Citigroup - India Construction: Section 80 I (A) Boogey: Back to Haunt Construction

[Sunil]

• Cash contractors to pay full tax – According to the Budget, companies executing cash contracts cannot claim section 80I (A) benefits but BOT developers can. This would take effect retrospectively from April 2000.
• Confusion on cash contracts from BOT - There is still some confusion if companies can claim Section 80 I(A) benefits on cash contracts emanating from their own BOT projects. Quantum of BOT projects in the orders backlogs of Gammon, Nagarjuna and HCC are 17%, 8% and less than 5%, respectively.
• Write-offs and future PAT reduction — According to our discussions with companies, a likely one-time impact might be Gammon (Rs350mn), Nagarjuna (Rs260mn) and IVRCL (Rs579mn). Using a 33% marginal tax rate for simplistic calculations, FY07 -09E Recurring PAT would be negatively affected by 17-24% and PAT margins would likely compress 1-3%.
• Liquidity crunch could reduce profits more — Besides the negative effect of increasing tax rates, there is likelihood that lower PAT margins could exacerbate a liquidity squeeze forcing companies to raise more debt (that too at higher interest rates if banks demand higher interest rates on the likely deterioration of credit worthiness). This could cause an additional reduction of Recurring PAT by 3–5%.
• No effect on L&T and Punj — No effect on L&T as it pays full tax on all contracts and a neglible effect on Punj Lloyd as its effective tax rate is on the higher side.

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