KEC International – A Power Utilization Play

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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’.  

High_voltage_transmission_towers_and_lines

High Voltage Transmission Towers and Lines

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.

KEC Business Portfolio, JainMatrix Investments

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.
Order Book Breakup_Feb2013, JainMatrix Investments

Fig 2 – Order Book Breakup, Feb 2013, JainMatrix Investments

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
Fig 3 – KEC Share Price History, JainMatrix Investments

Fig 3 – KEC Share Price History, JainMatrix Investments

  • 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.
Fig 4 - Quarterly Sales and Profits, JainMatrix Investments

Fig 4 – Quarterly Sales and Profits, JainMatrix Investments

  • The dividend is Rs 1.2 for a FV of 2, giving a high Dividend Yield of 2.2%. Fig 5.
Fig 5 – KEC Share Price and Dividends, JainMatrix Investments

Fig 5 – KEC Share Price and Dividends, JainMatrix Investments

  • 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.
Fig 6 – KEC, EPS and Cash Flow, JainMatrix Investments

Fig 6 – KEC, EPS and Cash Flow, JainMatrix Investments

  • 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.
Fig 7 – Price and PE Chart, JainMatrix Investments

Fig 7 – Price and PE Chart, JainMatrix Investments

  • 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.
Fig 8 – Price and EPS Chart, JainMatrix Investments

Fig 8 – Price and EPS Chart, JainMatrix Investments

  • 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.
Fig 9 – Orders Booked to Billings Ratio, JainMatrix Investments

Fig 9 – Orders Booked to Billings Ratio, JainMatrix Investments

  • 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:

Fig10 – Peer Benchmarking, JainMatrix Investments

Fig 10 – Peer Benchmarking, JainMatrix Investments

  • 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.

JainMatrix Knowledge Base

See other useful reports

  • Mahindra Holidays: Take this break !! – LINK
  • There’s nothing wrong with Apple Inc – LINK
  • Make Equity Investing less tricky: the JainMatrix Eleven – Link to Report
  • Yes Bank: The Brave Warrior of Indian Banks – Link to Report
  • Bharti Airtel: This is a year of consolidation – Link to Report
  • Arshiya International: A Collapsing Star – LINK
  • Adani Port – The Great Australian Adventure – Link to Report

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Disclaimer

These reports and documents are prepared by JainMatrix Investments Ltd. They are not to be copied, reused or made available to others without prior permission of JainMatrix Investments. Any questions should be directed to the director of JainMatrix Investments at punit.jain@jainmatrix.com Also see: https://jainmatrix.wordpress.com/disclaimer/

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Bharti Infratel IPO: Aggressive offering of Passive Infrastructure: Invest

SUMMARY

  • Date: Dec 6th 2012
  • Offering: Price Range Rs 210 – 240
  • Issue Period:  Dec 11 – 14
  • Retail gets an additional discount

Description: Bharti Infratel runs the tower network for Airtel, and also partners for this with Vodaphone and Idea. The business is sticky in terms of customers and has stable cash flows. The telecom sector is at an early stage of growth in India. Risks: The business is capital intensive. There is regulatory and litigation uncertainty. BIL has only recently turned Free Cash Flow positive. Opinion: BIL has the leadership and first mover advantage. The aggressive pricing may be justified by high growth, good financials, and resurgent industry. Invest for the long term, at Cut Off price.

Bharti Infratel – Description and Profile

  • Bharti Infratel (BIL) was started in 2006 as the tower subsidiary of Bharti Airtel. Revenues in FY12 were Rs 9597 crores with PAT 751 cr. Operating & profit margins are 38% & 7.8%.
  • BIL owns 33,000 towers, and holds 42% stake in Indus Towers, which has 110,000 towers. BIL thus owns 80,656 towers, a 21% share of the tower industry (and a combined 143,300 and 38%).
  • BIL, along with Indus, currently employ 2521 staff directly, and 5659 indirectly. Operations are spread across all 22 Telecom circles of India.
  • Currently Airtel owns about 86.1% of BIL, and PE firms 13.9%, see Fig 1. But Airtel will not sell any shares in IPO. So after the issue, its stake would fall to 79.4% and the PE firms will fall to 10.5%.
Fig 1 – Bharti Infratel Structure – Source Red Herring Prospectus

Fig 1 – Bharti Infratel Structure – Source Red Herring Prospectus

Why Is BIL going for an IPO?

The objects of the issue are:

  • Investments in Installation of 4,813 new towers – 1087 cr.
  • Upgradation and replacement on existing towers – 1214 cr.
  • Green initiatives at tower sites – 639 cr.
  • General corporate purpose and partial exit by investors Temasek Holding, Goldman Sachs, Anadale and Nomura – Over 1060 cr.

Soft Benefits:

  • In future Airtel can sell its shares and deleverage its stressed Balance Sheet.
  • Overall valuation of Airtel will get a boost on successful listing of BIL, since it retains 79% ownership.

Telecom Industry

  • The Indian telecom industry revenue reached Rs 1,36,100 cr. by Mar’12, and the mobile subscriber base is around 91.9 cr. Of that number, approximately 86.8 cr. are 2G subscribers and 5.1 cr. 3G.
  • The industry has gone through phases. While the 1990-’99 phase was an introduction phase, the 2000-’10 period saw massive industry and subscriber growth. We are now in a phase of hyper competition /consolidation, where operators may reduce from 12-15 to 6-8. For details, see LINK.
  • The business model is based on leasing of towers by service providers on 10-15 year contracts. There is customer stickiness and the revenue model is stable.
  • The total number of towers today is 376,000, and the Tower tenancy average rate for the industry is 1.7. BIL enjoys a higher tenancy of 1.9. The 1.7 – 1.8 range is considered the break-even point. Tenancies for independent telcos are estimated at around 1.46 times.
Fig 2 Industry Towers and Tenancy, Source Red Herring Prospectus

Fig 2 Industry Towers and Tenancy, Source RHP

  •  BIL is a pioneer in the industry as it initiated co-operation and alliances in the telecom towers industry. As a result, from being a competitive scenario, industry players were able to grow tower numbers rapidly and at the same time reduce costs of this critical infrastructure by sharing.
  • Airtel along with partners Vodaphone and Idea together having 68% of the mobile market by Revenue Market Share. They are also incumbents growing fastest. Thus BIL is in the safest position in the industry in the form of market share, growth prospects and revenue stability.
  • The key drivers for tower and tenancy growth will be: 1) Rural 2G expansion 2) new 3G capacity 3) Usage of higher frequencies 1800MHZ+ which is more tower intensive and 4) new 4G coverage.
  • Operating Costs structure of industry indicates that 50% of Opex is Energy, of which again 60% is Diesel costs. This is a risk as there is a good chance Diesel prices may be raised as it is subsidized.
  • Companies also face several barriers in the form of the complex and time-consuming approval process for the deployment of new towers, and public fear of radiation from current towers.
  • Industry players include Indus towers (109k towers), Reliance Infratel (50k), Bharti Infratel (33k), Viom Networks (42k), GTL Infra (33k), ATC (10k), Tower Vision (8k) and Ascend Telecom.
  • There are significant entry barriers for new players as the business is capital & technology intensive.

BIL financials:

  • We can see at a glance that financials are good. Revenues, EBITDA and PAT have increased at 23%, 31% and 57% CAGR over the last 3 years.  Fig 3.
Fig 3: Bharti Infratel Financials, JainMatrix Investments

Fig 3: Bharti Infratel Financials, JainMatrix Investments

  • The Free Cash flow of BIL has improved a lot from FY09, and turned positive in FY12. Fig 4.
  • Low debt-equity ratio of 0.2 times.
Fig 4: Bharti Infratel - Free Cash Flows

Fig 4: Bharti Infratel – Free Cash Flows

Key Strengths of BIL

  • Pioneering status in industry. Largest market share in a high growth industry.
  • Sharp business focus on growth and maintenance of passive telecom infrastructure.
  • Stable long term revenue visibility; High tower tenancy at 1.9 compared to industry average of 1.7
  • Low debt-equity ratio of 0.2 times, and Positive Free Cash Flows of late

Key Weaknesses/ Issues/ Challenges of BIL

  •  It’s a capital intensive business. As of now, BIL’s RoE was low at 5.3% in FY12.
  • Diesel is key input, and prices can be raised unexpectedly.
  • Industry in a financially stressed condition, due to regulatory overhang, hyper completion and stabilizing of subscriber growth. There is an ongoing consolidation in the industry.
  • While market pressures have resulted in consecutive quarter-on-quarter reduction in profits for several  companies including Bharti Airtel, a recent SC order on telecom licenses has forced operators to go slow on rollouts, reducing business for tower providers.
  • Regulatory uncertainty: BIL’s operations may be affected if certain proposed regulatory measures with respect to tower sharing among service providers, etc. are implemented.

Strategic Thoughts around this IPO

  • Telecom is a key infrastructure for a country, and the availability drives individual and corporate productivity. The benefits of mobiles are massive, and have changed our way of doing things.
  • Even today India is at an early phase of telecom usage. While raw penetration numbers indicate a saturation level, the fact is that (as per TRAI data of Mar ‘12) urban wireless penetration was 162.8% while rural wireless penetration was 38.3%, indicating:
    • New connections growth will essentially happen in rural areas, with churn in urban areas.
    • Market maturity will start with urban areas, where newer data intensive apps and smartphones will drive demand and consumption of telecom services.
  • Bharti Airtel is approaching the markets to list a firm after 10 years. The firm through this period has set new standards of business innovation, transparency, shareholder rewards and growth.
  • BIL has a unique model of passive infrastructure sharing, and cooperation among competitors.

IPO Offering Outline and Valuations:

  • Offer is of 18.89 cr. shares in price range Rs 210-240 available from Dec 11-14th.
  • This 10% dilution will collect upto Rs 4530 cr, and value the firm at 45,000 cr. market cap.
  • Market Lot – 50 Equity Shares
  • Maximum Subscription Amount for Retail Investor – Rs. 2,00,000
Valuations based on FY12 financials

PE range, TTM

 

PEG range, TTM

Forward EV/ EBITDA

Valuation per tower

Bharti Infratel

53 – 60 times

0.93 to 1.07 times

9-10.5 times

50-57 lakhs

Comments Aggressive pricing, but IPOs from leaders come at high prices Indicates fair valuation compared to growth rates Is reported to be cheap compared to global peers Is cheap compared to stake sale deals done in 2009 (78L) and 2007 (120-160L).

Fig 5: Multiple Valuation approaches

  • We can see that the Per Tower valuation has fallen significantly from 2007-09 levels. This can be explained by the current ‘hyper-competition’ phase of this industry. This may ease off in 2-3 years.
  • The reported forward EV/EBITDA value claims to be cheaper than global peers. However it should be noted that the Indian industry is very different from these, both from a development phase and a technology point of view, so this is a weak input.
  • While the PE range of the offering is high, it is justified by the growth, giving a fair PEG value range.
  • CRISIL Research assigns IPO grade ‘4/5’ to Bharti Infratel, indicating ‘above average’ fundamentals.

Opinion, Outlook and Recommendation

  • Telecom as a sector is at an early stage of growth in India. For BIL, the business model while capital intensive, generates good cash flows. Utilisation and tenancy can only improve from here.
  • The pricing, while apparently aggressive, commands a leadership premium and reflects a first mover advantage. Bharti Infratel is a good long term investment opportunity.
  • Airtel has always been a favourite among the institutions. The recent surge of Airtel stock by 36% from its Aug’12 lows is at least partially due to news of the BIL IPO.
  • With the recent uptick in the indices, BIL looks set to capture the imagination of newer investors. There may be pop on listing.
  •  Invest for the long term, at Cut Off price.
  • Check back on the website www.jainmatrix.com for updates.

JainMatrix Knowledge Base:

  • CARE IPO – they do care about shareholders – LINK
  • Bharti Airtel – This is a year of consolidation – LINK
  • Telecom – Auctions speak louder than words – LINK
  • TBZ: A Glittering IPO Offer – Invest  – LINK
  • MCX – 800 pound Gorilla of Commodities; Invest – LINK

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Disclaimer:

These reports and documents have been prepared by JainMatrix Investments Ltd. They are not to be copied, reused or made available to others without prior permission of JainMatrix Investments. Any questions should be directed to the director of JainMatrix Investments at punit.jain@jainmatrix.com Also see: https://jainmatrix.wordpress.com/disclaimer/

Bharti Airtel: This is a year of consolidation

_____________________________________________________________

  • Date: 19 August 2012
  • Large Cap – Mkt Cap Rs 99,115 crores
  • CMP: Rs 261
  • Advice:  Accumulate in FY13 through SIP
  • Target:  Mar ’14 target of 421

Summary

  • We have seen a fall of share prices by 39% this year. There’s no doubt that Bharti Airtel has lost its status as a safe long-term investment and Blue Chip for investors. The reasons are obvious to mobile users – low consumer prices, intense competition, poor telecom governance, and the 2G scam. Also Airtel invested in Africa, and paid heavily for 3G & 4G licenses. 
  • But Airtel remains the market share leader in Indian telecom and #5 by consumers worldwide.
  • Launch of 3G, 4G and mCommerce (Airtel Money) means it has comprehensive service offerings.
  • Businesses like Digital TV, fixed line, broadband, Enterprise telecom services and Passive Infra services all have synergies with the telecom core and also leadership in their niches.
  • The investments in 3G, 4G and Africa operations will in time propel Airtel into a profitable global telecom business as a low cost leader with a factory approach to call volumes. 

What to do now: The period FY2013 will be a year of consolidation.

  • The near term positive triggers include listing (IPO) of BhartiInfratel, exits by 4-5 competitors, auction of 2G licenses and refarming/ sale of spectrum. Airtel will see a return of Pricing power. 
  • Share price fall to current levels is a market excess, and offers investors an attractive entry point.
  • Long-term investors with a medium risk appetite can accumulate Airtel this year for a price target of 421 by August 2014.

Bharti Airtel – Description and Profile

  • Airtel is the market leader in the Indian telecom sector. Incorporated in 1995, it is a global telecom operator ranked #5 today in terms of customers.
  • Consolidated revenues are 71,505 crores (FY’12), and mkt cap is 99,115 cr. ranks it #13 in India.  Operations are spread over 20 countries and Airtel has an aggregate of 26.1 cr. customers. Of these, 20 cr. are in India itself.
  • Businesses are classified as B2C – consumer and B2B – Business. The B2C are Mobile, Telemedia (IPTV, broadband and fixed line), Digital TV (DTH) and MCommerce. Africa is essentially a mobile market, and is B2C.
Airtel - Business Segments, JainMatrix Investments

Fig 1 – Airtel – Business Segments, JainMatrix Investments

  • Market shares are 19% by subscribers and 29% by revenue, indicating a superior ARPU profile.
  • B2B services are Airtel Business (end to end telecom services) and Passive Infrastructure Services (towers)
  • Shareholding pattern is: Promoters Indian 45.7% and Foreign 22.8%; FIIs 16.9%; DII 8.1%; Bodies Corporate 4.6 %; Individuals – retail & HNI 1.5 and Other non institutions 0.4%.

Industry Note

  • The 2004-09 period with 2G and only 5-7 competitors looks like a happy phase from the distant past.
    • The controversial 2008 Telecom licenses brought in new players, intense competition and over Rs 50k crores of fresh investment into Indian Telecom.
    • The auction of 3G in May 2010 saw major players spend $13b (Rs 67,000 cr.). In retrospect they may have overpaid for this, as 3G adoptions has been slow after the launch.
    • Compared to this, the 4G licenses auction in 2010 raised $7.5b (Rs 38,000 cr.).
  • The governance for Telecom involves TRAI, DoT, Ministry of Comm./IT and TDSAT for disputes.
  • Per minute call tariff rates are among the lowest in the world. And the network expansion and 3G/4G rollouts are an ongoing capital-intensive requirement for many players.
Telecom Market shares in March 2012, JainMatrix Investments

Fig 2 – Telecom Market shares in Mar’12, JainMatrix Investments (Click to enlarge)

  • There are 15 operators in India – see Fig 2 for Subscriber Market Shares. Revenue market shares for Mar ’12 are Airtel 29%, Vodaphone 23% and Idea 15%.
  • Most operators are not able to make operating profits. And the market is reaching a subscriber saturation point. Reports are that consolidation has started, as of these, three (Etisalat, Videocon, STel) may exit fully, and Uninor and SSTL may exit partially (Fitch).
  • The total number of Indian subscribers of telecom services– wireless & wire line – is 95.1 cr. The tele-density is 78.5%. Broadband penetration is low at 1.1% (1.38 cr.).
  • In Feb’12, 122 telecom licenses issued by govt. in 2008 were cancelled by the Supreme Court. Many of the players, especially newer ones, are hit as their future is uncertain, and an expensive public auction process may be used to reissue the licenses.  Airtel however is not affected directly.
  • In the Mar’12 quarter, the total wireless subscriber base grew 2.83% to 91.9 cr. In terms of net additions, Idea led with 63.4 lakh followed by Uninor, Airtel and Vodafone with 61.3L, 55.8L and 27.4L respectively.
  • Nearly 18 months after launch of 3G, there are merely 1.5-2 cr. subscribers, less than 2% of the GSM subscriber base of 91.9 cr. Of these Airtel has 80 lakh and Idea 26 lakh. 3G ARPU may be 90-100 Rs/ month.

Key Challenges and Strategic Responses:

1) Intense competition in Indian market due to 15 players.

  • The Airtel strategic direction has changed from profitability to defending market share. This will help maintain overall revenue and growth, but signals lower profitability for a few quarters.
  • Marketing & Sales activities include aggressive brand building, sports sponsorships and marketing campaigns in media.
  • Bundling of Airtel’s consumer services is an opportunity. Currently this is being tapped through single payment mechanism with Airtel Money. If other synergies are tapped, this can improve product stickiness

2) Regulatory uncertainty in Telecom due to cancellation of 2008 licenses, separation of spectrum and licenses and non sharing of 3G customers among operators and a host of such issues

  • Many ground rules are changing in this industry due to the initiatives by troika of Indian Govt., TRAI and DoT. This includes higher service charges, potential new charges like spectrum and license fees, excess spectrum charge, refarming of spectrum, non-sharing of 3G services among operators and restrictions in voice and internet ‘combi packs’ by TRAI.
  • Airtel has joined other telecom players to vigorously defend its stance at TDSAT /Indian Courts.
  • In a perverse situation, consolidation in Indian telecom is being accelerated by the licenses cancellation.

3) Heavy Investments: Airtel won a number of 3G licenses (2010) and in important circles, but at a high price. It also won 4G licenses, which it launched in 2012.

  • 3G services have not initially taken off in the market as expected. Having spent large sums in the 3G auctions, Airtel is leading the push in 3G services with investments in m-Heath, m-Education, m-Commerce, e-governance, etc. and generating trials among current subscribers.
  • Airtel has already launched 4G services (essentially for data) in Bangalore and Kolkata. It will launch soon in Delhi, Mumbai and Kerala.

4) Airtel acquired the African telecom assets of Zain in 2010, for USD $9 billion (Rs 49,500 cr.) in cash.

  • This purchase provided entry into a high potential market and allows Airtel to start a second phase of corporate growth. (As per Airtel estimates), Africa will eventually overtake India and China as a telecom market – as population of Africa will peak at 1.8 – 2.0 billion.
  • By leveraging their balance sheet and with sound financial engineering, Airtel was able to service this loan for only $200 m (Rs 1100cr.) per year in ‘10. The ‘13 revenue target for Africa is $5 billion (27.5k crores).
  • However this market requires a couple of years of investments in markets for regulatory approvals, 3G rollout, network investments and marketing & sales to raise the profile of Airtel.

5) High debt due to purchase of Zain Africa, 3G and 4G, and network upgradation and expansion in all regions

  • Airtel continues to be an outsourcing leader with partners for networks, IT, and support services.
  • Airtel is planning on an IPO for its telecom tower unit BhartiInfratel Ltd. (BIL). This independent firm manages towers for any operator and listing this asset will help pare down debt.

6) Mobile Number Portability was perceived as a threat for Airtel. However, the first year of experience of this facility shows that Airtel is the second highest beneficiary of MNP.

Stock Valuation, Performance and Returns

  • CMP is 261. In the last 8 years, the market price has appreciated at 12% per annum CAGR.  However, the share has fallen from a high of 565 in Oct ‘07 by 54%, and within last 1 year by 39% to today’s CMP. See Fig 3.
  • Particularly worrying is the share price fall in August 2012, where after the Q1FY13 results on Aug 8th, the share fell by 14% in 3 days.
  • The maiden dividend of 20% declared in FY09 has been kept steady at this rate for next two years.
Price 5 year Trend, JainMatrix Investments

Fig 3 – Price 5 year Trend, JainMatrix Investments

Quarterly Sales and Margins

Fig 4 – Quarterly Sales and Margins

  • The quarterly sales and margins data, Fig 4, for the last 5 years is revealing:
    • The growth in Revenues is 31.1% and EBITDA too is up 25.7% CAGR over this period.
    • However Net Profit is flat, and the Profit margin has fallen in last 2 years from over 20% to 5% range.
  • The EPS, Cash flow and Investments Chart – Fig 5 – shows that Cash Flow has increased 21.6% CAGR over the last 5 years. But the investments required by the business has consumed a lot of this cash.
  • EPS peaked in 2010, and has fallen sharply thereafter.
EPS, Cash Flow and Capital Investments

Fig 5 – EPS, Cash Flow and Capital Investments

  • RoCE has fallen from 25% levels to 8.9% – a poor statistic; RoNW is 4.4%; Price/Book is 1.96.
  • Debt / Equity is 1.36 for the consolidated entity, indicating fair leverage.
Airtel - Price and PE chart, TTM

Fig 6 – Airtel – Price and PE chart, TTM

  • The Price and PE Chart – Fig 6 – show that the average PE over last 5 years is 22.5.
  • Current PE at 25.4 is in the Upper Quartile, at high levels, in spite of recent price fall.
Price and EPS Chart TTM, JainMatrix Investments

Fig 7 – Price and EPS Chart TTM, JainMatrix Investments

  • The Price and EPS chart – Fig 7 – clearly shows the EPS drop post April 2010.
  • The key question is, when will this fall in EPS be arrested and resume its growth path?

Benchmarking and Financial Projections

In a benchmarking exercise, we compare Airtel with 3 other firms, Table 8.

Benchmarking Analysis, JainMatrix Investments

Table 8 – Benchmarking Analysis, JainMatrix Investments

  • Airtel has healthy Sales growth, while Asset Turnover and EBITDA margins are excellent.
  • The ROCE is low, and profit erosion and price fall are signs of weakness for Airtel.
  • D/E is high but within the 2.0 times comfort zone
  • The Airtel consolidated Financials are projected till FY 2015, Table 9.
Financial Projections, JainMatrix Investments

Table 9 – Financial Projections, JainMatrix Investments

Risks:

  • Indian Telecom Regulatory and legal overhang.
  • Revenue pressures from the Indian government. The govt. is looking to bridge deficits with larger revenues from Telecom industry.
  • The current expectation is that M&As and exits will reduce competitive intensity in the sector. If this does not happen, it will affect profitability and margins.
  • The interest rates have risen in India, increasing debt-servicing costs. Our expectations are that rates have peaked in India, and should fall going forward. Any change in this affects financial projections.

Opinion, Outlook and Recommendation

  • The Telecom sector in India has achieved deep penetration, and voice services have been a language independent enabler of productivity, efficiency and knowledge. The success of Apple’s iPhone is an indication of future data services consumption, assuming the Indian market follows the developed markets trends.
  • In future the sector revenues will be driven by volume and price increases, value added services, 3G adoption, internet and application usage, 4G and incremental penetration. With maturity, the telecom sector revenues will be a Consumer play, reflecting personal income growth and habits.
  • Airtel is a volume leader in India, and is perceived as a technology leader with cutting edge offerings and the best network.  In Africa, the brand is slowly getting established.
  • The current financial performance is a trough due to a combination of Indian telecom governance challenges, intense competition, high interest rates and investments in Indian 3G/ 4G networks and African operations.
  • But FY2013 will see Airtel consolidating its leadership position in India & many African countries. In India about 6-7 players will exit or merge with other players due to investment/ profit pressures. After this, mobile call prices will rise, due to a return of pricing power. In FY14, the financial recovery will be swift & comprehensive.
  • The June 2010 bottom for the Airtel share was Rs 255, has held firm so far till August 2012. There may be more consolidation at these levels in rest of FY13.
  • The Mar 2014 target for Airtel is 421 based on a P/E target of 25 times and projections of financials. This is a 61% appreciation from current price levels. 

_____________________________________________________________

The author can be contacted over email at punit.jain@jainmatrix.com or on www.jainmatrix.com

JainMatrix Knowledge Base:

Other reports on Telecom

  • Telecom: Auctions speak louder than words – Article
  • Indian Telecom at Cross-Roads – Article
  • Indian Equity – Winds of Change – Article

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KEC International is a Modern Powerhouse

  • Date: February 16, 2012
  • CMP: Rs 60.6
  • Advice:  Firm is valued at Rs 82; available today at 37% discount
  • Target:   March 2014 target of 245

KEC International is the second largest transmission tower manufacturer in the world. It delivers such projects in 45 countries. Synergistic diversifications into Power Systems, Telecom, Water and Railways have de-risked the business. The SAE Towers acquisition (USA) in 2010 was also successful. The Order Book is at 2.2 times FY11 sales. In the last 6 years, Price has barely increased by 1% while the EPS growth is 30% CAGR. The steep price fall of 2011 is done with, and the recovery has started. The KEC share is available at a 37% discount to valuations. Invest for long term in this ‘modern powerhouse’.

Subscribers have received this report around 16th Feb or later on subscribing

KEC International – Description and Profile

  • KEC International is an Engineering Procurement and Construction (EPC) company focused on Power Transmission. It is the largest transmission tower manufacturing company in the world.
  • It is the 3,900 crores (FY11) flagship company of the RPG group. Current Market Cap is 1609 crores.
  • In addition to Power transmission, it has diversified into related areas like Power Systems, Cables, and new verticals like Railways, Telecom and Water. 90% of customers are Government firms.
  • Beyond India, it has supplied power infrastructure to 45 countries globally. In addition, in Sept ‘10, KEC took over SAE Towers, a US based lattice transmission towers manufacturer, for $95m giving it a strong North & Latin American footprint. The acquisition / integration has been successful.
  • Manufacturing plants are in India – Nagpur (Mah.), Jabalpur (MP) and Jaipur (Rajasthan); Americas – Monterrey (Mexico), Belo Horizonte (Brazil). Total tower manufacturing capacity is 251,000 MTs.
  • The shareholding pattern, indicates wide ownership with Indian Institutions (good) and medium Promoter ownership (fair)
JainMatrix Investments

Fig 1 – Shareholding Pattern of KEC – Click to expand

  • Employees number over 4200; Order Book is Rs.9,200 cr, giving about 2.2 years of visibility (@FY11).

Business Model and Strategy:

  • The core capability of KEC is its ability to deliver power transmission lines to Utilities, from design, to materials procurement, to execution, involving Project Management, Design & Engineering skills.
  • In a form of evolution and growth in related areas, KEC has expanded by:
  1. Backward integrated into Cables – manufacture and implementing cabling solution
  2. Forward integration – into Power Systems, designing and constructing substations (range of 220 to 1150 kV substations) and Electrical Balance of Plant (E- BOP) delivery services.
  • Looking beyond the Power industry, KEC has been able to reposition its EPC and manufacturing for:
  1. Telecom industry – telecom towers, cabling, installation and commissioning
  2. Railways EPC work (an acquisition, Jay Railway Signaling undertakes the railway infra projects)
  • Civil infrastructure – bridges, tunnels, workshop modernization, building of stations
  • Tracks related – new track laying/ improve old tracks, electrification /power systems.
  • Signaling and telecommunication network.

3. Water – this includes Irrigation and Hydroelectric construction, Embankment and Flood Control, Sewage and industrial effluent treatment and Potable water treatment and distribution

  • KEC is successfully diversifying its business, thus de-risking the overall business portfolio. See Fig 2.
JainMatrix Investments

Fig 2 – Order Book Breakup of KEC – Click to expand

Industry Note:

  • Classification: Power Industry is broadly classified into Generation, Transmission and Distribution.
  • The Indian power sector faces huge demand growth. But the government’s power capacity Plan v Achievement has been as low as 51.5% in the 10th Plan. (We are in 11th Plan now). The shortfall of peak power has been 8-12% in the last decade. Over 40% of Indian population still doesn’t have access to electricity. Many have access to poor quality power.
  • The Public sector dominates the industry, owning 70-80% of current assets. However the government is opening up to the Private sector. In future, 50% of investments are expected to be from the Private sector.
  • Power Generation has grabbed a lot of interest, but focus in India is now shifting to Transmission, as in 2-3 projects, even after generation and fuel linkages were in place, the Power Evacuation facilities were not ready and all stakeholders are suffering due to the delay.
  • Key players in the Power Transmission EPC are Areva T&D, Kalpatru Power, Jyoti Structures, Alstom Projects, etc. It’s a crowded market, and competition includes infra diversifieds like L&T, GMR and Reliance. A quick analysis shows among the listed focused firms, KEC has a 10-15% mkt share.
  • The Transmission industry bidding norms have changed recently to ‘Tarriff Based Competitive bidding’, where 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.
  • Also see reports on other related firms – BGR Energy Systems; Bottom Fishing and Winds of Change

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 30% of Orders Booked.
  • KEC has good presence beyond India, with 55% of current Orders Booked from other regions. In the present power cyclical down phase in India, KEC is focusing on business in other geographies.
  • 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 ‘10 SAE towers deal, KEC is now looking at additional acquisitions to accelerate growth

Stock valuation, performance and returns

  • KEC has shown a fine growth pattern (Fig 3) with Sales growing 18% CAGR over the last 6 years.
JainMatrix Investments

Fig 3 – Quarterly Sales and Profits at KEC

  • Net profit has grown very well at 24% CAGR.
  • Share price however has been volatile, moving to an all time high (in 2008) and low (in 2009).
JainMatrix Investments

Fig 4 – Price and dividends at KEC

  • EPS has been growing rapidly at 30% CAGR. Cash Flow however has been uneven.
JainMatrix Investments

Fig 5 – KEC – EPS and Cash Flow

  • Current PE at 9.3 is lower than current Industry average of 17.
  • The Price and PE chart – Fig 6 – indicates that current valuations are in the bottom quarter of 6-year historical charts. Definitely indicates undervalued status. This is in spite of the 90% surge from 20th Dec ’11 low of 32.
JainMatrix Investments

Fig 6 – Price and PE Chart of KEC

  • Price and EPS graph, Fig 7, shows that EPS accelerated till ‘08, then has been in the 5.5 – 7 range for next 3 years. The EPS should see an upside breakout from this range in the next few quarters. My expectation is that EPS will grow in the sector drawn in this chart.
JainMatrix Investments

Fig 7 – Price and EPS Chart

  • Debt equity at 1.51 (FY11) is very comfortable for an infrastructure firm.
  • Orders Booked to Billings, Fig 8, shows an improvement over the last two years.
Orders Booked to Billings Ratio for KEC International, JainMatrix Investments

Fig 8 – Orders Booked to Billings Ratio for KEC

  • Return on Capital Employed, ROCE, has been in a 22-40% range for the last 6 years.
  • Return On Net Worth, RoNW, also has been at 17-38% range. These are good numbers.
  • Operating margins have been hovering around 10% for last 3-4 years. This year’s high competition and entry into new sectors pushed it to around 8%. We expect this to revert to 10+ levels from FY13.
  • Cash and Cash equivalents are at 800 crores. Plus with a low DE ratio, KEC has access to a healthy war chest of internal cash plus debt with which they can look at new acquisitions.
  • PEG is at 0.4 – indicates safety and undervalued status

Financial Projections, with FY14 estimates

The consolidated financials and PE of KEC have been projected for the next 3 years.

Key Financials and Projections (Source: JainMatrix Investments)

Fig 9 – Key Financials and Projections (Source: JainMatrix Investments)

Risks:

  • Domestic interest rates unpredictability. This will affect the growth projections.
  • Hyper competition. Orders booked in the last 12-18 months in India have been at lower margins due to high competition. The projections assume an easing up of this in India.
  • 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 – already a part of the order book is affected due to unrest.
  • 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.
  • Past performance is no indication of future results

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 every rupee invested in generation must match an equal investment in T&D; however, in India it has been 1:0.5. There is now a huge opportunity for T&D players.
  • As a leading transmission EPC Company, KEC’s fortunes are linked to the regulatory environment and overall industrial climate of the Indian power sector. In a stable / improving environment, KEC should perform excellently based on the current manufacturing and execution capacities.
  • In 6 years, share price (adjusted) has increased by 1% while the EPS growth is 30% (CAGR). Other metrics like Sales, Orders Booked, Debt, etc too are favorable. The share is definitely under-priced.
  • Current price is low due to poor sentiment/ pessimism in the Indian markets around the Power sector. However KEC is well diversified across geographies as well as business segments.
  • From the steep fall of 2011, the share has bottomed out and risen rapidly of late, and is now at the key 200 DMA levels. Price should rise above this key level, and stay above for a fair period of time.
  • Near term positives include the weakening of the INR against the USD that should boost KEC revenues and profitability. It is an exporter of services, but most of its costs are in INR.
  • In FY12 end, and next few quarters, a lot of pending Power transmission projects are to be bid out, and KEC will win a fair share of new business.
  • The JainMatrix Investments valuation study prices the company at Rs 82, and so the share is today available at a 37% discount to this valuation 
  • March 2014 target of 245, giving a 300% appreciation.


For a pdf copy of this report, mail punit.jain@jainmatrix.com

…………………….

Disclosure: It is safe to assume that if the JainMatrix website recommends a stock, the researcher has already invested in it.

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Disclaimer:

These reports and documents have been prepared by JainMatrix Investments Ltd. They are not to be copied, reused or made available to others without prior permission of JainMatrix Investments. Any questions should be directed to the director of JainMatrix Investments at punit.jain@jainmatrix.com

Also see: https://jainmatrix.wordpress.com/disclaimer/