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Steady growth prospects; Retain BUY

Our View: We believe KEC international (KECI) would be one of the major beneficiaries of the government’s increasing focus on large infrastructure projects, rural electrification, railway electrification and expansion of metro rail network. The government has planned investments of Rs100trn+ in sectors like energy (~25‐27%), roads (~18‐20%), urban (~15‐17%), and railways (12‐13%) amount to ~70‐75% of the projected infrastructure investment. The well‐diversified order book across sectors, geographies and clientele provides revenue visibility in the near to medium term and reduces order book concentration risk. Opportunities in the domestic railway segment are significant driven by upgradation of rail infrastructure, rising electrification, DFCC projects as well as metro rail networks. With focus on faster execution, even the size of composite contracts is rising. We cut our FY22E earnings estimates by 7% respectively to factor the delay in normalization for international execution owing to COVID led disruptions & commodity price headwinds. We expect KECI to deliver ~20% earnings CAGR over FY21‐FY23E. It is currently trading reasonably at ~14x/12x FY22E/FY23E EPS (vs long term avg. 1‐yr forward P/E of 14x). Retain ‘BUY’ with revised TP of Rs414 at 14x earnings as we roll forward to FY23. We remain positive on KECI given its diversified & healthy order backlog, ability to bag orders in tough times & proven execution track record.

Key highlights of Q3FY21 earnings con‐call

* Growth in the quarter was led by robust execution in railway & civil business. The result would have been much better but due to intermittent challenges faced at international level especially in Brazil and impact on 3 projects of DMRC, RRTS due to environmental and farmer agitation created huge pressure on steel and cement availability. The company has taken a conscious call of not to continue fast tracking execution in some of the fast track projects in view of increasing commodity prices

* T&D: The company has seen progressive ramp up in domestic & International markets. There have intermittent challenges due to Covid in form of delay in approval of visa, work permits and stringent quarantine guideline. Overall, pipeline continues to be strong in international markets especially in SAARC, ME and Africa. In domestic market, revised bidding of Green corridor phase 2 tenders has been concluded for most of the schemes this month, the bidding for balance schemes is expected in next few weeks.  Ramp up in India T&D is expected from Q1FY22E due to TBCB and resolving of Essel issue. Bihar, TN, Kerala, Rajasthan are witnessing activity from SEB side and private order in Mumbai from Adani and Tata. Besides, recently acquired tower manufacturing facility in Dubai has been commissioned in Q3.  

* SAE business: Brazil operations were affected amidst fear of second wave. This has led to severe supply of raw material thereby affecting the execution of EPC as well as power supply projects. Despite these challenges, the company has energized one EPC project in Dec and started work on new EPC project has commenced. The company expects to complete two EPC projects in Q1 & Q2FY22E.

* Railway: KECI continued its high growth trajectory. In line with growth strategy the business continued to expand its portfolio in technologically enabled emerging growth areas of DFCC, Metro, and HSR Rail. Railways received first private order including a composite doubling project – track linking, signaling and OHE. Besides, the company undertook project for Metro electrification order from DMRC, ballast less track from Cochi metro, Signaling and telecommunication for DFCC, and construction of Depot cum workshop. This has enabled railway to transform from conventional EPC player to a technology player.  

* Civil: Business continued to make progress in in the area of Chemical and water pipeline segment. The company received repeat order in cement and residential segment.  

* Cables: Business has rebounded after muted H1. The business is progressing well due to development of new products and is on track to commercialize new products in Q4. Notably, over the last few year, the cable business has been instrumental in bolstering supply chain for railway business through backward integration.  

* Execution of existing smart cities and defence project in smart infra are on track.

* Guidance: The management expects Civil and railways business to grow by at least 50% and 20% respectively for FY22E. Interest cost as a % of sales is expected to be around 2% for FY21E

* Margin impact: The commodity prices have impacted during the latter part of the quarter; however, major problem is due to SAE, Brazil. The management expects Brazil problem to get over by Q1FY22E. Management has stated benign trend is witnessed in commodity prices and also availability. Though, present margins look sustainable.

* Increase in Working capital: As metal prices had increased the company resorted to stocking of inventory, as a result, inventory levels had increased. Besides, one or two large customers had issue in payment during the last two weeks of Dec which are paying now. So, increase in WC is more of a strategic and temperory blip. The management stated with interest cost going down, it is more liberal in stocking and payment related terms. The emphasis is on controlling interest cost than working capital.

* Ordering pipeline: The total tenders quoted and tenders to be quoted is ~Rs600bn (Railways ~Rs120‐130bn and Civil Rs100‐120bn)

* Forex gain: KEC had a forex gain of Rs70‐80mn during Q3FY21

Key highlights from Q3FY21 results:

* Revenue grew by 7%YoY at Rs32.9bn, in line with our estimates

* EBITDA declined by 6%YoY (+8% vs our estimate) at Rs2.98bn, mainly due to higher Erection & sub‐contracting expenses.  

* EBITDA margin compressed by 128bps YoY at 9.1% (+60bps vs our estimate)

* Adj. PAT came in at Rs1.45bn, flat yoy (+9% vs our estimates)

* YTD Order Intake stood at Rs68bn with robust order book (including L1 orders) of Rs240bn

      * Strengthened order book in International T&D with orders in Middle East and Africa

      * Railways expanded its portfolio in the technologically enabled/ emerging growth areas of Metros, DFCC and High‐speed trains

      * Civil continues diversification in new areas ‐ Secured breakthrough orders in the fast‐ growing Chemical and Water Pipeline segments

     * Solar secured a new order for a 13.6MW rooftop solar project

* Net Working Capital (NWC) stands at 144 days as on 31st Dec’20. Working capital position expected to normalize further in Q4.

* Net debt as on Dec’20 stood at Rs26.5bn

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