RBS: Sell Gammon India -Lower PAT on higher interest costs

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Gammon India 
Lower PAT on higher interest costs 
For 3QFY11 higher interest costs (up 13% qoq) led to a 30% disappointment vs
our forecasts at normalised PAT level for the standalone entity despite in line
sales and EBITDA. Profitability remains under pressure despite good execution
performance. We have Sell on the stock.

3QFY11 standalone PAT came 30% below on higher interest costs
! Net sales at Rs.13.7bn, +35% yoy and +16% qoq, RBS estimate was Rs.13.6bn.
! EBITDA came at Rs.1.1bn, +11% yoy and +8% qoq, RBS estimate was Rs.1.2bn.
! EBITDA margin declined 174bp yoy and 66bp qoq to 8.1%, RBS estimate was 8.5%.
! Depreciation came in line with forecasts at Rs.244m.
! Net interest was Rs.509m, up 50% yoy and 13% qoq, RBS estimate was Rs.380m.
! Tax expenses were at Rs.86m and tax rate declined to 26% from 35% in 2Q. RBS estimate
was 33%.
! Normalised profit came at Rs.247m, down 33% yoy and +14% qoq. RBS estimate was
Rs.351m.
! Taking into account a forex loss of Rs.146m, the reported profit came at Rs.102m, down 51%
yoy and 58% qoq.
! Normalised EPS for 3Q was Rs.1.8/share.
Higher depreciation and interest costs also impacted the 9MFY11 performance
! Net sales at Rs.38.6bn, up 37% yoy.
! EBITDA at Rs.3.2bn, up 11% yoy.
! EBITDA margins at 8.4%, down ~200bp yoy on higher raw material costs.
! Depreciation is at Rs.669mn, up 29% qoq.
! Net interest costs rose 22% yoy to Rs.1.33bn.
! Higher depreciation and net interest led to a 25% yoy normalised PAT decline of Rs.787m.
! Reported net profit declined 29% yoy to Rs.644m.

! Normalised EPS for the 9M was Rs.5.9/share.
Sales growth is on track, but not profitability
! The company has recorded impressive sales growth during the quarter keeping in mind the
performance of other construction companies in our coverage universe, which struggled
during the quarter. This was the result of fast tracked NHAI projects. However, lower margins
(lowest in our coverage universe) coupled with higher interest burden remain a cause of
concern for us. We wait for the management call before adjusting our forecasts and to get
more color on the profitability of the international operations of the company.




Valuation and risks to target price
Gammon India (RIC: GAMM.BO, Rec: Sell, CP: Rs110.20, TP: Rs151.00): Key risks to our SOTP-based target price are: 1) a faster turnaround at the international subsidiaries were
they to gain a foothold in the domestic power sector; and 2) a halt to the decline in standalone EBITDA margin and a return to the 1QFY10 level.