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*  We recently interacted with the management of KEC International Limited (KEC). We gathered that FY24 would be a clean year as SAE Tower’s (SAE) losses would cease to exist and margin impact due to high commodity prices would recover to earlier times.

* SAE Towers, which has been reporting losses for the past two years due to delays and high commodity costs, will likely complete the last leg of its EPC projects by Oct-Nov 2022. For FY24, management expects ~8% growth in SAE’s margin.

* Civil has been the driving force in the near term and will be adding to growth like Railways did a few years back. Diversification (Non-T&D FY22 revenue stood at 50% vs. 17% in FY16) has helped the company maintain healthy sales growth over the years.

* We roll forward our valuation to Sept’23 with a revised TP of Rs540 (earlier Rs495). We introduce FY25 EPS at Rs40, largely in line with consensus estimates with ~10% margin. We maintain BUY on the stock.

 SAE becomes Achilles Heel – Over the past two years, SAE has seen significant margin erosion on account of commodity inflation, supply constraints, and delays in EPC projects. Now, of the four EPC projects, only one project is due for completion (Expected by Oct-Nov 2022). Hence, all pain-related to these projects is likely to be over in the current fiscal. KEC is still evaluating whether to take new EPC projects in Brazil, given the risks associated. Supply orders have been profitable and a large part of the book is presently under this category. Consequently, in the medium term, the company will not be taking big EPC projects and projects with external engineering. SAE’s Mexico business is doing well and has orders for the next six quarters. There are renewable energy (RE) opportunities in the US as well, but logistics cost is acting as one of the determinants.

Long-term story intact: KEC has showed its ability to diversify across sectors (diversified into five new businesses since 2016), with exposure across T&D, railways, oil and gas, urban infrastructure, and other civil sectors, while keeping business fundamentals intact. Non-T&D formed 50% of the revenue in FY22 vs. 17% in FY16. Civil and urban infrastructure is going to be the structured growth story going forward. From executing small industrial plants in FY18, the company is now taking up high residential building, urban infra, data center, water pipelines, and airports projects, among others.

Valuation and outlook: Given that SAE’s losses will continue for the next one or two more quarters, we have sharply cut our FY23 numbers (20%), though there is not much change in FY24 EPS (down 1%). We have introduced FY25 EPS at Rs40, in line with street’s estimates. We expect KEC to return to ~10% margin in the coming years. We roll forward our valuation to Sept’23 with a TP of Rs540 (Rs495 earlier). We maintain BUY on the stock. Risks include further delay in project completion in SAE and weak order inflows.

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