Margin recovery expected only in FY16E… • KEC :: ICICI Securities

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Margin recovery expected only in FY16E… • KEC reported a weaker quarter operationally with revenues at | 2053.3 crore vs. our estimate of | 2235 crore, owing to slower execution and currency headwind in Brazil affecting revenues • EBITDA margins at 5.1% disappointed as KEC booked losses in legacy orders • Order inflows for Q3FY15 stood at | 1422 crore while the implied order backlog for Q3FY15 stood at | 8681 crore, down ~15% YoY. KEC is currently L1 in | 4000 crore worth of orders, which is expected to be awarded in Q4FY15E • During the quarter, the company booked a profit of ~| 135 crore (pre-tax) on sale of its Thane land, which led to a higher-thanexpected bottomline despite execution and margins disappointment Diversity: Helps KEC tap opportunity, cushion uncertainty across cycles Sensing fierce competition in Power Grid (PGCIL) orders, KEC diversified into international markets like Middle East North Africa (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% in FY10-14 vs. domestic companies that faced a challenging economic environment. However, with PGCIL rationalising competition, KEC also started bidding for PGCIL order 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 6.5% over FY14-16E to | 8840 crore. Margin recovery expected in FY16E Entry level strategy in business segments coupled with cost overruns in some projects resulted in margins falling to a historical low of 4.1% in Q4FY13. Overall, FY13 recorded lowest ever margins of 5.5%. Post that, as per the management’s guidance, margins have been on the mend as Q4FY14 saw margins improving 290 bps to 7%. Hence, FY14, on the whole, witnessed margin gains of 70 bps to 6.2%. In Q2FY15 and Q3FY15, KEC reported EBITDA margins of 5.6% & 5.1%, respectively, on the back of booking of losses in legacy orders. Hence, we expect KEC to report margins of 6%, 8% in FY15E, FY16E, respectively, given the management is bidding for orders where margins are in the 8-9% range. Debt reduction/efficiency in working capital to strengthen balance sheet KEC’s gross debt has increased from | 2127 crore in Q4FY14 to | 2600 crore in Q2FY15, owing to an increase in working capital cycle from 92 days in FY14 to 111 days in Q2FY15. However, the recent sale of land enabled KEC to reduce its debt, which stood at | 2350 crore in Q3FY15. Furthermore, release of delayed payments by Power Grid will provide relief to the balance sheet and lower interest costs for KEC. Going ahead, we estimate D/E ratio to be at 1.7x in FY16E. Recovery gradual but valuations well ahead of fundamentals… KEC is currently trading at 11.6x 16E EPS, which largely prices in most of the margin recovery benefit expected next year. We would like to see more stability in margin recovery coupled with a reduction in leverage which is currently at 1.7x on FY16E, before turning positive on the stock. We continue to value the stock at 12x FY16E EPS and lower our target price to | 89/share (given the cut in FY16E earnings). We maintain our HOLD recommendation on the stock.

LINK
http://content.icicidirect.com/mailimages/IDirect_KECIntl_Q3FY15.pdf