Jul-14 Aug-14 Sep-14 Oct-14 Nov-14 Dec-14 Jan-15 Feb-15 Mar-15 Apr-15 May-15 Jun-15 Jul-15 Hindustan Exide Industries Unilever KEC International Recovering from a weak phase KEC International s stock price has gained 58% over the last 6 months and has outperformed the BSE Capital Goods index by 42%. Despite thus run up, we continue to be positive on KEC as its fundamentals are improving. KEC has been reporting contraction in margins on account of the orders in its new businesses, which were bid with the entry level pricing strategy. However, going forward, with stable margins expected from the transmission tower business coupled with improvement in margins from new businesses, the overall margins profile of the company will start to look up. Thus, we maintain our BUY recommendation on the stock with a revised Target Price of Rs174, valued at 14x (a 10% discount to its mean P/E multiple of 15x) on the back of improved visibility on order inflows, executions and margin improvements due to robust order book. Order inflow traction remains intact KEC derives >75% of its standalone revenues from transmission projects and the rest from small presence in pipeline infrastructure and biomass energy segments. In domestic markets, KEC has been a key beneficiary of healthy order flows from PGCIL. The order book currently stands at Rs120bn. KEC International has order book at 1.25x FY15 revenue, which is in line with our expectations. Further, the Company is expected to report robust order inflows in FY16-17E (the last year of 12th plan), on the back of increased capex driven domestic orders from PGCIL and other state utilities. Margin improvements ahead; Legacy orders nearing completion The company has legacy orders, which it expects to be completed by 2QFY16E. The new recent orders and the unexecuted orders in the order book after the completion of legacy orders will have better margins going forward. The company has short closed some of these legacy orders in agreement with clients, especially in water segment. In FY15, KEC did not receive any order in water segment, as the company was very selective in bidding. Recently, it has bagged 2 orders worth Rs2.5bn in Railways and in addition the company has L1 in railway orders worth Rs7.0bn. BUY CMP* (Rs) 145 Target Price (Rs) 174 Upside/ (Downside) (%) 20 Bloomberg Ticker KEC:IN Market Cap. (Rs mn) 37,329 Free Float (%) 50 Shares O/S (mn) 257 Shareholding Pattern (%) Dec 14 Mar 15 Promoter 50.0 50.1 FII 5.9 4.6 DII 28.0 26.2 Others 16.1 19.0 (Rs mn) FY15 FY16E FY17E Sales 84,678 96,675 112,344 EBITDA 5,117 7,264 8,751 Net Profit 1,609 2,320 3,181 EPS (Rs) 6.3 9.0 12.4 DPS (Rs) 0.8 1.1 1.5 FY15 FY16E FY17E P/E (x) 23.0 16.1 11.7 P/B (x) 2.7 2.3 2.0 EV/EBITDA 9.5 6.7 5.6 ROE (%) 7.4 16.2 18.9 Divi. Yield (%) 0.5 0.7 1.0 1 Year Stock Price Performance 160 140 Ex-Power business vertical to supplement growth 120 KEC has ventured into power systems, cables, railways, and water businesses signaling a large potential for the company in these verticals. It acquired US-based SAE Towers Holdings, a leading manufacturer of steel lattice 100 80 60 transmission towers in Americas in Sep 10. This helped KEC foray into large markets of North and South America, Canada, Mexico, Brazil, and other Note:* CMP as on neighboring countries. Recently, the company has bagged new orders, which are at competitive margin and do not have losses like earlier, when the company took orders at low margins or at break even margins as entry strategy but it eventually ran into losses due to cost overruns. Research Analyst: Rupesh Sankhe Contact: (022) 3320 1606 Email: rupesh.sankhe@relianceada.com P a g e 1
Order inflow traction remains intact KEC derives >75% of its standalone revenues from transmission projects and the rest from small presence in pipeline infrastructure and biomass energy segments. In domestic markets, KEC has been a key beneficiary of healthy order flows from PGCIL. The order book currently stands at Rs120bn, out of which 51% of revenue comes from domestic market and the remaining 49% of revenue comes from international market. KEC International has order book at 1.25x FY15 revenue, which is in line with our expectations. Further, the Company is expected to report robust order inflows in FY16-17E (the last year of 12th plan), on the back of increased capex driven domestic orders from PGCIL and other state utilities. The company has seen improved traction in T&D business, both from domestic and international markets. In domestic market, apart from PGCIL, the company is viewing lot of tenders from SEBs like Tamil Nadu, Karnataka, West Bengal, and Rajasthan. In international markets like Oman, Abu Dhabi, Africa and SAARC countries, KEC is eyeing on increasing bids for upcoming tenders. Highlight of recent orders bagged July 10, 2015 Transmission & Distribution Businesses The Company has secured orders in India, Kenya and the Americas amounting to Rs5.10bn. Domestic: Secured two orders of Rs1.26bn from PGCIL for supply and construction of Transmission Lines in Northern India. International: Secured an order of Rs3.03bn for the construction of HVDC transmission Line in Kenya. In addition secured orders of Rs 0.81bn for supply of lattice towers, monopoles & hardware in the Americas. Cables Business KEC has secured orders of Rs1.12bn for the supply of Power and Telecom Cables. June 6, 2015 Transmission & Distribution Businesses KEC secured orders in India, Africa, the Middle East and the Americas amounting to Rs6.13bn. India: Secured orders worth Rs4.58bn, details of the same are as follows: Four orders of Rs3.72bn from PGCIL for construction of Transmission Lines in the Northern, Southern, Eastern (Indo- Bangladesh) and Central Regions. Turnkey order of Rs0.86bn for construction of transmission lines and Substation in Southern India from Karnataka Power Transmission Corporation Limited. International: Secured orders of Rs1.55bn, details of the same are as follows: Secured orders of Rs1.15bn for underground cabling works in Saudi Arabia. P a g e 2
In addition, secured small orders totaling Rs0.40bn in Africa, the Middle East and the Americas. Railways Business KEC secured a composite order of Rs2.88bn for electrification, civil works, track laying, signaling and telecommunication works in Madhya Pradesh from Rail Vikas Nigam Limited. Cables Business KEC secured orders of Rs1.01bn for the supply of Power and Telecom Cables. Exhibit 1: Outstanding Order book (Rs95bn as on March 2015) Exhibit 2: Order book by Geography SAE, 10% SAARC, 9% East Asia Pacific, 2% Americas, 10% Cables, 6% T & D (Excl. SAE), 75% Railways, 5% Africa & Central Asia, 11% India, 51% Water, 4% MENA, 17% Source: Company, RSec Research Source: Company, RSec Research Margin improvements ahead; Legacy orders nearing completion KEC has diversified into other verticals like Water Management, Cables and Railways. The company's profitability has been significantly impacted over the last few years as it went aggressive on bidding projects at low margins to acquire the necessary pre-qualifications. KEC has executed large quantum of loss making orders in the new business verticals. The new businesses of Railways and Water are in their nascent stage leading to higher developmental costs, in turn leading to negative margins. In Power Systems, profits were also impacted due to poor margins in the sector. All these factors affected the company s margins. EBITDA margins for KEC fell from 11% in FY09 to a low of 6.0% in FY15. The company has legacy orders, which it expects to be completed by 2QFY16E. The new recent orders and the unexecuted orders in the order book after the completion of legacy orders will have better margins going forward. The company has short closed some of these legacy orders in agreement with clients, especially in water segment. In FY15, KEC did not receive any order in water segment, as the company was very selective in bidding. Recently, it has bagged 2 orders worth Rs2.5bn in Railways and in addition the company has L1 in railway orders worth Rs7.0bn. SAE Tower, international subsidiary of KEC in Mexico, has reported losses largely on account of lack of orders (Mexico market is currently impacted by delay in approvals), however, the company has strong order book in Brazil. Overall, we expect steady improvement in margins, driven by reducing backlog of low margin legacy orders, improved margin profile in new orders and breakeven in tower and cable business. P a g e 3
Exhibit 3: EBITDA Margin trend (%) 14 12 10 8 6 4 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16E FY17E Source: Company, RSec Research Ex-Power business vertical to supplement growth KEC has ventured into power systems, cables, railways, and water businesses signaling a large potential for the company in these verticals. It acquired USbased SAE Towers Holdings, a leading manufacturer of steel lattice transmission towers in Americas in Sep 10. This helped KEC foray into large markets of North and South America, Canada, Mexico, Brazil, and other neighboring countries. KEC forayed into the international railway market by securing a railway electrification order from Malaysia worth Rs300mn. It diversified into the water business in FY11 by winning its first order of Rs310mn for construction of a canal in Madhya Pradesh. The company is expected to complete the telecom tower business sale to ATC by 2QFY16E at consideration of around Rs0.81bn. Recently, the company has bagged new orders, which are at competitive margin and do not have losses like earlier, when the company took orders at low margins or at break even margins as entry strategy but it eventually ran into losses due to cost overruns. Outlook and Valuation We maintain our earnings estimates for FY16E & FY17E. We expect strong order backlog of Rs120bn coupled with improving margins to drive 41% CAGR in KEC s earnings over FY15-17E. It may be noted that in the last 10 years, KEC has traded in the range of 6x-30x its 1-year rolling forward PE multiple. Thus, we maintain our BUY recommendation on the stock with a revised Target Price of Rs174, valued at 14x (a 10% discount to its mean P/E multiple of 15x) on the back of improved visibility on order inflows, executions and margin improvements due to robust order book. P a g e 4
Key Risks Slow pick-up in international markets Rising competitive intensity in each of its businesses Continued weakness on margin front, especially in T&D segment Major slowdown in T&D spending in key markets like India, Middle east & Europe Forex exchange variation risk, as KEC has strong presence overseas P a g e 5
Profit and Loss Statement Y/E March (Rs mn) FY13 FY14 FY15 FY16E FY17E Revenues 69,795 79,018 84,678 96,675 112,344 Growth (%) 20.0 13.2 7.2 14.2 16.2 EBITDA 3,814 4,932 5,117 7,264 8,751 Growth (%) (19.1) 29.3 3.8 42.0 20.5 EBIT 3,253 4,227 4,236 6,515 7,898 Growth (%) (23.2) 29.9 0.2 53.8 21.2 Interest 1,944 2,633 3,089 3,011 3,059 Other income 160 138 116 122 131 EBT 1,469 1,732 1,264 3,625 4,970 Income taxes 818 883 1,001 1,305 1,789 Effective tax rate (%) 55.7 51.0 79.2 36.0 36.0 Extra-ordinary items (1) (181) 1,347 - - Reported net income 650 668 1,609 2,320 3,181 Adjustments (1) (181) 1,347 - - Adjusted net income 651 849 263 2,320 3,181 Growth (%) (69.0) 30.3 (69.0) 783.1 37.1 Shares outstanding (mn) 257.0 257.0 257.0 257.0 257.0 EPS (Rs) 2.5 2.6 6.3 9.0 12.4 Balance Sheet Y/E March (Rs mn) FY13 FY14 FY15 FY16E FY17E Cash and cash eq 1,556 1,440 2,063 2,314 2,231 Accounts receivable 28,870 38,078 38,529 38,405 44,630 Inventories 3,960 5,052 4,764 5,610 6,187 Others current assets 14,454 15,626 19,162 20,992 21,367 Gross fixed assets 11,749 13,627 13,394 13,633 15,100 Net fixed assets 8,230 9,403 8,211 7,700 8,314 CWIP 301 519 600 700 800 Intangible assets 5,007 3,778 3,943 3,943 3,943 Deferred tax assets, net (621) (514) (527) (527) (527) Total assets 61,757 73,382 76,745 79,137 86,945 Accounts payable 23,696 32,131 33,248 33,888 35,619 Other current liabilities 11,045 9,890 8,429 11,601 13,257 Provisions 885 1,251 1,219 1,351 1,301 Debt funds 14,660 18,195 20,551 16,918 18,537 Equity capital 514 514 514 514 514 Reserves & surplus 10,958 11,401 12,784 14,865 17,718 Shareholder's funds 11,472 11,915 13,298 15,379 18,232 Total liabilities 61,757 73,382 76,745 79,137 86,945 P a g e 6
Cash Flow Statement Y/E March (Rs mn) FY13 FY14 FY15 FY16E FY17E Net income + Depreciation 1,211 1,373 2,490 3,070 4,034 Other adjustments (596) (802) (1,150) (409) - Changes in working capital (3,317) (3,795) (4,484) 1,801 (3,841) Cash flow from operations (2,702) (3,224) (3,143) 4,462 193 Capital expenditure (1,110) (161) 229 (339) (1,567) Change in investments - (181) 1,347 - - Cash flow from investing (1,110) (342) 1,576 (339) (1,567) Issue of equity 0 0 0 0 0 Issue/repay debt 3,422 3,535 2,357 (3,633) 1,619 Dividends paid (84) (86) (166) (239) (328) Change in cash & cash eq (473) (116) 623 251 (83) Opening cash 2,029 1,556 1,440 2,063 2,314 Closing cash & cash eq 1,556 1,440 2,063 2,314 2,231 Key Ratio Y/E March FY13 FY14 FY15 FY16E FY17E EBITDA margin (%) 5.5 6.2 6.0 7.5 7.8 EBIT margin (%) 4.7 5.3 5.0 6.7 7.0 Net profit margin (%) 0.9 1.1 1.9 2.4 2.8 ROE (%) 5.8 7.3 7.4 16.2 18.9 ROCE (%) 10.7 12.4 10.5 16.1 18.1 Debt/equity (x) 1.3 1.5 1.5 1.1 1.0 EV/Sales (x) 0.7 0.6 0.6 0.5 0.4 EV/EBITDA (x) 12.8 9.9 9.5 6.7 5.6 P/E (x) 57.2 43.9 23.0 11.0 8.0 P/BV (x) 3.1 3.0 2.7 2.3 2.0 P a g e 7
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