All Powered Up | Value Research A strong order book & high sales growth will power KEC International, despite concerns over forex losses
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A strong order book & high sales growth will power KEC International, despite concerns over forex losses

Profile
KEC started off in 1945 as Kamani Engineering and in last six decades since, the company has burgeoned into one of the world’s largest Power Transmission companies.

KEC International (KEC) is engaged in the engineering procurement construction (EPC) business in power transmission, distribution, sub-station, railways and telecom.

It has exported towers to over 20 countries and has an increasingly strong presence in the Middle East, the Pacific Rim countries and Africa. The company has successfully executed projects ranging from voltages of 33 KV to 800 KV in India as well as abroad.

Recently KEC International has entered into a strategic alliance with POWER Engineers Inc, USA to form KEC Power India (KPIL). This jointly owned company undertakes designing of substations, both in the domestic and international arenas, including projects in the USA.

Promoters
KEC International is a part of the US$ 2.5 billion RPG Group. The promoter’s stake in the company is routed through various holding companies. Other major shareholder is mutual funds which have a significant exposure (30 per cent) in the company.

This company is under the stewardship of R. D. Chandak, an experianced hand in power infrastructure space.

Investment Rationale
Minimal Translation Losses
A major part (65 per cent) of KEC’s revenues comes from overseas where the order prices are usually fixed. This forces KEC to hedge its costs on aluminium for conductors and steel for power supply. Most of the orders booked for Q3FY09 were received in FY08, when the material costs of steel and aluminium were at their peak.

This led to high cost of hedging, which were margin depletive in nature. This eliminated the operating leverage for the company as material costs climbed 800 bps during the quarter and a further 1,100 bps for 9MFY09.

Furthermore, the company incu-rred forex losses of Rs 165 million on customer advances, leading to an overall margin decline of 630 bps to 8.2 per cent. But despite this, operating margins of 8.6 per cent and 9 per cent for FY09 and FY10E respectively can be assumed. Add to this the YTD outstanding customer advances of US$ 70 million and one can expect the company’s losses on translation to be minimal in the coming times.

Unexecuted Order Book One of KEC’s major positives is the unexecuted order book of Rs 50 billion. Based on the revenue estimate of FY09E, the bill/book ratio stands at 1.4x. Furthermore, the current quarter also marked the inflow of one of the company’s largest orders worth Rs 6.6 billion, awarded by Egyptian Transmission Company for a contract of a 500 KV line.

Optimistic Sales Growth On the back of the overall domestic tender pipeline exceeding Rs 94 billion till March 2009, KEC’s order wins are optimistic. The company is expected to garner Rs 16 to 18 billion from Maharashtra State Electricity Distribution and Power Grid. Although aggressive execution could lead to potential upsides in revenue, sales growth has still been factored in at 27.6 per cent and 24.6 per cent for FY09 and FY10E respectively.

Risk & Concerns
Mounting Interest Costs
KEC converted secured loans of close to Rs 3-4 billion from the dollar to rupee denominated loans, resulting in interest costs jumping by 67 per cent to Rs 297 million and by 43 per cent for 9MFY09 to Rs 710 million. This conversion was undertaken by the management to avoid MTM losses on debt in the balance sheet. But this led to the company’s PAT nose-diving by 52.3 per cent to Rs 250 million for the quarter and by 39 per cent for 9MFY09. In the coming times, PAT is expected to decline further by 29 per cent in FY09. However, PAT is expected to grow by 47 per cent in FY10E, pushing EPS upto Rs 36.4.

Valuation
Forex losses and high material cost hedges from legacy orders loom large over the company. This leads to conservative margin estimates of 8.6 per cent in FY09E and 9.0 per cent in FY10E. Hence, as mentioned earlier, profits are expected to decline in FY09. But the same are expected to grow in FY10E.

The stock at a price of Rs 161 quotes at P/Es of 6.5x FY09E and 4.4x FY10E. The stock is recommended as BUY with a price target of Rs 203, an upside of 26 per cent from the current levels.

The discount given to the average earnings multiple of the stock takes into account the risk of order cancellations followed by rising interest costs on working capital and translation losses on customer advances.




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