KEC International's focus on cash flows, working capital paying off

Operating profit margins have seen a sharp revival from 6% in FY15 to 9.5% in FY17

KEC International’s stock has had a strong run up on the bourses led by a rebound in profitability and better cash flows. This in turn is helping to reduce its debt and boost return ratios. Operating profit margins have witnessed a sharp revival at 9.5 per cent in FY17, compared with 6 per cent in FY15, with the change in management’s focus towards profitable projects.

A reduction in the working capital cycle has helped KEC lower its net debt to equity position to 1.1x from 2.3x over the same period. While these initiatives have helped the stock rise over 250 per cent during FY15-17, most of it has come in the past one year. The stock has more than doubled in the past one year and scaled its all-time high of Rs 303.65 on Thursday.

The RPG group company sees majority of its revenue coming from the transmission and distribution (T&D) segment, mainly engineering-procurement-construction (EPC) contracts, which contributes nearly two-third to the order book, including international and domestic orders.

The company witnessed an all-around strong order inflow of Rs 12,358 crore in FY17, while it worked on projects where working capital cycle was shorter and could lead to debt reduction.

It is not only the T&D segment, but also railways and international subsidiary, SAE Towers, contributing to order inflows (12-13 per cent each in FY17). The comparatively smaller cables and solar businesses contributed 8 per cent and 5 per cent, respectively.

With good order flows, analysts are working on a revenue growth of 15 per cent in FY18 and expect the profitability to be maintained at current levels. Analysts at JM Financial said sales growth would be led by the railways segment, which are expected to double at Rs 800 crore. The railways’ order book tripled in FY17 at Rs 1,500 crore and an execution pick-up by state transmission companies will help as delayed ordering will lead to a shorter execution cycle in this segment.

Analysts at IIFL also expect the emerging segments such as railways and solar to grow 80 per cent and 2x, respectively in FY18, led by a strong order book. 

The margins are also likely to remain robust (as in the T&D segment), according to analysts at Sharekhan, who expect SAE Towers to execute EPC projects on the T&D side in Brazil, besides the tower supply that they have been doing till now.

The addressable opportunity in Brazil, in terms of laying transmission lines, is about 30,000 km, equivalent to the annual ordering from Power Grid Corporation in India, they said. Clearly, KEC is on a robust growth path.

But, given the strong run up in stock prices, most of the analysts’ target prices have been achieved. Analysts such as Mehul Mehta at Sharekhan said they would be reviewing target prices after the June quarter results. 

While the earnings-led re-rating is already playing out, balance sheet improvement, a further increase in return ratios and cash flows can drive the next leg of re-rating, analysts said. Long-term investors could use corrections for a better entry point.