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KPP: Earnings growth at
inflection point
We expect strong growth in FY12-13 earnings but remain cautious
compared to management guidance
Margins are likely to remain stable; cash flow expected to improve
somewhat in FY12 and more significantly in FY13
We lower our FY12-13 EPS estimates by c6-7% and cut TP to
INR165 from INR185; at 5.4x FY13e PE, the stock is attractive even
on our conservative estimates; hence we reiterate OW
Investment thesis
With a c30% increase in the group’s order intake
last year, we believe KPP is in a strong position to
deliver strong sales growth this year. We expect
revenue growth to be particularly strong at the
JMC Projects, which recorded c110% order
intake growth in FY10 and has seen its order book
swell to c3.4x FY11 sales. Management is
currently guiding for growth of c15-20% at KPTL
and c35-40% at JMC, implying growth of c20-
25% at the group level. We have taken a slightly
conservative view compared to this guidance and
forecast growth of c18% in group revenues
(c14.6% at KPTL and c35.1% at JMC). If
management is able to ramp up execution, the
firm may beat our expectations.
We expect margins to remain under pressure and
assume a c30bp decline in the group EBITDA
margin to c10.8% in FY12 compared to c11.1% in
FY11. Furthermore, we believe capex is likely to
come down as the company is past its investment
phase and hence depreciation should also start
inching lower. Consequently, we expect revenue
growth to be reflected more strongly in earnings
growth from this year onwards, with EPS forecast
to grow c20% in FY12 and c22% in FY13.
In addition, we expect cash flows to witness
significant improvement over the coming years as
most of the company’s assets – i.e. Thane real
estate, Shubham Logistics, transmission BOT
(build-operate-transfer) project and JMC Projects
– become cash generative. This, in our opinion,
should drive a re-rating in the stock.
We have taken a conservative view on execution,
thus lowering our FY12-13 EPS by c6-7%.
Consequently, we lower our target price to
INR165 from INR185 earlier, which implies that
12 months from the now the stock should be
trading at a 12m forward PE of c7.1x on a 24
month estimated EPS of INR22.9.
The stock remains attractive, trading at c6.6x
FY12e PE and c5.4x FY13e PE compared to
historical trading average 12-month forward PE of
c14.3x for the last 5 years. We note that during
the 2008-09 crisis the stock had de-rated to an
average trough multiple of 6.8x versus the current
12-month forward multiple of 6.4x, implying the
market is factoring in higher earnings risk this
time. Given that the rest of the sector has not derated
to valuation levels seen during 2008-09, we
believe this discount is unwarranted and the stock
is attractively priced. Consequently, we reiterate
our OW rating.
The key bull and bear factors related to KPP are
as follows.
Bull factors
Biggest transmission EPC player with a
strong order book at both KPTL (c2x FY11
sales) and JMC (c3.4x FY11 sales)
Strong balance sheet with lower gearing than
KEC and better working capital management
than Jyoti Structures
Cash generation likely to improve significantly
as capex normalizes and company’s assets
become cash generative from FY12-13
Key beneficiary of the anticipated growth in
domestic transmission orders in FY13 as KPP
remains a top three vendor on the power grid
Valuation remains attractive
Bear factors
Margins remain under pressure due to
competition and cost inflation
Muted earnings growth in last five years in
spite of strong sales growth
Margins at JMC still burdened by high
interest cost and depreciation
Valuation
Our target price of INR165 is derived from our
preferred EVA valuation methodology. Within
this, we ascribe a value of around INR124 to
KPTL and a value of around INR140 to JMC
Projects. At this stage, we are not giving any
value to any other assets as they are not yet cash
generative. For KPTL (standalone business), we
assume target sales growth of c8%, through-cycle
operating return margin of c10.5% and WACC of
c14.7%. For JMC, we assume a target sales
growth of c8%, through cycle operating return
margin of c6.5% and WACC of c15.0%. Our
target price implies that 12 months from now the
stock should be trading at a 12-month forward PE
of c7.1x on 24-month forward EPS of INR22.9.
Under HSBC’s research model, for stocks without
a volatility indicator, the Neutral rating band is
5ppt above and below the hurdle rate for India
stocks of 11%. This translates into a Neutral
rating band of 6% to 16% around the current share
price. Our 12-month target price of INR165
suggests a potential return of c58% (ex-dividend),
which is above the Neutral rating band; hence, we
reiterate Overweight on the stock.
Risks
The key risks related to our investment include:
Delay/cancellation of transmission projects
Excessive pricing pressure
Expensive acquisition
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