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Buy KEC International Ltd For Target Rs.450

Order inflows remain on track; outlook improving

Commodity price inflation may pose risk to margins

* Order inflow environment improving: The momentum of order wins has continued in this quarter, with KECI winning ~INR25b worth of orders, including the recently won order worth ~INR10b. Notably, order inflows have commenced in the Railways segment and are likely to pick up hereafter. 9MFY21 order wins (to date) amount to ~INR68b. Although this is below INR98b worth of orders won in 9MFY20, we attribute the wins to large firsttime orders in the Civil segment in the base year –as the company had forayed into metros (Kochi and Delhi metro orders). The order inflow momentum is picking up – as we enter a busy season in terms of construction activity and work commences to fulfil the orders bunched up due to the pandemic. As a result, we expect KECI to surpass FY20 order inflows in FY21 (+11% YoY) v/s our earlier assumption of flat order inflows.

* Business diversification strategy playing out well: We expect the Railways and Civil segments to dominate order inflows. On the other hand, contribution from the Power T&D segment would come off due to the slowdown in Power Grid’s capex. Within Railways, recent order wins have been broad-based as KECI has won orders in the emerging growth areas of metro, DFCC (Dedicated Freight Corridor), and high-speed trains. In the Civil segment, KECI has bagged orders from the fast-growing segments of Chemicals, Water Pipelines, and Cement. Orders in T&D have been from India as well as other geographies, with the Middle East and Americas (SAE) dominating order wins in the international market. As indicated by the management in 2QFY21, the bid pipeline has been healthy in the international T&D segment across Africa, the Middle East, and SAARC – the company has bid for ~INR300b worth of orders in the last couple of months.

* Leverage under control; favorable interest cost tailwind: KECI has been able to scale down its net D/E to 0.8x in FY20 from the peak of 2.4x in FY16. Net debt in 1HFY21 stood at ~INR24.3b, in line with the management target of INR25b. The company has benefitted from the recent tailwind of lower interest rates, with interest cost as a % of sales at 2.1%/2.4% in 2QFY21/1HFY21 (against 2.9%/3.1% in 2QFY20/1HFY20). KECI’s strategy of remaining an asset-light EPC player is expected to keep balance sheet-related risks in check. Lower interest rates in the domestic as well as international markets have helped the company lower effective cost of debt.

* Commodity price inflation needs to be monitored: The sharp rise in commodity prices poses challenges to the EPC business. Among the commodities, steel poses the key risk in terms of price. To build caution, we have marginally reduced our EBITDA margin assumption by 40bps each year over FY21–23E. This offsets the higher order inflow assumption, as a result of which our FY21–23E EPS estimates remain unchanged.

* Valuation and view: KECI is steadily diversifying its business to avoid concentration risk from the Power T&D business, with the Railways and Civil segments emerging as strong growth avenues. The company’s performance over the past few years has been commendable given that not many have been able to sustain growth with a top line of >INR100b in India in the EPC space. We believe the company has in place all the ingredients for growth over the next 3– 5 years. A strong promoter parentage and focus on the balance sheet should help KECI emerge stronger from the COVID-19 crisis v/s peers. End-1HFY21, KECI had a strong order book of INR195b + L1 orders, implying OB/rev of 1.6x the TTM revenue. At CMP, the stock is trading at 13.2x/11.7x on FY22/FY23E EPS. We maintain Buy, with TP of INR450 (15x FY23E EPS, marginally below the longterm one-year forward multiple of 15.5x).

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