Management Speak: KEC International (Outperformer) - Growth trajectory on track

We met management of KEC International. Below are the key takeaways:

Non-T&D segments to drive growth: Management expects share of non Transmission & Distribution (T&D) revenues to touch 40% in a few years (~25% currently), led by growth in railways and civil. Railway revenues are expected to double in FY19E on strong order book (Rs41.5bn, ~5x FY18 railway revenues). Order intake momentum is likely to continue led by intake from electrification projects, orders related to Dedicated Freight Corridors (DFC), pick up in signalling upgradation projects (presently <15% of backlog) and focus on international markets. Civil is performing well in the industrial segment and management expects residential projects to pick up gradually, as KEC builds capabilities.

T&D intake to be led by substation, international orders: Slowdown in PGCIL orders is being offset by State Electricity Boards (SEBs) and private players. Rising spend on intrastate T&D coupled with higher share of renewables is driving rise in substations orders, which are expected to touch 50% in the medium term (~20% of backlog currently). International intake is likely to be driven by Brazil (US$4-5bn worth tenders to come up annually) in addition to opportunities in the Middle East and SAARC, given the high infrastructure deficiency in these regions.

Margins to stay steady at ~10%: While rise in commodity prices would impact raw material (RM) costs, impact would be minimal given the low share of fixed priced orders (<20% of order book). In addition, INR depreciation would have a positive impact on margins (~50% revenues from international). Management expects margins in railways, which are currently lower due to higher overheads (project level margins similar), to converge with T&D margins once execution picks up, led by positive operating leverage. Lower margins in Civil are offset by a tighter working capital cycle (lower interest costs). In few SEBs, longer payment cycles are factored in the bids, resulting in higher margins offsetting higher interest costs. Accordingly, management remains confident of sustaining interest cost at 2.5% of revenues despite higher interest rates. 

Valuation and view

KEC is seeing strong traction in its operational performance, led by focus on execution and controlled interest costs through a hold on working capital. Moreover, strong order wins from transmission and segments such as railways and civil would provide revenue visibility. As a result, we estimate 15% earnings CAGR over FY18-20E with stable margins. At 16x FY20E earnings, the stock looks attractive, given our view of sustained earnings momentum and superior return ratios. We reiterate our Outperformer rating on the stock with a target price of Rs450.