annual investment plan. To further augment its freight earnings, IR plans

to spend Rs750bn over the next seven years on dedicated freight corridors,

bypasses, flyovers, automatic signalling, doubling/trebling of lines, etc.

Dedicated freight corridor

IRs golden quadrilateral, ie lines linking the four metros (Delhi-Mumbai-Chennai-Howrah/Kolkata), and its diagonals, viz Delhi-Chennai and Mumbai-Howrah,

contribute 55% of annual freight revenues but cover just 16% of IRs total route

length. The Planning Commission estimates capacity utilisation at the western

(Mumbai-Delhi) and eastern corridors (Howrah-Delhi) at around 150%. This network

is believed to be saturated at most sections, according to the Planning Commission.

The need to decongest the golden quadrilateral is greater than ever, given rising

transport elasticity and the Planning Commissions expectations of healthy economic

growth in the coming years. In order to achieve this, IR is building a dedicated freight

corridor (DFC) on the western and eastern routes, which is due to be completed by

FY12, for an outlay of Rs280bn. We believe this huge outlay, coupled with IRs

increasing tilt towards awarding comprehensive higher-value contracts, bodes well for

construction companies.

The eastern corridor connecting Sonnagar to Ludhiana (1,279kms), with an extension

connecting to Dadri, will be an electrified line and will cost Rs115bn, according to IR

estimates. Freight traffic on the eastern corridor mainly comprises coal feeding into

power plants in north India, finished steel, cement and limestone. The IR expects

total freight traffic on this route to go up from 52MT in FY06 to 143MT in FY22.

The western corridor consists of 1,483 kms of double-line diesel tracks from

Jawaharlal Nehru Port Trust to Dadri via important cities such as Vadodara,

Ahmedabad and Palanpur. Freight on the western corridor mainly comprises ISO

containers from JNPT and Mumbai Port in addition to commodities such as fertilisers,salt and cement. Container freight on this route is expected by the IR to increase

from 0.69m TEUs in FY06 to 6.2m TEUs in FY22, while other commodities are

expected to go up from 23MT to 40MT during the same period. An SPV named

Dedicated Freight Corridor Corporation of India Limited (DFCCIL) has been set up

Gradual ramp-up of

dedicated corridor project

provides new growth

avenue for construction

companies


17/54



with a mandate to undertake planning and development, mobilisation of financial

resources, and construction, maintenance and operation of the Dedicated Freight

Corridors.

According to the task force of the Committee on Infrastructure, dedicated freight

corridors present a good opportunity for running railways on commercial principles

and introducing above the rail competition. If the recommendations of the task force

are accepted fully, it could open the door to private rail operations in the DFC as well,in our view.

To gear up for large railway construction, the Ministry of Railways is gradually

upgrading construction contractors from earlier item-based contracts for small

sections to turnkey execution of fixed lengths of railway lines, including signalling. An

early pre-qualification will help companies gain large orders with limited competition.


18/54



Company profiles

The following are the latest reports published on these companies:


Gammon India 19

Hindustan Construction 29

IVRCL Infrastructures & Projects 37

Nagarjuna Construction 46


19/54

Enhancing role in power sector

We raise our EPS forecasts on better sales traction ahead and hydropower's growing contribution. The stock looks attractive at 6.6x

FY09F, given its recent sharp correction and including our

adjustment of Rs216.8 for the subsidiary value. Buy, TP Rs486.8.

Key forecasts

FY06A

FY07A

FY08F

FY09F

FY10F

Revenue (Rsm) 14764.6 18660.3 24258.4 33961.7 41433.3

EBITDA (Rsm) 1871.3 1721.6 2304.5 3158.4% 4143.3%

Reported net profit (Rsm) 1042.6 444.8 1190.3 1561.3% 2119.7%

Normalised net profit (Rsm) 1053.8 936.2 1190.3 1561.3 2119.7

Normalised EPS (Rs) 12.9 10.8 13.7 18.0% 24.4%

Dividend per share (Rs) 0.64 0.50 0.70 0.80 0.80

Dividend yield (%) 0.19 0.15 0.21 0.24 0.24

Normalised PE (x) 25.9 31.0 24.4 18.6 13.7&

EV/EBITDA (x) 15.7 18.5 14.9 11.9 9.42

Price/book value (x) 3.14 2.53 2.30 2.06 1.80

ROIC (%) 15.1 9.12 8.25 9.42 10.1

1. Post-goodwill amortisation and pre-exceptional itemsAccounting Standard: Local GAAPSource: Company data, ABN AMRO forecasts

year to Mar, fully diluted

Sales momentum to improve sharply

Management has said sales momentum improved sharply in March 2008. It expects

continued improvement for the rest of FY09, clocking full-year sales of Rs36bn. We

build in 5% slippage from delays in approvals or land acquisition, and raise our FY09

net sales forecasts 10% to Rs34bn, given the strong order book to average sales

ratio of 3.45x for FY08F.

Raising EPS forecasts on the back of better sales momentum

Building in cost pressures, we trim our EBITDA margin by 30bp in FY09, but this

should be offset by better sales momentum, resulting in our EPS upgrade of 5.3% to

Rs18. For FY10, we build in a 70bps margin expansion on rising revenue contribution

from the highly profitable hydro power projects, leading to an EPS upgrade of 12% to

Rs24.4. The recent acquisition of Italian power equipment makers Fraco Tossi and

Sadelmi should expand GIPL's scope beyond civil contract works in the high-growth

power sector in the medium term. In the short term, we are concerned about

acquisition funding and turnaround risk.

GIPL seems on course to expand its scope

Subsidiary GIPL looks on schedule in all its six projects under implementation, two of

which should start generating revenue after March 2009. The company has also

insulated itself from sudden hikes in project costs and, with better-than-expected

traffic growth, has realised equity IRR expansion of over 20%. The firm has been able

to cherry-pick high IRR projects due to its portfolio approach and expects some of

them to be securitised in the short term, addressing its funding requirements.

Subsidiary value revised

We revisit subsidiary value, given the sharp correction in comparables, leading to a

subsidiary valuation of Rs216.8. Adjusting for this, the stock trades at what we see as

an attractive 6.6x FY09F earnings. Considering the sharp correction in the stock price

and our raised EPS forecasts, we upgrade the stock to Buy, with a new target price of

Rs486.8 (vs Rs648.90 previously). At our target, the stock would trade at 15x FY09F

earnings after adjusting for subsidiary value of Rs216.8 vs our EPS CAGR of 33% for

FY08-10F, which is at the lower end of the PE valuation for our universe.


India



Equities Team

Priced at close of business 18 June 2008. Use of%& indicates that the line item has changed by at least 5%.This note should be read along with our sector report (Widening scope of operations, 19 June 2008) for a betterunderstanding of the investment argument.


Price performance (1M) (3M) (12M)

Price (Rs) 407.0 392.6 387.8

Absolute % -17.7 -14.7 -13.7

Rel market % -7.0 -18.0 -21.2

Rel sector % -11.2 -16.1 -7.7

Price

Rs334.85

Target price

Rs486.80 (from Rs648.90)

Market capitalisation

Rs29.05bn (US$677.16m)

Avg (12mth) daily turnover

Rs41.91m (US$1.04m)

Reuters Bloomberg

GAMM.BO GMON IN

Buy (from Sell)Absolute performance

n/a

Short term (0-60 days)

Overweight

Market relative to region

Thursday 19 June 2008 Change of recommendation

Gammon India

200

300

400

500

600

700

800

900

Jun 05 Jun 06 Jul 07

GAMM.BO Sensex

Stock borrowing: Impossible

Volatility (30-day): 38.49%

Volatility (6-month trend): 52-week range: 845.00-332.00

Sensex: 15422.31

BBG AP Construction: 297.36Source: ABN AMRO, Bloomberg

19


20/54


G A M M O N I N D I A 1 9 J U N E 2 0 0 8 2

Expanding power sector capability

We upgrade Gammon India to Buy on strong sales momentum and

improving power sector capability on the back of the recent acquisition of

Italian power equipment makers. We see 45% potential upside to our TP.

Sales momentum ready to accelerate

Gammon Indias net sales have shown a CAGR of 27% from FY03-07,

underperforming its peers. The companys sales growth has been volatile, ranging

from a measly 1.2% in FY06 to 58% in FY07. For the nine months ended December

2007, the company reported a 24% yoy rise in net sales to Rs15.2bn. However,

Gammon has seen strong sales traction in the March 2008 quarter, as its long-

gestation hydro power projects have started gaining sales momentum. Hence,

despite sluggish nine months, we believe Gammons 4Q08 sales will rise 45.4% yoyto Rs9bn and that it will meet our full-year FY08 sales estimate of Rs24bn. We

believe Gammon will carry this sales momentum into FY09, and hence raise our net

sales forecast to Rs34bn, implying growth of 40% yoy.

Chart 1 : Quarterly sales and growth trend

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

1Q05

2Q05

3Q05

4Q05

1Q06

2Q06

3Q06

4Q06

1Q07

2Q07

3Q07

4Q07

1Q08

2Q08

3Q08

-30%

-20%

-10%

0%

10%

20%

30%

40%

50%

60%

Sales % yoy (Rs m)

(Rs m)

Source: Company data, ABN AMRO

Volatile EBITDA margins nearing bottom

Gammons EBITDA margins have been less than 10% for the last seven quarters,

due, we believe, to its high reliance on transport engineering projects. Rising input

prices are a general risk to the entire construction sector, but Gammon has guided it

is well protected by escalation clauses for nearly 85% of its projects by value. We

expect the remaining 15%, which mostly includes projects won from subsidiary

Gammon Infrastructure Projects Limited (GIPL) such as the Kosi Bridge Infrastructure

project, will put pressure on the margins. Hence we build a marginal 30 bps yoy hit

to EBITDA margin for FY09 at 9.3%. We believe EBITDA margin will bottom out at

this level and begin to rise in FY10 as the proportion of hydro power in the companys

net sales rises to ~30% from 22% in FY08. We expect a 10% EBITDA margin in FY10

due to higher share of sales from hydro power, which is still below its historical high

of 12.7% in FY06.

We expect the sales

momentum to be sustained

through FY09

We estimate 10% EBITDA

margin for FY10

20


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Chart 2 : EBITDA margin trend

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

FY02 FY03 FY04 FY05 FY06 FY07 9MFY08

Source: Company data

We expect order inflow to improve from NHAI, hydro projects

Gammon India, which enjoyed a large share of cash contracts and BOTs in the initialrounds of road contract awardings, has been going slow on road orders in recent

times as the increased competition has made the segment unattractive. NHAI has

called for nearly 35 package tenders for phase V of the widening of the Golden

Quadrilateral, and so management hopes to win some orders in the coming months.

Also, various state governments in North and North-Eastern India are aggressively

exploring opportunities in hydro power. Gammon has participated in some prestigious

projects, so we believe it should be among the companies winning orders early.

As of end-December 2007, Gammons order book was at Rs7.4bn, or 3.45x average

sales for FY08F.

Acquisitions to penetrate deeper in the power sector

Gammon has acquired 75.1% of Franco Tosi Meccanica Spa (manufactures turbines

for thermal and hydro power plants up to 500MW and 350MW, respectively) and a

50% stake in Sadelmi Spa (engaged in the balancing of plant solutions mainly for the

power sector). The stake has been acquired through equity infusion of 40m in

Franco Tosi and 7.5m in Sadelmi. The acquisitions have been funded by debt raised

at 7.75% in the books of a new fully-owned overseas subsidiary of Gammon India

According to Gammon Indias management, Franco Tosi has 2,000MW capacity and

operates at just 20% utilisation, leading to losses in 2007. The turbines are based on

the technology supplied by Siemens and Westinghouse. Management asserts that the

poor profitability is due to the low utilisation level and that it is confident of a

turnaround given the order book of 200m vs a break-even revenue of 160m.

Gammon expects to generate EBITDA margins of 12% on the order book, which

comprises orders for eight turbines (mostly thermal), all with sub 100MW capacity in

Europe and Latin America. Gammon has given no commitments about work force

retention. The company expects sales of 125m in 2008. Gammon is exploring the

option of sourcing components from India to improve the profitability of Franco Tosi.

Gammon asserts that Franco Tosis products will be competitive in the Indian markets

despite the higher manpower costs in Italy.

Sadelmi recorded sales of 120m in 2007, with around 2% EBITDA margin and netlosses of 0.5m. The order book stands at 350m, which we estimate should

generate EBITDA margins of 10%. Gammons management sees Sadelmi as a

strategic fit in the power sector as it will help in meeting the pre-qualification norms

and in moving up the value chain to become an EPC service provider with in-house

Fresh tenders from NHAI

should benefit Gammon

India

The recent acquisitions of

Franco Tosi and Sadelmi

should provide a strategic

fit

21


22/54



designing skills. Therefore, Sadelmi plans to set up an office in India and jointly bid

for power projects with Gammon India. Gammon expects to generate sales of 150m

at Sadelmi in 2008.

Table 1 : Key financials of the two acquired companies, 2007

m Sadelmi Franco Tossi

Order book 350 200

Capacity utilisation - 20%

Sales 120 90

EBITDA margin 2% -5%

PAT -0.5 -42*

Debt 0 52

Gross block 66 134

Headcount (nos) 150 600

* Includes 30m of write-offs due to acquisitionSource: Company data

In our view, the acquisitions reflect Gammons aim to increase footprint in the power

sector, which is poised to see huge investments over the next few years. While

Sadelmi helps Gammon get into EPC for power plants, Franco Tosi allows Gammon to

tap into the growing demand for power equipment in India. Gammon is confident of

turning around these companies and believes the debt raised to fund the acquisitions

will be recovered from the companies themselves. We believe the financials of

Gammon will come under strain in the short term, as it may have to bear the

additional interest burden till the two companies generate enough cash flows.

However, we see them positively over the medium term given the strategic fit in

terms of capability in the booming power sector.

EPS upgrade driven by sales momentum uptick

Despite a 30bp cut in our EBITDA margin estimate for FY09 to 9.3%, we raise our

EPS estimate by 5.2% to Rs18 on a 10% upgrade in net sales to Rs34bn. We

estimate PAT for FY09 at Rs1.56bn, representing 31% yoy growth. The EPS upgrade

is significant, considering we do not forecast profits from Gammons Al Matar Oman

JV in FY09, following the completion of the JV operations. Gammon guides the final

profit will be booked in the March 2008 quarter.

Table 2 : EPS revision snapshot

(Rs m) FY09F old FY09F new % diff FY10F old FY10F new % diff

Sales 30,808 33,962 10% 38,510 41,433 8%

EBITDA 2,958 3,158 7% 3,697 4,143 12%

EBITDA margin 9.6% 9.3% (30) bps 9.6% 10.0% 40 bps

Adj EPS 17 18.00 5% 22 24.43 12%


GIPL projects look ready to deliver in FY09

GIPL, which has 14 projects under various stages of development across sectors such

as ports, roads and power, was listed in April 2008. Currently four projects (viz

Rajahmundry Expressway Ltd - REL (road annuity), Andhra Expressway Ltd - AEL

(road annuity), Cochin Bridge - CBICL (bridge, annuity + toll) and Vizag Seaport -

VSPL (port, toll)) are operational and contributing to revenues.

In the case of VSPL, which has an overall capacity of 9 MTPA, the revenue risk has

been mitigated to a great extent, as the company has entered into a take-or-pay

agreement with SAIL. Under this agreement, SAIL is obligated to use cargo facilities

at a minimum of 3 MTPA at an agreed service charge of Rs189/t. Additionally, SAIL is

required to pay a penalty of 71.43% of the service charge (Rs189/t) for the portion

of cargo that falls below 3 MTPA. However, SAIL can use the facility for cargo in

excess of 3 MTPA at 58.2% of the usual service charge. In FY08, VSPL handled 4.5

We raise FY09F EPS by

5.2%

22


23/54



MTPA despite SAIL not using the facility. This concession, which extends up to FY34,

is expected by Gammon to handle 7.5 MTPA or 83% of total capacity by as early as

FY10. VSPL operates at a very high EBITDA margin of ~70% and a healthy equity

IRR of over 20%.

Gammon also expects the Mumbai Nasik Expressway Ltd (MNEL), GIPLs only toll-

based road project, to contribute to its top line by end-FY09, when the remaining 50

km stretch should be completed. GIPL claims 10% traffic growth on this route vs itsinitial estimate of 4% traffic growth. This concession does not involve sharing returns

with NHAI if traffic growth exceeds estimates, and hence implies superior IRR, in our

view.

Table 3 : GIPL Projects (Rs m)

Name Type

Project

cost Debt Equity

GIPL

stake COD

Extends

till Current Status

Rajahmundry Expressway Ltd Road - BOT Annuity 2,564 2,360 204 94% Sep-04 Nov-19 Revenue generating

Andhra Expressway Ltd Road - BOT Annuity 2,481 2,330 151 94% Oct-04 Apr-19 Revenue generating

Cochin Bridge Infra Bridge - BOT Annuity + Toll 258 258 0 98% Jan-04 Apr-20 Revenue generating

Vizag Seaport Port - Toll 3,137 2,100 1037 74% Jul-04 Mar-32 Revenue generating

Mumbai Nasik Expressway** Road BOT Toll 7,530 6,500 520 70% Apr-09 Jul-25 Under development

Kosi Brige Infra Bridge BOT- Annuity 4396 3,913 483 100% Apr-10 Apr-27 Under development

Gorakhpur Infrastructure Road BOT Annuity 6,492 5,754 738 95% Oct-09 Apr-27 Under development

Sikkim Hydro power BOOT 4,300 3,225 1075 100% Dec-11 Dec-40 Financial closure yet to be achieved

Punjab Biomass Power BOO 4,140 3,105 1035 50% May-09 - Financial closure yet to be achieved

Mumbai offshore container terminal Port BOT Toll 12,000 9,600 2400 50% Dec-10 Aug-37 Financial closure yet to be achieved

Pravara Co-gen BOT 1,650 1,238 413 100% Sep-09 Sep-34 Financial closure yet to be achieved

SEZ Adityapur 1,000* na na 38%

Bio-mass power, Haryana 3,680 2,760 920 50% LOI received MOU yet to be signed

Tidong Hydel project, HP 4,500* na na 50% LOI received MOU yet to be signed

Yangthang Hydro power, HP Preferred bidders but no LOI yet

Beedi multipurpose port, Gujarat Preferred bidders but no LOI yet

* Estimated values ** Grant Rs510mSource: Company data, ABN AMRO

Subsidiary value revisited

GIPL Post the listing of subsidiary GIPL, we value Gammons 76.2% share atthe current market price and apply a 15% holding company discount. This

extends a value of Rs157.1/share to Gammon Indias share.

ATSL We value Gammon Indias 28.87% stake in ATSL at a 25% premium tothe 14.3x FY08A PE of KEC International (a leading power transmission tower

maker in India) due to ATSLs superior profitability). Adjusting for a 15% holding

company discount, we arrive at a value of Rs30.6/share for Gammon India.

Sadbhav Engineering We continue to value Gammons 8.8% stake in SadbhavEngineering at a 15% holding company discount to the current market cap,

leading to a fair value of Rs9.4/share for Gammon.

Gammon Realty We value the subsidiary at a 15% holding company discountto its FY08 BVPS, resulting in Rs10.2/share for Gammon.

Gammon Billimoria We value Gammon Indias 51% stake in Billimoria at 15x

FY09F PAT (in line with the parents valuations), producing a fair value ofRs9.5/share for Gammon.

23


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Table 4 : Subsidiary valuation

GIPL value

@ market

price)

Gammon

Realty

(2008

BVPS)

ATSL

FY07A

PAT (Rs m)

Sadbhav

mkt cap

(Rs m)

Gammon

Billimoria

FY09F PAT

(Rs m)

Base value 146 16.0 605 10,861 127

Multiple n/a 1 17.9 n/a 15

Gammon's Holding 76.2% 75.06% 28.87% 8.80% 51%

Holding company discount 15% 15% 15% 15% 15%

Value / share post discount 157.1 10.2 30.6 9.4 9.5

Market price as at 17 June 2008Source: Company data, ABN AMRO estimates

Upgrade to Buy with new target price Rs504.8

We value the parent at 15x FY09F EPS of Rs18 (at the lower end of the PE valuation

for our universe, considering its weak historical ROE) versus its EPS CAGR of 33%,

which, together with subsidiary valuation of Rs216.8/share, leads to an SOTP

valuation of Rs486.8/share, implying 45% potential upside. Adjusting for our

estimate of the subsidiary value, the stock trades at what we see as an attractive

valuation of 6.6x FY09F EPS. Hence, we upgrade our recommendation to Buy (from

Sell). The key reason for our target price downward revision is our low subsidairy

value and the change in our target PE.

The key risks to our SOTP-based target price are: 1) project delays affecting

contribution to the top line; 2) management's inability to pass on high input cost to

customers; and 3) prolonged delay in turning around recent Italian acquisitions,

thereby impacting consolidated entity profitability.

Adjusting for our subsidiary

value estimate, we find the

stocks valuation

compelling at 6.6x FY09F

EPS

24


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F O R E C A S T S & A S S U M P T I O N S


Key assumptions

Table 5 : Order status, sales and expenses assumptions (Rs m)

FY06A* FY07A FY08F FY09F FY10F FY11F

Order inflow 25956 40,480 28,000 50,000 45,000 50,000

Change 56% -31% 79% -10% 11%

Order book, year-end 55,680 77,500 81,242 97,280 100,847 101,127

Change 39% 5% 20% 4% 0%

Order book to average sales 4.74 5.1 3.8 3.3 2.7 2.2

Net sales 11,812 18,660 24,258 33,962 41,433 49,720

Growth 1.2% 58% 30% 40% 22% 20%

Raw materials and other construction expenses as net sales 80% 82% 81% 81% 79% 79%

Labour and personal expenses as net sales 6% 8% 8% 9% 10% 10%

EBITDA 1,497 1,722 2,305 3,158 4,143 4,972

EBITDA margin 12.7% 9.2% 9.5% 9.3% 10.0% 10.0%

Net interest expenses as net sales 3.2% 0.7% 0.9% 0.9% 1.0% 0.9%

Pre-tax profit margin 7.7% 7.4% 7.2% 6.8% 7.5% 7.7%

* Annualised to 12 monthsSource: Company data, ABN AMRO forecasts

Table 6 : Sensitivity of target price to GIPL valuation

-10% Base case 10% 30% 50%

GIPL Value/share (Rs) 131 146 160 189 218

Value/Gammon share (Rs) 141 157 173 204 236

SOTP (Rs) 489.1 504.8 520.5 551.9 583.3


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GAMMON INDIA: KEY FINANCIAL DATA

Income statement

Rsm FY06A FY07A FY08F FY09F FY10F

Revenue 14764.6 18660.3 24258.4 33961.7 41433.3

Cost of sales -12893 -16939 -21954 -30803 -37290

Operating costs n/a n/a n/a n/a n/a

EBITDA 1871.3 1721.6 2304.5 3158.4 4143.3

DDA & Impairment (ex gw) -371.0 -352.2 -485.6 -565.6 -645.6

EBITA 1500.2 1369.4 1818.9 2592.8 3497.7

Goodwill (amort/impaired) n/a n/a n/a n/a n/a

EBIT 1500.2 1369.4 1818.9 2592.8 3497.7

Net interest -470.9 -135.7 -218.0 -315.9 -399.5

Associates (pre-tax) 86.3 130.5 130.5 0.00 0.00

Forex gain / (loss) n/a n/a n/a n/a n/a

Exceptionals (pre-tax) n/a n/a n/a n/a n/a

Other pre-tax items 21.5 19.0 19.0 19.0 19.0

Reported PTP 1137.1 1383.2 1750.4 2296.0 3117.2

Taxation -83.3 -447.0 -560.1 -734.7 -997.5

Minority interests n/a n/a n/a n/a n/a

Exceptionals (post-tax) -11.2 -491.4 0.00 0.00 0.00

Other post-tax items 0.00 0.00 0.00 0.00 0.00

Reported net profit 1042.6 444.8 1190.3 1561.3 2119.7

Normalised Items Excl. GW -11.2 -491.4 0.00 0.00 0.00

Normalised net profit 1053.8 936.2 1190.3 1561.3 2119.7

Source: Company data, ABN AMRO forecasts year to Mar

Balance sheet


Cash & market secs (1) 1342.6 959.9 -33.4 -1748.5 -2249.4

Other current assets 10126.7 13844.5 17978.2 24254.1 29255.2

Tangible fixed assets 3770.6 7014.8 8029.2 9163.6 10018.0

Intang assets (incl gw) n/a n/a n/a n/a n/a

Oth non-curr assets 1161.8 1504.4 1584.4 1609.4 1629.4

Total assets 16401.7 23323.6 27558.4 33278.6 38653.2

Short term debt (2) n/a n/a n/a n/a n/a

Trade & oth current liab 4970.4 6571.1 8653.1 11172.1 13197.8

Long term debt (3) 1705.9 3714.9 5214.9 6714.9 7714.9

Oth non-current liab 467.2 1534.9 1067.1 1286.6 1595.3

Total liabilities 7143.4 11820.9 14935.0 19173.5 22508.0

Total equity (incl min) 9258.3 11502.7 12623.4 14105.1 16145.2

Total liab & sh equity 16401.7 23323.6 27558.4 33278.6 38653.2

Net debt (2+3-1) 363.2 2755.0 5248.3 8463.4 9964.3

Source: Company data, ABN AMRO forecasts year ended Mar

Cash flow statement


EBITDA 1871.3 1721.6 2304.5 3158.4 4143.3

Change in working capital -1725.4 -495.5 -1314.4 -2534.2 -1951.3

Net interest (pd) / rec -449.4 -116.7 -199.0 -296.9 -380.5

Taxes paid -104.0 -413.0 -525.1 -688.8 -935.2

Other oper cash items -742.7 -948.8 -1109.7 -1049.1 -777.8

Cash flow from ops (1) -1150.2 -252.4 -843.7 -1410.5 98.6

Capex (2) -916.9 -3596.4 -1500.0 -1700.0 -1500.0

Disposals/(acquisitions) 0.00 0.00 0.00 0.00 0.00

Other investing cash flow 4045.5 1507.2 -80.0 -25.0 -20.0

Cash flow from invest (3) 3128.6 -2089.3 -1580.0 -1725.0 -1520.0

Incr / (decr) in equity 21.1 0.01 0.00 0.00 0.00

Incr / (decr) in debt -1325.1 2009.0 1500.0 1500.0 1000.0

Ordinary dividend paid -59.8 -50.1 -69.6 -79.6 -79.6

Preferred dividends (4) n/a n/a n/a n/a n/a

Other financing cash flow 0.00 -0.02 0.00 0.00 0.00

Cash flow from fin (5) -1363.8 1958.9 1430.4 1420.4 920.4

Forex & disc ops (6) n/a n/a n/a n/a n/a

Inc/(decr) cash (1+3+5+6) 614.6 -382.7 -993.3 -1715.1 -501.0

Equity FCF (1+2+4) -2067.1 -3848.8 -2343.7 -3110.5 -1401.4

Lines in bold can be derived from the immediately preceding lines.Source: Company data, ABN AMRO forecasts

year to Mar

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GAMMON INDIA: PERFORMANCE AND VALUATION

Standard ratios Gammon India Hindustan ConstructionIVRCL Infrastructures &

Projects

Performance FY06A FY07A FY08F FY09F FY10F FY09F FY10F FY11F FY09F FY10F FY11F

Sales growth (%) 69.4 26.4 30.0 40.0 22.0 27.0 24.0 20.0 37.4 30.0 20.7

EBITDA growth (%) 93.3 -8.00 33.9 37.1 31.2 27.1 26.1 20.0 37.3 28.7 18.5

EBIT growth (%) 86.7 -8.72 32.8 42.5 34.9 23.5 27.2 20.4 38.2 28.9 24.1

Normalised EPS growth (%) 105.0 -16.6 27.1 31.2 35.8 44.4 39.2 23.7 31.3 28.8 25.0

EBITDA margin (%) 12.7 9.23 9.50 9.30 10.0 11.9 12.1 12.1 9.97 9.88 9.70

EBIT margin (%) 10.2 7.34 7.50 7.63 8.44 8.53 8.75 8.78 9.14 9.07 9.32

Net profit margin (%) 7.14 5.02 4.91 4.60 5.12 2.58 2.90 2.99 5.79 5.73 5.94

Return on avg assets (%) 9.50 5.17 5.25 5.82 6.63 4.99 5.36 5.53 6.92 7.77 8.30

Return on avg equity (%) 16.0 9.02 9.87 11.7 14.0 9.19 10.5 11.3 16.2 17.6 18.5

ROIC (%) 15.1 9.12 8.25 9.42 10.1 8.18 8.36 8.50 15.3 16.1 17.0

ROIC - WACC (%) 2.48 -3.47 -4.34 -3.17 -2.50 -4.41 -4.23 -9.48 2.77 3.49 4.39

year to Mar year to Mar year to Mar

Valuation

EV/sales (x) 1.99 1.70 1.41 1.10 0.94 1.27 1.10 1.01 1.03 0.80 0.62

EV/EBITDA (x) 15.7 18.5 14.9 11.9 9.42 10.7 9.07 8.33 10.3 8.06 6.43

EV/EBITDA @ tgt price (x) 22.8 26.1 20.6 16.1 12.6 11.3 9.53 8.72 13.2 10.3 8.31

EV/EBIT (x) 19.6 23.2 18.9 14.5 11.2 14.9 12.5 11.5 11.3 8.78 6.69

EV/invested capital (x) 2.95 2.17 1.88 1.63 1.46 1.48 1.34 1.25 2.12 1.81 1.60

Price/book value (x) 3.14 2.53 2.30 2.06 1.80 2.51 2.09 1.91 2.60 2.18 1.83Equity FCF yield (%) -7.58 -13.3 -8.07 -10.7 -4.82 -9.14 -11.2 -13.3 1.47 2.97 9.70

Normalised PE (x) 25.9 31.0 24.4 18.6 13.7 30.4 21.9 17.7 17.4 13.5 10.8

Norm PE @tgt price (x) 37.6 45.1 35.5 27.0 19.9 33.2 23.9 19.3 22.7 17.6 14.1

Dividend yield (%) 0.19 0.15 0.21 0.24 0.24 0.77 0.86 1.03 0.50 0.63 0.83

year to Mar year to Mar year to Mar

Per share data FY06A FY07A FY08F FY09F FY10F Solvency FY06A FY07A FY08F FY09F FY10F

Tot adj dil sh, ave (m) 81.5 86.7 86.8 86.8 86.8 Net debt to equity (%) 3.92 24.0 41.6 60.0 61.7

Reported EPS (INR) 12.8 5.13 13.7 18.0 24.4 Net debt to tot ass (%) 2.21 11.8 19.0 25.4 25.8

Normalised EPS (INR) 12.9 10.8 13.7 18.0 24.4 Net debt to EBITDA 0.19 1.60 2.28 2.68 2.40

Dividend per share (INR) 0.64 0.50 0.70 0.80 0.80 Current ratio (x) 2.31 2.25 2.07 2.01 2.05

Equity FCF per share (INR) -25.4 -44.4 -27.0 -35.9 -16.2 Operating CF int cov (x) -1.33 2.38 -0.60 -1.43 3.72

Book value per sh (INR) 106.7 132.6 145.5 162.6 186.1 Dividend cover (x) 17.6 18.7 17.1 19.6 26.6

year to Mar year to Mar

Priced as follows: GAMM.BO - Rs334.85; HCNS.BO - Rs116.75; IVRC.BO - Rs363.00Source: Company data, ABN AMRO forecasts

GAMMON INDIA: VALUATION METHODOLOGY

Table 7 : SOTP-based target price

Base value RS Multiple Holding

Holding company

discount Value/share

Gammon India Limited 2009F EPS 18.0 15 270.0

GIPL valued @ current market price 146 n/a 76.20% 15% 157.1

Gammon Realty (BV/share) 16 1 (implied) 75.06% 15% 10.2

ATSL (FY07 PAT Rsm) 605 17.9 28.87% 15% 30.6

Sadbhav Engineering (market cap) 1,0861 n/a 8.80% 15% 9.4

Gammon Billimoria (FY09F PAT Rs m) 127 15 51.00% 15% 9.5

Total 486.8

Priced as of 17 June 2008Source: Company data, ABN AMRO estimates

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Strategic analysis Average SWOT company score: 3 Sales split 1H08

Gammon India

Company description Buy Price relative to country

Gammon is one of the oldest construction companies in India with a substantial exposure to

transport engineering projects such as bridges, roads, etc. It has gained good ground in BOT

projects involving public-private partnership through its subsidiary GIPL, especially in its core area

of transport engineering. It has won the second-largest number of contracts for four laning of the

Golden Quadrangle and is the highest beneficiary in value terms from the NHDP's annuity projects.

However, Gammon suffers from lower ROE and profitability due to a high dependence upon

transport engineering projects, which are typically low-margin. With the recent acquisition of

turbine maker Franco Tossi and Balance of Plant manufacturer Sadelmi in Italy, Gammon plans to

emerge as an EPC contractor in the high-growth power segment.40

60

80

100

120

140

160

Jun

05

Oct

05

Jan

06

May

06

Aug

06

Dec

06

Apr

07

Jul

07

Nov

07

Feb

08

Jun

08

Competitive position Average competitive score: 2- Broker recommendations

Transport

Engineering

40%

Hydraulics

& Irrigation

18%

Energy(excluding

Hydro)

20%

Hydel

power

11%

Housing

3%

Environment

& pipeline

8%

Source: Company data

Market dataHeadquarters

Gammon House, Veer Savarkar Marg,

Prabhadevi, Mumbai 400025

Website

www.gammonindia.com

Shares in issue

86.8m

Freefloat

69%

Majority shareholders

Humid Investments & Traders Pvt Ltd

(6%), Summicorp Ltd (5%), HSBC Global

Investment Fund (5%)

Supplier power 3-Suppliers of key raw materials have significant bargaining power. However, companies are well

covered through price escalation clauses, and the same are passed on to the customers.

Barriers to entry 2+In the transport engineering segment, especially road projects, barriers to entry are relatively low.

However, in sectors such as energy and hydro power, higher barriers to entry exist.

Customer power 1-In the currently thriving Indian economy, customer power is weak as the order books of all the

quality construction companies are full and customers must agree to the escalation clauses.

Substitute products 3+Substitutes are limited as the industry works on a cost-plus basis and design primarily comes from

the customers.

Rivalry 2-Despite overlap in the kind of projects undertaken, rivalry is largely subdued due to heavy

investment in infrastructure and companies' healthy order books.

Scoring range 1-5 (high score is good) Plus = getting better Minus = getting worse

India

Country view Overweight Country rel to Asia Pacific

We expect Indian growth to remain robust in 2008, driven by domestic demand due to the rise in

wages and farm incomes. We see a structural growth story emerging in real estate and agriculture,

in line with the government's 11th five-year development plan of redistributing income beyond the

city centres. We remain selective buyers of consumer discretionary and consumer staples,

especially in upstream industries such as cold chain, agri-businesses and organised retail. We think

the IT sector is also worth a fresh look as valuations look increasingly undemanding at present

levels and major players have demonstrated an ability to protect their margins.

The country view is set in consultation with the relevant company analyst but is the ultimate responsibility of the Strategy Team.

90

110

130

150

170

190

210

230

250

Jun

05

Oct

05

Jan

06

May

06

Sep

06

Dec

06

Apr

07

Jul

07

Nov

07

Feb

08

Jun

08

0

2

4

6

8

10

12

14

Buy Hold Sell

Source: Bloomberg

Strengths 4Gammon's experience in executing complex transport engineering projects such as bridges and

tunnels has been useful in establishing it in the PPP space. Similarly, by using its strength in hydro

and nuclear power civil contracts, the aim is for the Italian acquisition to emerge as an EPC player.

Weaknesses 2A long gestation period for projects is a cause for concern, in our view, because it limits growth

prospects for Gammon despite its high order-book-to-sales ratio vis--vis peers.

Opportunities 3We believe the government of India's aggressive infrastructure plans, such as the big-ticket metro

projects in Hyderabad and Mumbai, and plans to harness 50,000 MW of hydro power by FY17,

provide Gammon with promising growth prospects.

Threats 1Competition is rapidly catching up in Gammon's mainstay area of transport engineering, thereby

affecting profitability.

Scoring range is 1-5 (high score is good)

Strategic & competitive overview

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Restructuring to capture growth

Slower-than-expected sales momentum and high interest costs leadus to cut our EPS forecasts 35%. We believe the strained balance

sheet and low ROE relative to the sector require equity dilution to

fund growth. We trim our target price to Rs127.4. Hold.

Key forecasts

FY07A

FY08A

FY09F

FY10F

FY11F

Revenue (Rsm) 23576.2 30827.6 39151.1 48547.3 58256.8

EBITDA (Rsm) 2152.6 3666.1 4659.9& 5874.2& 7049.1

Reported net profit (Rsm) 427.5 1087.7 2511.6% 1408.2& 1741.4

Normalised net profit (Rsm) 792.8 700.6 1011.6 1408.2 1741.4

Normalised EPS (Rs) 3.01 2.66 3.83& 5.34& 6.60

Dividend per share (Rs) 0.75 0.80 0.90& 1.00& 1.20

Dividend yield (%) 0.64 0.69 0.77 0.86 1.03

Normalised PE (x) 38.8 44.0 30.4% 21.9% 17.7

EV/EBITDA (x) 20.1 12.5 10.7 9.07 8.33

Price/book value (x) 3.41 3.07 2.51 2.09 1.91

ROIC (%) 7.17 7.66 8.18 8.36 8.50

1. Post-goodwill amortisation and pre-exceptional itemsAccounting Standard: Local GAAPSource: Company data, ABN AMRO forecasts

year to Mar, fully diluted

Trend of disappointing quarterly results continued in March 2008

For the March 2008 quarter, Hindustan Construction Company (HCC) reported a

27.5% yoy rise in net sales to Rs10.6bn and PAT of Rs381m. Adjusting for

extraordinary items in both periods (a forex loss in March 2008 of Rs84m and prior-

period taxes in the March 2007 quarter), normalised PAT grew 26.5% yoy to

Rs465m. Even though the EBITDA margin expanded by 370bp yoy to 12.4%, it was

below our expectations, down 50bp qoq. Hence the results disappointed us by 17%

on EBITDA and 23% in normalised PAT.

Worst of sea link project impact on PAT is over, but strains debt:equity

The initial round of settlements should help recoup part of the Rs4bn loss suffered by

HCC on the Bandra-Worli sea link project and stop the bleeding it caused on the PAT

level. However, the drawn-out delay in the project coupled with the capital intensity

of its business model has led to sub-optimal utilisation of resources, thereby

expanding the debt-to-equity ratio to 1.9:1. We think this will continue to be a strain

on HCC, especially in a scenario of rising interest rates and weak equity fund raising.

Hence, we trim our EPS by 35% for each of FY09F and FY10F.

Real estate projects still comprise 60% of value; maintain Hold

Even after marginally reducing our assumptions for Lavasa and the IT park, the real

estate subsidiary value of Rs69.9 per share is a substantial part of the current stock

price. Considering Lavasa is a long-duration project, the cyclical risk of the real estate

sector is more pronounced. Hence despite an attractive valuation of 12.1x FY09F

standalone EPS, we maintain Hold with a downwardly revised SOTP target price of

Rs127.4 (from Rs209) because we expect high equity dilution risk to the

parent/subsidiary in a low-ROE scenario. The restructuring of business into different

verticals and gradual entry into the build-operate-transfer (BOT) space should be

medium-term drivers.


India



Equities Team

Priced at close of business 18 June 2008. Use of%& indicates that the line item has changed by at least 5%.This note should be read along with our sector report (Widening scope of operations, 19 June 2008) for a betterunderstanding of the investment argument.


Price performance (1M) (3M) (12M)

Price (Rs) 136.0 118.3 97.55

Absolute % -14.2 -1.3 19.7

Rel market % -3.0 -5.1 9.3

Rel sector % -7.3 -2.9 27.9

Price

Rs116.75

Target price

Rs127.40 (from Rs209.00)

Market capitalisation

Rs29.92bn (US$697.56m)

Avg (12mth) daily turnover

Rs174.50m (US$4.34m)

Reuters Bloomberg

HCNS.BO HCC IN

HoldAbsolute performance

n/a

Short term (0-60 days)

Overweight

Market relative to region

Thursday 19 June 2008 Change of target price

Hindustan Construction

50

100

150

200

250

300

Jun 05 Jun 06 Jul 07

HCNS.BO Sensex

Stock borrowing: Difficult

Volatility (30-day): 62.07%

Volatility (6-month trend): 52-week range: 278.90-96.80

Sensex: 15422.31

BBG AP Construction: 297.36Source: ABN AMRO, Bloomberg

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H I N D U S T A N C O N S T R U C T I O N 1 9 J U N E 2 0 0 8 2

Restructuring to capture more growth

We trim our EPS by 35% for FY09F and FY10F due to execution slippage and

higher interest costs. The restructuring of businesses into separate verticals

and gradual entry into BOT should be medium-term drivers. Maintain Hold.

March 2008 quarterly results disappoint

For the March 2008 quarter, HCC reported a 27.5% yoy rise in net sales to Rs10.6bn

and PAT of Rs381m. Adjusting for extraordinary items in both periods (a forex loss in

March 2008 of Rs84m and prior-period taxes in the March 2007 quarter), normalised

PAT grew by 26.5% yoy to Rs465m. Even though EBITDA margin expanded by 370bp

yoy to 12.4%, it was below our expectations of 14.2% and down 50bp qoq. Hence

the results disappointed by 17% on EBITDA and 23% in normalised PAT (Rs607m)

due to nonavailability of joint-venture profits (FY07: Rs154m).

For full year FY08, HCC recorded a 154% yoy rise in reported PAT to Rs1.09bn as a

result of a 31% yoy rise in net sales to Rs30.8bn and a 280bp yoy expansion in

EBITDA margin to 11.9%. However, excluding extraordinary items in both years,

normalised PAT declined by 12% yoy to Rs701m due to higher interest expenses and

non-availability of joint-venture profits (FY07: Rs244m).In terms of sales mix, power

and transportation marginally improved their share, at the cost of the water division.

Chart 1 : EBITDA margin trend

0

2,000

4,000

6,000

8,000

10,000

12,000

1Q07 2Q07 3Q07 4Q07 1Q08 2Q08 3Q08 4Q08

0%

2%

4%

6%

8%

10%

12%

14%

Net Sales (Rs m) EBITDA margin

Source: Company data, ABN AMRO

Order inflow momentum lags the industry

The company failed to meet its guidance of Rs120bn in the order book to end FY08 at

Rs101.6bn, representing 9% yoy growth. Among the significant orders was

constructing Rock Caverns for crude oil storage at Visakhapatnam of 1m metric tons.

Among the divisions, water and irrigation saw more than a doubling of the order book

to R.21.3bn, whereas roads saw a marginal dip.

The March 2008 quarter

results disappointed us by

17% on EBITDA and 23% in

normalised PAT (Rs607m)

due to nonavailability of

joint-venture profits (FY07:

Rs154m)

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H I N D U S T A N C O N S T R U C T I O N 1 9 J U N E 2 0 0 8 3


Chart 2 : Order book trend

0

20,000

40,000

60,000

80,000

100,000

120,000

140,000

FY06A FY07A FY08F FY09F FY10F

order book (Rs m)

0.0

1.0

2.0

3.0

4.0

5.0

6.0order book/avg sales

Closing Order book (Rs m) Order book/avg sales


Increasing proportion of power in sales should help protect EBITDA margins

HCCs sales mix from hydropower has substantially lagged the order book in the pasttwo years because hydropower projects have relatively longer gestation periods. With

the projects on hand gaining momentum, we feel a more profitable hydropower

contribution can gradually improve from 25% of sales in FY08, thereby helping

absorb cost pressure increases from steel, cement and bitumen. Hence, we trim our

EBITDA by about 7% for each of FY09F a

construction and engineering by abn

Documents