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Muted T&D execution impacts earnings

Weak execution under Latin American subsidiary SAE and slippage in some domestic projects due to farmer agitation impacted KEC International’s overall execution in Q3FY21. However, railways (up 44% YoY) and civil (up 206% YoY) supported the overall growth of 7% (YoY). Margins were subdued due to cost escalation in SAE and higher mix of low margin in non-T&D contribution. Around Rs60bn of L1 position and strong orderbook of Rs179bn (1.4x TTM sales) lend growth visibility. Increase in commodity prices may impact margins going forward and working capital is high due to delay in certain collections and inventory stocking given high raw material prices. Factoring muted recovery in near-term execution, we cut FY21E earnings by 12% and expecting recovery, we raise FY22E earnings by 4.5% and maintain BUY with a revised target price of Rs426 (previously: Rs435).

* Muted T&D execution impacts overall growth: Weakness in the Brazilian market, delay in some domestic projects due to farmer agitation impacted the overall growth. Given the high commodity prices, the company is expecting normalisation of the same before providing thrust towards ramp up of the execution. However, strong growth in railways and civil supported the overall revenue and this trend is likely to continue.

* Higher mix in non-T&D and high commodity prices impact margins: EBIDTA margin declined 130 bps YoY to 9.1% impacted by higher mix of relatively low margin non-T&D contribution. Commodity price has increased recently and hence, overall margins are likely to be impacted, especially the fixed price contracts. Management believes prices will normalise and hence, it is trying to time the overall execution to limit the damage to margins.

* Healthy order pipeline: Overseas order prospects are healthy and overall the company has bid ~Rs300bn worth of projects currently with ~Rs200bn future bids in pipeline.

* Maintain BUY on healthy growth prospects: Railways and civil segments are expected to be in high growth phase in near to medium term. Normalisation of margins, control on working capital and lower interest rates will support earnings growth. Factoring recovery in muted near-term execution, we cut FY21E earnings by 12% and expecting recovery, we raise FY22E earnings by 4.5% and maintain BUY with a revised target price of Rs426 (previously: Rs435).

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