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June 2014 Promotion – this share has appreciated 112% to today’s CMP 117.

This is the 2013 update of the report called KEC International is a Modern Powerhouse, published in Feb 2012. Available on LINK.

• Date: March 11, 2013
• CMP: Rs 55.0
• Small Cap: Market Cap 1394 crores
• Advice:  Firm is valued at Rs 82; available today at 49% discount
• Target:   March 2014 target of 179.  Medium Risk.

KEC International is a Power transmission EPC firm with operations in 48 countries. The synergistic diversifications into Power Systems, Telecom, Water and Railways are stabilizing. The Order Book has grown by 10.3% in a challenging FY13 year. The KEC share is available at a 49% discount to valuations. Invest for long term in this ‘Power Utilization Play’.  

KEC International – Description and Profile

• KEC International (KEC) is a global Engineering Procurement and Construction (EPC) firm with a focus on Power Transmission. It is the largest transmission tower manufacturing company in the world.
• It is the 5,900 crores (FY12) flagship company of the RP Goenka group. Current Market Cap is 1238 cr. Employees number over 4800; Order Book is Rs.10,150 cr, giving about 1.5 years of visibility.
• From a core of Power transmission, it has diversified into EPC related areas like Power Systems, Cables, Railways, Telecom and Water. Fig 1. About 90% of KEC customers are Government firms.

Fig 1 – KEC is diversifying its business portfolio 

• Beyond India, it has operations in 48 countries. The 2010 takeover of SAE Towers, a US based lattice transmission towers manufacturer has given it a good North & Latin America footprint.
• Manufacturing plants are in India – Nagpur, Jabalpur and Jaipur; in Americas at Monterrey (Mexico) and Belo Horizonte (Brazil). Total tower manufacturing capacity is 274,000 MTs.
• Shareholding pattern is Promoter 44.5%, MFs/DII 36.5%, FIIs 2.2%, Individuals 11.1% and Others 5.7%. The wide ownership with Indian Institutions is good and medium Promoter ownership is fair.

Business Model and Strategy

• The core capability of KEC is its ability to deliver power transmission lines to Utilities, including design, materials procurement, execution and Project Management.
• KEC also provides EPC services to Telecom, Railways and Water, see Fig 1. KEC has expanded into Power related areas – Cables, manufacture and cabling solution and – Power Systems, designing and constructing substations and Electrical Balance of Plant (E- BOP) delivery services.
• KEC is successfully diversifying its business, thus de-risking the overall business portfolio. See Fig 2.

Industry Note:

• Power Industry is broadly classified into Generation, Transmission and Distribution. The Indian power sector faces huge demand growth. But the government’s power generation capacity Plan v Achievement was 68% in the 11th Plan. (We are in 12th Plan now). Peak power shortfall has been 8-12% in 10 years. 40% of people have no access to electricity, and others access poor quality power.
• The Public sector dominates the industry, owning 70-80% of current assets. However with the opening up to the Private sector, upto 50% of new investments are expected to be Private sector.
• The key Power sector constraints are Fuel Linkages, State Elec. Board financial conditions and T&D losses. Most of the SEBs did not raise tariffs due to political and state govt pressures. This is being corrected now by the Central Govt. Power Generation has grabbed a lot of interest, but with Fuel Linkages still an issue, and restructuring of SEBs a slow process, the focus will now shifting to T&D.
• T&D losses are 32% of generating capacity compared to the global average of 10%. The T&D projects help with better grid connectivity, reduction in losses and upgradation of Transmission equipment. T&D losses are due to power theft, poorly T&D equipment, low T&D capacity and bad metering. Thus KEC International is a Power Utilization Play, a critical need of the day in India.
• The Transmission industry bidding norms have changed recently to ‘Tarriff Based Competitive bidding’. Here the Service Providers like KEC are responsible for Build, Own, Operate and Transfer of power lines. TSPs earn in the form of Transmission Charges payable by long-term customers.
• Key players in the Power Transmission EPC are Areva T&D, Kalpatru Power, Jyoti Structures, Alstom Projects, and infra diversifieds like L&T, GMR and Reliance. A quick analysis shows among the listed focused firms, KEC has a 10-15% mkt share.
• After a period of intense competition, we are now witnessing a consolidation favoring larger established players. The no. of players qualified for Power Grid’s new orders has come down to only three compared to at least 10 two years ago.

Unique strengths of KEC

• Diversification of KEC beyond the Transmission EPC sector is good, as diverse businesses follow different cyclical patterns. Businesses set up in the last 3 years account for 27% of Orders Booked.
• KEC has good presence beyond India, with 51% of current Orders Booked from other regions. In the last one year, KEC has also seen a resurgence of T&D demand from within India.
• As the flagship RPG Group firm, KEC enjoys good management focus for its initiatives. Established in 1945 as Kamani Engineering Company, the firm has a rich past, and has again reinvented itself into a modern powerhouse. Ramesh Chandak, the MD & CEO is a CA and has lead KEC for the last 10 years.
• Following the SAE towers M&A, KEC is now looking at additional acquisitions to accelerate growth.
• Unlike many other Infra majors, KEC is very well managed financially with low leverage and good FCF

Stock Valuation, Performance and Returns

• The share price has been volatile, moving from the all time high of 184 in Nov’07 to a low of 22 in Dec’08. Thereafter, the price has been affected by the overall low sentiment for infrastructure. Fig 3

• KEC has shown a fine growth pattern (Fig 4) with revenues, but not with margins.
• Sales have grown 19% CAGR over the last 5 years; EBITDA by 12% and Net Profit by 7% resp.
• Operating margins had been around 10% previously. The recent high competition and entry into new sectors pushed it to around 6%. We expect this to steady at this level and slowly recover.
• Typically the highest revenues are in the March quarter, due to the year-end of Govt. clients. Fig 4.

• The dividend is Rs 1.2 for a FV of 2, giving a high Dividend Yield of 2.2%. Fig 5.

• EPS has been growing at 7% CAGR.  Current PE at 9.2 is lower than Industry average of 15 times.
• Free Cash Flow (FCF) however has been good.  It fell in FY11 primarily due to the SAE Tower acquisition. It’s been zero to positive for 4 out of last 5 years, and the highest in FY12. This is a very big positive for KEC, as unlike other infra companies, this is well managed financially. Fig 6.

• The Price and PE chart is Fig 7. The PE ratio has a historical average of 17.5. It has moved in the range of 5-30 times across bear and bull phases of the market.
• The current PE is 9.2 times. Current valuations are in the bottom quarter of a 6-year period. Definitely indicates undervalued status.

• Price and EPS graph, Fig 8, shows that EPS accelerated till ‘08, then has been in the 5.5 – 7 range for the last 3 years. The recent fall was due to the investments in new sectors. My expectation is that EPS will grow in the sector drawn in this chart. Fig 8.

• Consolidated Debt Equity at 1.01 (FY12) is low for an infrastructure firm. This is a positive.
• Orders Booked to Billings, Fig 9, has been steady at 1.5 times.

• Return on Capital Employed, ROCE, has been in a 22-36% range for the last 6 years.
• Return On Net Worth, RoNW, also has been at 19-24% range. These are good numbers.
• The Beta of KEC is 2.14 (Reuters) indicating high volatility compared to the Indices.

Peer Benchmarking

We have compared KEC with leading listed Peers, Chart 10:

• Relative to the peers, KEC has good ROCE and RoE numbers reflecting good financials.
• D/E is good relative to peers. Valuations are not excessive. Price/ Book is low.
• KEC comes out able to hold its own compared to Infra peers.

Risks

• Domestic interest rates are expected to fall. A change there will affect our costs projections.
• High competition in Power Transmission and Entry into new segments. Orders booked in the last 12-18 months in India have been at lower margins, but our projections assume an easing up of this.
• Indian Power sector challenges. The key current issues are (1) financial stress among Utilities, particularly State Electricity Boards that are facing Tariff inflexibility and Collection issues, (2) Power Plants facing issues with fuel linkages and a shortage of Coal & Natural Gas, and (3) project execution delays due to government clearances like environmental, land acquisition, etc. This has affected the investment climate in this sector. The projects under execution by KEC are also affected, and execution/commissioning may be delayed.
• Business uncertainty in MENA region – unrest and riots in this region can affect ongoing projects.
• Unpredictable events like a European sovereign default, some new media issue/ bad publicity or any governmental charge sheet, etc. can occur that can mar equity performance for short periods.

Opinion, Outlook and Recommendation

• India has a surging growth in electricity demand, yet there is a 9-13% power deficit today. This will widen in the next few years. Globally the thumb rule is that one rupee invested in generation must match an equal investment in T&D (1:1); however, in India it has been 1:0.5. There is now a huge opportunity for T&D players.
• KEC should perform excellently based on the current strategy and execution capacities.
• In 6 years, share price (adjusted) has fallen 12%, while the EPS growth is 7% (both CAGR). Other metrics like Sales, Orders Booked, Debt, etc too are favorable. The share is under-priced.
• Current price is low due to poor sentiment/ pessimism in the Indian markets around the Power sector. However KEC is well placed to be a beneficiary of a sentiment revival.
• In the next few quarters, a lot of pending Power transmission projects are to be bid out, and KEC should win a fair share of new business.
• JainMatrix Investments values the company at Rs 82, so the share is available at a 49% discount
• March 2014 target of 179, giving a 225% appreciation.

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