EUR 120.00 For Business Accounts Only

MOSL: K E C Intl (Buy)- Back on growth track post a challenging last year

K E C Intl.: Back on growth track post a challenging last year; Diversification playing out well, financial leverage to kick in 

(KECI IN, Mkt Cap USD1.1b, CMP INR321, TP INR438, 37% Upside, Buy)

 

• Business diversification to pick up pace: KEC International (KEC) has been attaining successful business diversification, reducing its dependency on Power T&D segment in general and Power Grid capex in particular. Key highlights:
• While Power Grid has traditionally been the largest customer for the company, we estimate that it now forms only ~7% of the order book (v/s ~30% in FY16) with KEC actively capitalizing on other growth opportunities as well. Subsequently, we believe that Power Grid is now no more the largest customer for the company.
• SEBs have overtaken Power Grid, with the share of the former in domestic Power T&D now at ~46% versus 38% for the latter.
• SAARC region has emerged as the new growth engine with an order book CAGR of 29% over FY14-18, driving growth in the international business.
• Railways segment now forms 26% of order book, having grown 10x over the past three years.
• Civil segment can be similar story as Railways. We estimate Civil revenue CAGR of 31% over FY19-21 (v/s management's target of 100% CAGR).
• Scenario analysis suggests upside to our EPS estimate: While our base-case scenario builds in 31% revenue CAGR (FY19-21) in Civil business, our bull-case scenario (assuming management is able to attain its ambition of ~INR20b of revenue from Civil in FY21) suggests an 8% upside to our FY21 EPS estimate. This would also result in higher gross debt owing to increased working capital requirement; however, net D/E is likely to remain unchanged at 0.5x for FY21. Moreover, the contribution of Power T&D (incl. SAE) is likely to decline further to 60% in FY21 v/s our base-case assumption of 65%. Note that the share of Power T&D has been falling from the level of ~85% in FY16, reflecting business diversification is playing out.
• Room for financial leverage to play out: We note that G-Sec/CP rates are down 120bp/150bp from the peak levels around end-Sep'18. Interest rates have corrected in the international markets as well. Moreover, the company has reverted back to an optimal debt mix, as against an unfavorable mix last year. Thus, we believe that there is room for financial leverage to play out. Our sensitivity analysis of the impact of interest rates accounting for gross debt and interest bearing acceptances and advances from customers suggests that for every 50bp decrease in interest rates, earnings increase by 2.5% for KEC. We model flat interest expense over FY19-21, despite the expected strong 16% revenue CAGR over the same period.
• Maintaining Buy with higher TP: We raise our target multiple to 15x from 12x earlier, in line with its historical trading multiple of 15x, and raise our TP to INR438. We maintain our Buy rating on the stock on account of (a) the declining business concentration risk due to its foray into Railways, Civil, etc., (b) EPS CAGR of 24% over FY19-21 and (c) RoE profile of 20%+.