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Impressive revenue growth; margins impacted

KEC International’s (KEC) Q1FY23 revenue grew 31% YoY to Rs33bn, led by robust execution across all segments. YTD FY23 order inflows stood at Rs34.7bn, taking the order backlog to over Rs300bn (including L1 position of Rs80bn). Management expects ordering momentum to continue, mainly in T&D (international T&D, Ladakh HVDC and green energy corridor phase-II), civil, railways and oil & gas segments. The management indicated opportunity pipeline of Rs1.1trn. Higher raw material and interest costs and continued losses at SAE Tower impacted profitability. Management guided profitability will improve Q3FY23 onwards on the back of reduction in commodity prices and completion of SAE’s legacy orders. During the quarter, net debt and working capital days increased due to change in billing method for railway orders and loss funding for SAE towers. Factoring in improved outlook as indicated by the management, mainly on lower commodity prices and profitability improvement for SAE Tower, we maintain our BUY rating while revising our target price to Rs566. (Previously: Rs502)

* Non-T&D led to strong revenue growth:Both T&D & non-T&D businesses of the company witnessed pick up in execution with non-T&D leading the growth (+46% YoY). Civil business continued to lead with revenue doubling to Rs5.9bn led by strong execution in metros, water pipeline and industrial projects. Cables/railway revenue grew at 26%/19% YoY, respectively. Management expects civil segment revenue to double in FY23 on the back of strong orderbook and tender pipeline across verticals. Other than civil, management expects execution to remain robust across all segments.

* Margins may improve in H2FY23: EBIDTA margin contracted 120bps YoY to 5.1% due to higher raw material costs, freight costs and losses at SAE Towers. As the factors impacting the margins persist, it is likely to remain benign for another quarter. However, as execution of new orders gathers pace and commodity prices remain stable, margins are expected to improve in H2FY23

* Debt and working capital remain elevated: Net debt increased by Rs8.9bn YoY to Rs34bn in Q1FY23 vs Rs26bn in Mar’22. Working capital days increased to 158 days as on Jun’22 vs ~130 days on Jun’21. It was largely due to the change in billing methodology for railway orders to milestone-based payments and increased losses for SAE Towers. Management expects these to compete by Q3FY23 and release the working capital.

* Maintain BUY: Strong order backlog and robust order pipeline provide healthy revenue visibility. The company has guided for 15% YoY growth in order inflow and revenue each in FY23. Any normalisation on current headwinds related to higher commodity prices, supplychain disruption may boost execution and profitability.

Valuation and outlook

The T&D business is currently facing challenges impacted by elevated commodity prices. However, management continues to drive efforts to push execution while striking a balance with reasonable margin. As execution of earlier booked orders on elevated commodity prices picks pace and legacy projects of SAE Brazil are completed, we expect the company to see expansion in margins

The non-T&D business continues to deliver robust growth and we believe the margin profile in those segments, primarily civil, should expand as the segment matures. The company is in a strong position to harness the recent push by the government towards strengthening the infrastructure in the country.

As indicated by the management, margins are expected to remain under pressure for another quarter and expect significant improvement from FY24. We factor this by trimming our FY23E earnings estimates by 8% and raising FY24E earnings by 12.7%. Given the improvement in outlook, we maintain our BUY rating on the stock. We assign a multiple of 18x on FY24E EPS and arrive at a target price of Rs566 (previously: Rs502).

Key risks: Any further increase in commodity prices and any incremental challenges at SAE Towers..

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