KEC International- On growth trajectory
Edelweiss reports KEC surpasses the expectations; rerating to continue
By Neha Seth
KEC International Limited is a global infrastructure engineering, procurement and construction (EPC) major and India's second largest manufacturer of electric power transmission towers. Incorporated in 1945 as Kamani Engineering Corporation by the RPG Group, it designs and manufactures transmission towers and telecom infrastructure. It has presence in the verticals of power transmission and distribution, cables, railways, renewables and civil. Globally, the company has powered infrastructure development in 63 countries.
RPG Enterprises, established in 1979, is one of India's fastest growing business groups with turnover of over Rs 22,000 crore. The group has more than fifteen companies managing diverse business interests in the areas of infrastructure, tyre, IT and specialty.
Over the last two years, the company has moved from being a meager transmission line towers (TLT) EPC contractor to a sub-station player now, thus improving its addressable market opportunity. The company’s nearly 55 to 60 per cent revenue comes from the international market. The company's order backlog at the end of financial year 2017 was Rs 12,600 crore with 80 per cent contributed by transmission projects, including SAE Tower ON and substations and 20 per cent in new businesses such as railways, cables and water. The execution cycle for railways is reducing and for transmission and distribution (T&D) segment it is 18 to 24 months.
Tepid top-line; sales across business divisions
For the quarter ended in June, KEC clocked moderate 6 per cent year on year revenue growth. The management has maintained its revenue guidance of 15 per cent growth for 2018. The short-term disruptions due to GST implementation in domestic T&D, largely substations, need to be monitored closely.
Transmission and Distribution business: International T&D market grew by 13 per cent whereas the domestic business recorded Rs 100 crore sales loss due to GST implementation; the sub-station to contribute 20 to 25 per cent to T&D revenue.
Railways Division: The business jumped 129 per cent during the quarter and the company is targeting Rs 750 to 800 crore revenue in railways in fiscal 2018. The business now has Power Grid Corporation of India (PGCIL), IRCON International and RITES Ltd. as its customers.
SAE Business: The SAE business of the company fell 40 per cent YoY as two large projects were put on hold owing to environment clearance issues. SAE sales were deferred as supplies were held back due to environment clearance issues. As soon as the clearances are received, revenue will be booked.
Solar Business: In the first quarter, revenues from solar rooftop or offgrid are Rs 20 to 25 crore. The solar business is expected to witness strong revenue growth on the back of execution of recently won 130MW order.
During the April-June’17 quarter, margins ramped up 90 basis points (bps) to 9.5 per cent YoY and the management is maintaining its guidance for fiscal 2018 of 9 to 9.5 per cent. The margins are expected to remain stable as it continues to be KEC’s primary focus.
The margin expansion was witnessed primarily in the domestic T&D segment and SAE business, though the cables division did not perform well.
Bottom-line springs a positive surprise
The profit after tax (PAT) for first quarter of 2018 fiscal has exceeded estimated 20 per cent led by lower-than-expected interest expense on better working capital management and lower tax rate, and operating performance was in line with the estimates. The 12 per cent decline in interest cost and 8 per cent fall in tax rate (sustainable) drove 100 per cent year on year PAT growth.
Domestic business orders prospects
KEC has an EHV 400kV cables project; it is expected that revenue will flow from these cable projects in the second half of financial year 2018. The company is gaining good ordering traction in Orissa, Andhra Pradesh, Tamil Nadu, Karnataka, et al.
The EPC major has received a major cables order from PGCIL worth of Rs 100 crore of 200kV cabling near Chandigarh to be supplied from its plant in Baroda. Although the order from PGCIL has been tapering, rise in tariff-based competitive bidding (TBCB) projects is compensating the same. Most of the order inflows continued to be domestic with TBCB orders contributing substantially.
The company has bid for orders worth Rs 2,000 crore in railways, however management has alluded that owing to impact of GST there could be some issues.
Expectations of orders pick up in international business
The Mumbai-based company wants to focus and build a base in its international business. It expects the business to pick up further with large order inflow from Jordan, Saudi, Indonesia, Thailand, et al.
Primarily, in the T&D segment KEC is L1, comprising 95 per cent of total Rs 4,500 crore where a large portion is from international projects in Afghanistan, Bangladesh, Brazil and Africa, whereas Railways segment is around Rs 450 crore. Currently, the company is L1 in a large EPC tender in Brazil and the management expects the business in Brazil to ramp up from fiscal 2019.
During the quarter, order intake at Rs 2,700 crore L1 positions at Rs 4500 crore largely in international T&D, lending comfort to 10 per cent 2018 order intake growth estimate.
Debt and interest rates
As on June 30 2017, debt is at Rs 2,200 crore, increased by Rs 300 crore from March 31, 2017. For the quarter, interest rate fell to 3.5 per cent and is expected to slump further with improving ratings and thus leading to an average cost of debt of 7.0 per cent as against 7.5 per cent from previous sequential year.
Improvement in working capital cycle
The number of days taken by debtor to make payments has decreased by six days and eliminating the impact of inventory buildup due to GST, the working capital cycle has improved.
The earnings multiple will continue to rerate riding the improved opportunities in T&D and railway businesses; and unwavering focus on profitability, sufficiently reflected in strong performance of the last three to four quarters.
Over 2017-19, a robust 20 per cent plus earnings CAGR is estimated. The upcoming earning per share for fiscal 2019 is revised to 3 per cent each factoring in dip in interest cost and tax rate. Over the next two years, strong 20 per cent EPS growth is expected with stable margins of 9.5 per cent.
With strong impetus on T&D spent by select states and PGCIL, the bid pipeline for KEC remains healthy at Rs 12,000 crore over the next two to three quarters.
Moving up the scale, the company is targeting higher ticket projects in the railways EPC, solar and civil infra space, which could help company achieve higher growth rate. The key drivers for fiscal 2018 order intake growth of 10 per cent will be international T&D, sub-stations and civil infrastructure.
In second quarter, state boards are holding back dispatch clearances, there may be a marginal shift in revenue from the second quarter to the third quarter given confusion on GST persists. However, no significant effect on annual numbers is expected.
The key risk to the company is major slowdown in T&D spending in significant markets such as India, Middle East and African markets. Moreover, as KEC has 40 to 45 per cent of fixed price contracts, forex exchange variation risk and commodity risk also adds to its shares of challenges. Any delay in execution of current order book poses a risk to revenue and OPM assumptions. As per management, while the revenue concentration risk has ebbed in Saudi Arabia, however, recovery of Rs 1,000 crore from the projects executed remains the biggest risk. As of now, customers are paying on time.
GST rollout was smooth, but the loss of sales due to it was Rs 100 crore as KEC had to stop dispatches given the company was not able to bill prior to GST.