Healthy EBITDA margin and PAT expansion more than offset a minor GST transition- related impact on KEC International’s (KECI) quarterly execution. Order inflows for 2QFY18 remained healthy at Rs 30bn, leading to a strong order book of Rs 140bn. Management is confident of achieving ~10%+ revenue growth with EBTIDA margins of ~10% for FY18E. We believe GoI’s push towards transmission, railways and solar sectors would create a plethora of opportunities for KECI. The company is well-placed in terms of steady execution, improving margins and WC cycles, which should facilitate an improvement in its return ratios and cash flows. We remain LONG on KEC with a Mar’19 TP of Rs 379 (vs. Rs 375 earlier) based on FY19E P/E of 18x.
GST-related slowdown hurts domestic business: KECI achieved 2QFY18 sales of Rs 21.3bn (+25% qoq/+3% yoy), ~6% below EE of Rs 22.7bn mainly due to a GST-related slowdown in the domestic market. Power T&D (incl. SAE) revenues stood at Rs 17bn (+15%/-5% qoq/yoy). Lower-than-expected operating expenditure led to EBITDA margins of 10.1% (+9.4% qoq /+8.8% yoy) vs. EE of 9.0%. Recurring PAT came in at Rs 893mn (+42%/37% qoq/yoy), 14% higher than EE of Rs 781mn.
Momentum in railway biz continues; higher T&D orders from SEBs/private players: Railways business remained on a strong growth trajectory with 2QFY18 revenues at Rs 1.19bn (-25% qoq/+80% yoy). Order inflows from railways were affected by confusion over GST and should improve in 2HFY18E. For 1HFY18, order inflows from SEBs and private players made up for the weak order inflows from Power Grid (PGCIL). Recently, PGCIL has tied up with states like Bihar and Uttar Pradesh, and tenders are expected soon. On the international front, order inflows are likely to remain strong from Africa, SAARC, Saudi Arabia and other Middle East countries.
Balance sheet to improve with reduction in receivable days, lower interest cost/ sales: KECI should see a reduction in its receivable days due to (1) faster execution of projects and, (2) closure of projects leading to retention money flowing back into the business. Lower interest rates helped reduce finance costs/sales, and we expect the ratio to decline from ~2.9% in FY17 to ~2.1% in FY20E. This will aid PAT margin expansion and an improvement of return ratios.
Scarcity of well-managed EPC businesses to support multiple re-rating: KECI has emerged as a well-managed EPC business with a strong balance sheet and high growth potential. An EBITDA/PAT CAGR of 22%/30% over FY17A-FY20E should support a further re-rating. The stock is currently trading at 19.4x/15.0x FY18E/FY19E P/E. Key risks would be slow order inflows and unexpected margin pressures.
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