Exposure to airports, power and road and first-mover position provides profitable assets, but valuation has run up

Net profit CAGR of 43% over FY08-10e

Initiating coverage with an Underweight (V) rating and a target price of INR595, 20.5% downside from current level

Flying too high

GMR Infrastructure (GMR) is one of the first private infrastructure players to adopt a construction-neutral development strategy by offloading construction risk to third parties. A first-mover advantage has helped GMR build up a portfolio of profitable assets focused on airports, roads and power plants. The company has a risk mitigation strategy with a good mix of assets under operation and under development across different sectors and a diverse list of clients.

The airport business also benefits from real estate appreciation as GMR has c1,250 acres of land on a 60-year government lease ready to be developed commercially at the Delhi and Hyderabad airport projects. We estimate that this real estate contributes c41% of the company’s overall valuation. GMR has expanded outside India and has a 40% equity stake in a consortium that has won a contract to operate Sabiha Gokcen International Airport (SGA) in Istanbul. GMR is trying to turn around its power portfolio, changing strategy to focus on assured fuel supply. In the road sector, GMR has unlocked value through financial engineering and securitising receivables.

The company’s business fundamentals remain strong but its valuation has run ahead of its one-year earnings prospects. We have valued all of GMR’s projects using a DCF approach as most of the projects are for fixed durations. Based on this, we have valued the company at INR197.1bn, or a per-share value of INR595, 20.5% below the current share price. Even after the recent correction of 25% from its historic peak, we believe there is still some downside to the stock. We initiate coverage on GMR with an Underweight (V) rating. The key upside risks to our valuation are the contribution of the SGA Airport in Istanbul and a higher-than-expected valuation of airport real estate. Key business risks are uncertain interest rates and airport traffic, aviation fuel shortages, increased competition, and regulatory, finance and execution risks

Valuation

Most of GMR’s projects are conducted over fixed durations of 15-60 years. After the concession period, the assets are handed back to the government at no cost. We believe DCF is the most suitable approach to value the company. We have valued GMR’s entire current business at INR197.1billion, translating into INR595 per share. The two airports should be the key value drivers for the company; they contribute c77% of the total value, including the associated real estate businesses. The Delhi airport project contributes c23% of the overall valuation and Hyderabad airport c54%. Of the current airport valuation, real estate contributes 40%, with Delhi real estate contributing 33.7% to Delhi International Airport Limited (DIAL) valuation and Hyderabad real estate contributing about 73% to Hyderabad International Airport Limited (HIAL) valuation. We have valued Delhi airport assuming passenger CAGR of 12% over FY08-15e with passenger growth of 18.4% for FY08e. Aeronautical revenues are capped at 11.6% return on the fixed assets, so there is not much upside.

Nonaeronautical revenue, currently at USD3.9 per pax, should reach the international level of more than USD9 per pax by FY15, a 16% CAGR over the period. If we compare Delhi airport valuation on EV per pax, at our valuation it will be USD96 for FY09e vs average USD64 EV per pax for Asian airports under HSBC coverage. The Hyderabad airport should contribute c54% to overall valuation, with real estate contributing a major part of the revenue. As the Hyderabad airport is a green field project, the revenues are not regulated. We have assumed the current passenger growth rate of 40% to continue at 13% CAGR over FY08-15. We have factored in investment in capacity renovation after every 20 years of operation. According to our estimates, the Hyderabad airport will generate a high return on invested capital. The Hyderabad airport valuation on EV per pax works out to USD189 for FY09e vs average USD64 EV per pax for Asian airports under HSBC coverage. The real estate business contributes Rs 122 billion for 1,000 acres of land translating into Rs 122 million per acre. The valuation contribution of HIAL is higher than Delhi airport despite Delhi airport handling more capacity because there is no return cap on HIAL revenue charges, it has a lower revenue share of 4% (with a 10-year deferred payment schedule) vs the Delhi airport, which has 45.99%; and has a higher contribution from the real estate business. Based on our assumption, we have arrived at a DCF value of Rs 197 billion. However, GMR will continue to bid for new projects, so there is likely to be incremental value creation for shareholders.