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Cost pressures and adverse mix impact margins

KEC International’s 15% YoY revenue growth in Q1FY22 was led by 52% YoY rise in the non-T&D segment, while T&D declined 4% YoY due to 27% drop in the Mexican subsidiary SAE. Civil segment growth of 192% YoY and cable 110% supported overall growth. Order intake was strong at Rs44bn (+128% YoY) with current orderbook at Rs204bn (1.5x TTM sales).

Increase in commodity prices and higher mix of non-T&D led to 250bps YoY lower EBIDTA margins at 6.3%. Factoring-in the margin impact, we cut our earnings estimates by 13.1% and 8.5% for FY22E and FY23E respectively, and downgrade the stock to ADD. Our revised target price is Rs456 (previously: Rs499).

* Cable and civil offset weakness in T&D: Civil, railway and cable segments continued with their growth momentum offsetting the weakness in T&D segment, especially in SAE. Growth from both domestic and Latin American T&D markets was impacted by the second wave of covid. However, the non-T&D business grew 52% YoY and contributed 49% of revenues in Q1FY22 vs 36% in Q1FY21.

* Higher mix of non-T&D and high commodity prices hit margins: EBIDTA margin declined 250bps YoY to 6.3% due to higher mix of the relatively low-margin non-T&D contribution. Commodity prices have recently increased, hence overall margins are likely to be hit, especially under fixed-price contracts.

* Debt increased; focus on collections: Net debt increased to Rs25bn in Q1FY22 from Rs24bn in Q1FY21 and Rs17bn in Q4FY21. Current net working capital stands at 135 days and the company is focused towards collections.

* Downgrade to ADD due to margin stress: Civil, railway and cable segments are expected to remain in high-growth phase in the near to medium term. Hence, margins in the said segments are relatively lower than in core T&D. Additionally, commodity prices too are impacting the margins. Healthy growth prospects, strong balance sheet and high return on capital are likely to support valuations in the near term. Order intake has been strong with healthy L1 position. We downgrade the stock to ADD with a revised target price of Rs456 vs Rs499 earlier.

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