Gammon stares at a tough road ahead

Gammon Infra is selling its prized assets to reduce debt. The move may impact its profit, leaving it with not enough resources to service its remaining debt

Gammon Infrastructure's recent announcement that it will sell its stake in nine projects (six road projects and three power projects) doesn't seem to have convinced the market of a possible turnaround in the company's fortunes - the stock which appreciated 15.5 per cent after the asset-sale was announced has lost 29 per cent since then.

The sale will nearly halve the company's debt, but that hasn't turned investor sentiment. In fact, Gammon Managing Director KK Mohanty has gone a step ahead and said that from a seller (of assets), the company wants to become a buyer once its balance sheet is deleveraged. Clearly, there is some dissonance between the company's plans and the investors' perception.

To be sure, Gammon is one of the several road builders that have announced major asset sale. The key reason is that these companies are finding it hard to service the debt they had taken on the back of high traffic projections which led to aggressive bids during 2010 to 2012.

In many cases, those projections turned out to be exaggerated. Experts say while most companies had expected traffic growth of 8-10 per cent, real growth has been just 4-5 per cent. In addition, the weakening macros, declining GDP growth and higher interest rates took their toll on the company's profitability and balance sheet. The delays in project execution due to various regulatory clearances only made matters worse. As a result, the operating profits were not adequate to service debt, which forced many companies to go for corporate debt restructuring and sell assets.

Gammon, too, saw its consolidated debt increase from Rs 1,336 crore in FY09 to close to Rs 4,000 crore now. Post 2012-13, the company has changed the accounting period twice. For the nine months ended September 2014 (it now follows October-September financial year), its earnings before interest, tax, depreciation and amortisation (EBIDTA) was Rs 313.59 crore. But, post interest expenses (of Rs 206.52 crore), depreciation (Rs 168.24 crore) and tax (Rs 39.6 crore), it ended up with a loss of Rs 40.25 crore.

For nine months ending June 2015, the situation changed but not in a big way. Even as both revenues and operating profit grew over 32 per cent, the latter at Rs 395 crore was just enough to take care of interest (Rs 169 crore) and depreciation (Rs 199 crore). After paying tax of Rs 9.42 crore, the company ended with a net profit of Rs 18 crore (against a loss of Rs 56.6 crore, adjusted for one-off items, in the corresponding year-ago period).

No easy task

Now that some key operational projects are being sold, it remains to be seen if Gammon will have enough profits to service the left-over debt.

In all, Mohanty expects a reduction of about Rs 1,718 crore in the debt of Rs 2,000 crore on operational projects after the asset sale. However, Gammon will still be left with another Rs 2,000 crore of debt on the remaining projects which are under implementation. The other worry is that the projects being sold contribute Rs 500-600 crore per annum to revenues and earned EBITDA margins of around 55 per cent. Hence, revenues and profits will fall from here on.

Experts also feel that Gammon is selling its best assets to reduce debt and will be left with not many profitable assets. The distressed situation and uncertain business environment are seen as among the key reasons why the company could not cut a better deal. Says Centrum Infrastructure Advisory MD & CEO Sandeep Upadhyay: "While market conditions remain benign, my belief is that Gammon could have negotiated a higher valuation from the buyer but for its weak financial position. Of the nine assets sold, the Mumbai-Nasik road project was a jewel, which could have fetched a much better premium."

While the move will surely lower debt, it is unlikely that Gammon will be in a position to acquire new assets, say analysts. The company has said that it will be on a lookout for assets as there are many good ones that it may be able to get at low valuations. However, experts feel that the company will require funds to complete projects under development first.

They also point out that typically after the commissioning of projects there is a lead time before they start to stabilise. During this period, the interest and depreciation charges too start reflecting in the company's P&L account. Thus, challenges will continue and the way forward may not be that easy.

The three or four assets that Gammon will be left with do not have much value currently, though experts like Upadhyay say these could fetch more value once they become operational. Gammon also has a port asset which it is selling to another potential buyer. The company's 60 per cent stake in the port is valued at about Rs 62 crore of equity value. But, this may not be enough to meaningfully lower its debt or improve its financials.

Clearly, there is more to be done. The market's worry can also be gauged from the stock's movement. From a high of Rs 35 in 2008, it has witnessed sharp movements in between, but the broader trend has been bearish. It has lost almost 40 per cent in the last two months. Sentiments will reverse only when more concrete developments take place.