Waiting for margins to stabilise… • KEC :: ICICI Securities, PDF link

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Waiting for margins to stabilise…
• KEC reported strong execution as revenues came in ahead of
expectations at | 2173 crore vs. our estimate of | 1890 crore. The
power transmission segment grew 22% YoY in terms of revenues
• EBITDA margins at 5.6% disappointed as KEC booked losses in the
range of | 20 crore in legacy orders
• Order inflows for Q2FY15 stood at | 1100 crore while the order
backlog for Q2FY15 stood at | 9322 crore, down ~9% YoY. KEC is
currently L1 in | 2000 crore worth of orders, which is expected to be
awarded in FY15E
• Lower-than-expected margins led to PAT disappointment coming in
at | 20 crore vs. our estimate of | 27 crore
Diversity: Helps KEC tap opportunity/cushion uncertainties across cycles
Sensing fierce competition in Power Grid (PGCIL) orders, KEC diversified
into international markets like MENA, Americas and CIS countries in
FY11-12. As a result, as of FY14, international revenues share stood at
59% whereas international order backlog share stood at 56%. Therefore,
timely diversification helped KEC clock revenue CAGR of 20% over
FY10-14 as against domestic companies, which faced a challenging
economic environment. However, with PGCIL rationalising competition,
KEC started bidding for PGCIL order as well and the share rose from low
of 12% in FY11 and 6% in FY12 to 31% in FY13 and 20% in FY14. Going
ahead, we expect reasonable backlog of | 9322 crore to ensure revenue
CAGR of 5% over FY14-16E to | 8657 crore.
Margin recovery encouraging; more gains still in offing, going ahead
Entry level strategy in business segments coupled with cost overruns in
some projects resulted in margins falling to historical low of 4.1% in
Q4FY13. Overall FY13 recorded lowest ever margins of 5.5%. Post that
as per management’s guidance, margins have been on the mend as
Q4FY14 saw margins improving 290 bps to 7%. So FY14, on the whole,
witnessed margin gains of 70 bps to 6.2%. Going ahead, the
management commentary suggests further margin gains in FY15E. In
Q2FY15, KEC reported EBITDA margins of 5.6% on the back of booking
| 20 crore of losses in new business segments. Though margin recovery
is consistent, the magnitude of recovery disappointed against our
anticipation of 6.7%. Hence, we expect KEC to report margins of 6.9%
and 8% in FY15E and FY16E, respectively, given the management is
bidding for orders where margins are in the range of 8-9%.
Debt reduction/efficiency in working capital to strengthen balance sheet
Gross debt has increased from | 2127 crore in Q4FY14 to | 2300 crore as
of Q1FY15 and | 2600 crore in Q2FY15, owing to an increase in working
capital cycle from 92 days in FY14 and over 100 days in Q1FY15 and 111
days in Q2FY15. The recent sale of land can help KEC reduce debt by |
212 crore coupled with the release of delayed payments by Power Grid
will provide relief to balance sheet and lower interest costs for KEC.
Going ahead, we expect D/E ratio to be 1.6x by FY16E from 1.7x in FY14.
Recovery gradual but valuations well ahead of fundamentals
KEC is currently trading at 12x FY16E EPS, which we believe is ahead of
its fundamentals. We would like to see more stability in margin recovery
coupled with reduction in leverage, which is currently at 1.6x on FY16E,
before turning positive on the stock. We value the stock at 12x FY16E
EPS and maintain our target of | 99/share albeit improving economic
variables as stock price is ahead of its fundamentals at this point in time

LINK
http://content.icicidirect.com/mailimages/IDirect_KEC_Q2FY15.pdf