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Weak quarter; unwinding of high NWC critical

KEC International’s (KEC) Q1FY23 PAT at Rs310m was below estimate of Rs421m due to weak margins. EBITDA margins declined 120bps YoY to 5.1% (estimate: 6.4%) due to continued losses at SAE (EBITDA/PAT loss of Rs700m/Rs1bn) and higher input costs. KEC expects losses at SAE to cease upon completion of the balance one legacy projects in Oct-22 (four completed in Q1). NWC deteriorated to 148 days (137 days in Q4) while net debt (including acceptances) rose sharply to Rs61bn (Rs48bn in Q4) due to backended payment terms in Railways and T&D businesses. KEC expects the debt to reduce and working capital to improve in H2 and has guided for NWC of 130-135 days by Mar23. With softening of commodity prices and completion of loss making projects in SAE, KEC has guided for +10% margins in FY24. Maintain BUY with PT of Rs500.

Margins impacted due to steep losses in SAE business and higher input costs

Revenue grew by 31% YoY to Rs33.2bn (estimate: Rs29.6bn). T&D revenue grew by 18% YoY to Rs19.4bn. Non-T&D revenue grew by 46% YoY to Rs16.7bn led by Civil (up 2x YoY to Rs6bn) and Railway (up 19% YoY to Rs7.1bn). EBITDA grew by 5.3% YoY to Rs1.7bn (estimate: Rs1.9bn). Margins declined 120 bps YoY to 5.1% due to losses in SAE business and higher input costs. SAE reported EBITDA/PAT loss of Rs700m/Rs1bn in Q1. Interest costs grew sharply by 54% YoY to Rs1bn due to rise in debt and acceptancesNon-

SAE business shows QoQ improvement led by softening of commodity prices

While commodity prices have generally hurt margins, recent softening from peak levels of March offered some respite. KEC’s standalone (non-SAE business) showed QoQ improvement. Standalone revenue/ EBITDA grew 21.9%/3.7% YoY to Rs28.5bn/Rs2.3bn. Standalone EBITDA margin improved 90bps QoQ to 8.2% (down 140bps YoY) in Q1FY23.

Guides for 10%+ margins in FY24 and expects NWC/debt levels to improve in H2FY23

KEC expects margins to remain impacted in Q2FY23 but improve in H2FY23 led by softening in commodity prices. KEC expects strong growth in Civil business with double digit margins in FY23E. Growth in Railways would be moderate with margins remaining stable at ~10%. Oil & Gas vertical is likely to see strong growth on low base. Overall, KEC expects margins to improve to 10%+ levels in FY24. While order inflows in YTDFY23 have been moderate at Rs35bn, L1 position at Rs80bn+ remains strong. KEC has maintained order intake guidance of Rs200bn for FY23 (up 16% YoY) aided by strong bid pipeline of Rs1.1tn. Order backlog stood at Rs237bn (1.6x TTM revenues) as on June-22.

Expect relief on margins and NWC in H2FY23; maintain Buy

We expect completion of legacy EPC contracts in SAE to provide material relief on margins in H2FY23. Also, KEC remains confident of a significant unwinding of NWC in H2. Given that NWC levels for EPC companies in general remain benign, we hold on to this guidance at present. We have lowered EBITDA margins in FY23 by 60bps to 7.2% leading to 15% cut in earnings. For FY24E, we factor EBITDA margin recovery of 9.5% in line with historical levels. KEC is among the few credible names in diversified E&C space with strong management, good governance and diversification into technologically enabled areas. Maintain Buy with TP of Rs500 (16x FY24 EPS)

Valuations

Rsm FY23E New FY23E Old % chg FY24E New FY24E Old % chg Net Sales 1,58,066 1,58,066 0.0% 1,77,058 1,77,058 0.0% EBITDA 11,378 12,273 -7.3% 16,803 16,273 3.3% EBITDA margin % 7.2% 7.8% 9.5% 9.2% Adj. PAT 4,365 5,127 -14.9% 8,031 7,967 0.8% Diluted EPS 17.0 19.9 -14.9% 31.2 31.0 0.8% Source: Centrum Broking KEC International vs. Nifty Midcap 100 1m 6m 1 year KECI.IN 1.2 (19.3) 1.2 NSE Midcap 100 9.4 1.1 8.3 Source: Bloomberg, NSE Key assumptions Rsm FY21A FY22A FY23E FY24E Order inflows 1,18,760 1,72,030 2,00,045 2,23,281 EBITDA Margins (%) 8.7% 6.6% 7.2% 9.5% Interest costs as a % of revenue 2.0% 2.3% 2.5% 2.3% Effective tax rate (%) 26.9% 17.7% 26.4% 27.0% Debt 19,282 28,749 33,000 30,000 Net WC days 108 127 126 118 Capex 1,752 2,854 2,500 2,500 Source: Company, Centrum Broking We expect completion of legacy EPC contracts in SAE to provide material relief on margins in H2FY23. Also, KEC remains confident of a significant unwinding of NWC in H2. Given that NWC levels for EPC companies in general remain benign, we hold on to this guidance at present. We have lowered EBITDA margins in FY23 by 60bps to 7.2% leading to 15% cut in earnings. For FY24E, we factor EBITDA margin recovery of 9.5% in line with historical levels. KEC is among the few credible names in diversified E&C space with strong management, good governance and diversification into technologically enabled areas. Maintain Buy with TP of Rs500 (16x FY24 EPS).

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