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Muted quarter; order intake impressive

KEC International’s Q3FY22 revenue growth was muted at 1.5% YoY impacted by 15% YoY decline in T&D revenue. EBITDA margin shrank 190bps YoY (flat QoQ) to 7.2%, mainly due to elevated commodity costs and execution challenges in SAE Brazil. During 9MFY22, the company booked its highest-ever order intake of Rs141bn (up 106% YoY), taking the total orderbook to Rs244bn (1.8x TTM sales). Due to near-term headwinds in margins, we cut our earnings estimate for FY22E/FY23E by 19%/1%, respectively. However, we believe the company is poised to leverage the increase in infrastructure allocation in Budget 2022 with initiatives announced recently around Gati Shakti. Also, we expect strong order inflow in civil segment and revival in T&D segment (India) over the next two years. We, hence, upgrade our rating on the stock to BUY with a revised target price of Rs613, and a target multiple of 18x FY24E EPS (previously: Rs510).

Civil segment continues to lead non-T&D pack: Revenue from civil segment grew 81% YoY to Rs4.8bn, while cables/railway/T&D grew 27%/9%/(15)% YoY, respectively. Execution in international T&D business was impacted due to intermittent covid challenges and strategic realignment of dispatches owing to high commodity prices. We expect strain in T&D execution to continue for at least another quarter. However, execution in non-T&D segment has been robust with 37% YoY growth in 9MFY22 revenue.

Margins remain low but stable: EBIDTA margin contracted 190bps YoY to 7.2% as raw material proportion to sales expanded 220bps. Margin was impacted due to lower execution in T&D business and continued losses in SAE Brazil. As the factors impacting the margin persist, margins are likely to remain benign for another quarter. However, new order inflows factor in higher input costs, hence, margins are expected to revive in coming years.

Debt and working capital remain elevated: Net debt increased to Rs29bn in Q3FY22 from Rs26bn in Q3FY21 on the back of delay in collection from railways, impacting the overall net working capital. Geopolitical tension in Afghanistan and continued losses in SAE Brazil further strained the working capital. However, the company is expecting working capital to normalise to ~110days going forward.

Upgrade to BUY: The central government has recently announced key initiatives around Gati Shakti towards building a robust, multi-modal infrastructure in the country. With its successful diversification in railway and civil segments, the company is in a sweet spot to benefit from the expected increase in investments towards building infrastructure. Hence, we upgrade the stock to BUY with a revised target price of Rs613.

Valuation and outlook

The T&D business is currently facing challenges such as 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 should expand as the segment matures. The company is in a strong position to harness the recent push by the government towards strengthening infrastructure in the country. The initiatives announced around Gati Shakti and PLI schemes are likely to spur investments in key growth areas of metro, airports, data centres, etc. where the company has already established its presence.

A healthy orderbook gives us comfort on sustained execution level. Due to near-term headwinds, we trim our FY22E/FY23E estimates by 19%/1%, respectively. However, the company has a strong orderbook and is in a strong position to leverage the expected increase in spends towards infrastructure in the country. We have introduced our FY24 estimates and accordingly rolled over our valuations. Assigning a target PE multiple of 18x on FY24E, we upgrade our rating on the stock to BUY with a revised target price of Rs613 (previously: Rs510).

Key risks: Any further increase in commodity prices and any incremental challenges towards collections.

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