The outlook for the power transmission line EPC (engineering, procurement and construction) sector is more sanguine than other segments in the infrastructure space, as business visibility is relatively good and margin pressure is less severe.
KEC International is among the best bets in the space, not only because it is the largest player but more due to a well-diversified order book — both in terms of geography and business mix. In fact, after the bagging of orders worth Rs 1,253 crore last week, KEC’s order-book position of Rs 9,000 crore has reached the highest level in its history.
Analysts expect the company to report a sales growth in high double digits and maintain its operating profit margin in 2011-12 and 2012-13, despite competition and high input scenario. Besides strong fundamentals, valuation of four times 2012-13 estimated earnings is at the trough.
Strong visibility
Besides geographical diversification of the order book (60 per cent international and the rest domestic), venturing into new areas like power systems, water, cable and telecom, which contribute 35 per cent of the total order book, has also helped achieve a milestone. According to KEC Managing Director Ramesh Chandak, the strategy of becoming an overall infrastructure player, instead of a purely transmission company, has helped.
| IMPROVING PROSPECTS | |||
| In Rs crore | FY11 | FY12E | FY13E |
| Net sales | 4,477 | 5,513 | 6,574 |
| % chg y-o-y | 14.6 | 23.1 | 19.2 |
| Operating profit | 474 | 490 | 627 |
| % chg y-o-y | 16.5 | 3.3 | 28.0 |
| Net profit | 197 | 190 | 261 |
| % chg y-o-y | 3.7 | -3.7 | 37.8 |
| EPS (Rs) | 7.7 | 7.4 | 10.2 |
| % chg y-o-y | 3.7 | -3.7 | 37.8 |
| PE (x) | 5.4 | 5.6 | 4.1 |
| E: Estimates Consolidated financials Source: Company, Analysts reports | |||
“KEC’s globally diversified model has enabled it to gain an edge over its domestic peers in the transmission and distribution space. While domestic players have struggled to secure orders amid slowdown, KEC has consistently maintained its average quarterly rate of Rs 1,200 crore over the past several quarters. In addition, new businesses of water, railway and telecom are faring well (the pace of new orders is gradually increasing),” points out Angel Broking Analyst Shailesh Kanani.
The company expects to grow its order book at 15 per cent in 2011-12 as the pipeline remains strong. It has a large number of tenders pending from PowerGrid, followed by private utilities and also in some overseas markets (Abu Dhabi, Saudi Arabia, South Africa, Nigeria, Central Asia, Brazil and Canada), and margins to be maintained around 9-10 per cent.
Rahul Garg, analyst, HSBC Securities and Capital Markets, says: “The Rs 9,000-crore order book is likely to drive annual sales growth of 20-25 per cent in FY12-13, as a majority of these orders are scheduled for delivery over the next 18-24 months.” He expects margins to surprise positively in 2012-13, as new ventures improve and mark-to-market losses reverse.
Risks, valuations
However, in the medium term, the mark-to-market losses on account of rupee depreciation remain a key risk. The company incurred a forex loss (notional) of Rs 17 crore in the September quarter, which, along with a jump in interest cost (85 per cent), led to a net profit margin drop of more than 200 basis points.
The other risk emanates from the progress of generation projects. If the pace of execution remains slow, it could impact KEC’s longer-term prospects, as transmission projects typically start 12-15 months after the commencement of construction of a generation project. High working capital intensity of business (consolidated debt-equity ratio of 1.5 times), increasing competitive pressures and project execution risk in the West Asian and North African region are other concerns.
While these concerns had seen the stock touch Rs 31.8 (52-week low) on December 20, it has recovered 29 per cent since then to the present Rs 42. Analysts believe there is some steam left, given the target multiple of 6-7 times one-year forward earnings. Kanani says: “Given the latent potential of the company and healthy return ratios (25 per cent), valuations well below its average historic multiple are compelling.” Garg, too, reiterates his overweight rating and has a target price of Rs 80.
