* Overseas order inflows driving growth:
After remaining lackluster in the last three years (with only 1.4% CAGR during FY2014-FY2016), KEC International’s order inflows have expanded by a significant 26% YoY to Rs8,634 crore in 9MFY2017. The strong growth in order inflow has been driven largely by the overseas contracts, with their contribution being 63% of total orders. In terms of business verticals, order inflows from the Railways stand at approximately 17% of order inflows in 9MFY2017 compared to only 4% in 9MFY2016.
* Focus on controlling receivables cycle leading to reduction in debt:
Due to a clear focus on controlling the receivables cycle, gross receivable days have fallen by 28 days to 218 days as of 9MFY2017 on a YoY basis, and the management is guiding for receivable days of 180 days by the end of FY2019. The substantial improvement in the receivable cycle has led to a reduction in borrowings by Rs570 crore to Rs3,265 crore during 9MFY2017.
* Diversified business mix reduces risk of dependence on any one segment:
Over the last couple of years, KEC has been able to diversify its revenue base, by gradually raising the contribution from the Railways and Cables segments to 14.5% in FY2016 from 9.7% in FY2014. Going forward, we estimate their contribution in the company’s total revenue to increase further, with these segments forming 26% of total order inflows during 9MFY2017 compared to 16% in 9MFY2016. The emerging vertical of Solar EPC projects accounted for 2% of total revenue during 9MFY2017 vs. 0.7% in 9MFY2016. However, with the government’s increasing focus on Renewable Energy, the Solar EPC vertical’s contribution to total revenue is estimated to multiply manifold. Therefore, going forward, KEC’s revenue base should get further diversified, reducing the risk of over dependence on the Power T&D segment for incremental growth.
*Softening competitive intensity to result in accelerated order inflows with higher profitability:
We believe that one of the major players in Power Transmission Tower EPC segment consistently reporting a worsening financial performance over the last few quarters should result in softening of the competitive intensity for KEC. Therefore, growth in order inflows and profitability should witness an upswing in the years ahead. We estimate the company’s earnings to compound at a CAGR of 33.5% during FY2016-FY2019E, driven by a revenue CAGR of 8.9%. Given that the Debt-to-Equity ratio will improve to 0.7:1 by the end of FY2019E from 1.5:1 in FY2016, we rate KEC as a ‘Buy’ with a price target of Rs230, valuing the stock at 14x average EPS of FY2018E and FY2019E.
* Key concerns:
KEC is exposed to commodity price risk due to the fixed price nature of its contracts in the overseas markets. However, the company enters into backto- back contracts to book raw materials for the projects as soon as they receive the order or secure L1 position. KEC is also exposed to currency risk since nearly 50% of its total revenue comes from the overseas projects. However, the company incurs expenses for these projects in foreign currency and hence the risk is primarily restricted to the profit in these projects.
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