India’s capex cycle appears to be on revival path, led by the government budgetary push, particularly in the power transmission, renewable energy and railways sectors. Diversified EPC infrastructure company KEC International is a beneficiary here.

The stock of KEC International trades at a one-year forward P/E of around 21 times, around 50 per cent above its five-year historical average P/E of 14 times. KEC has seen tailwinds such as highest ever order book providing strong revenue visibility. However, margins dipped significantly over the last two years due to legacy orders, input cost pressures and supply chain challenges. While the management believes the worst is over, it remains to be seen if margins have bottomed out. Weighing positives against the risks, we recommend investors to hold the stock of KEC International.

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Business

KEC International (a part of R.P. Goenka Group) is engaged in the business of executing power transmission and distribution (T&D) and other projects in the engineering, procurement and construction (EPC) infrastructure space. Currently the company undertakes projects in more than 30 countries, earning 40-50 per cent of its revenues from overseas projects.

While T&D dominates revenue (49 per cent), KEC is also present in other segments such as railways (20 per cent), civil infrastructure (19 per cent), cables (9 per cent) and oil and gas pipelines (3 per cent).

Under the T&D space, KEC offers solutions ranging from design, manufacturing, supply, installation, and commissioning of transmission Lines, substations and underground cabling wherein Power Grid Corporation and state electricity boards are its customers. Its railways segment provides turnkey solutions in railways overhead electrification projects and executes complex projects such as track laying, signalling and telecom, road over bridges and other railway infrastructure.

KEC’s civil infrastructure business focuses on the construction of factories, buildings, urban infrastructure, warehouses and water treatment plants. Cables division offers a range of cables and high tension and extra high voltage turnkey cabling solutions. Its oil and gas division is involved in the construction of oil & gas cross-country pipelines where it forayed in 2021 via acquisition of Spur Infrastructure.

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Recent performance

Historically, Indian T&D space has been the mainstay of KEC’s business, comprising 65–70 per cent of sales up to FY17 while overall T&D comprised about 80 per cent. However, following a slowdown in Indian transmission capex post-FY18, KEC diversified into non-T&D areas, which now comprise half of revenue. The company, over the years, has been able to diversify both segment and geography-wise through organic and inorganic ways. For instance, in FY11, KEC acquired SAE Tower Holdings LLC to gain foothold in the Americas. During FY21, it took over Indian companies - Jay Railway Signalling and Spur Infrastructure, to help build pre-qualification for signalling projects and to foray into oil and gas pipelines business respectively.

During 2010-19, KEC maintained double-digit EBITDA margin with a 10 per cent revenue CAGR. While the revenue grew at 12 per cent CAGR during FY19-23, margins started taking a hit post pandemic (FY21-23) reducing to 4.8 per cent in FY23. While margins have been impacted due to headwinds such as spiking commodity prices, supply chain challenges and increasing logistics costs, it was the SAE business (15 per cent of T&D business) in Brazil which impacted margins the most. SAE saw various challenges in executing three legacy projects, such as country-specific issues, supply shortages and abnormal rise in steel prices leading to cost overruns and execution delays.

The situation appears to be easing as the company has closed legacy projects by Q4FY23 and the SAE business has started delivering positive EBITDA Q4 onwards. Also, the debt taken up for SAE is getting refinanced at less interest rate. Further, margins have also been impacted due to the execution of legacy fixed price-based projects taken during Covid period to shield revenues.

With this, as per management, these issues are almost behind and margin improvement has started. The management guides a revenue growth of 15-20 per cent in FY24 with an EBITDA margin expansion to 7-8 per cent. The management looks towards going back to the double-digit margin. Further, from the peak D/E of 3 times in FY16, KEC has reduced its debt to 1 while it might have to take on debt for working capital requirement.

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Orders and outlook

As of FY23, the company is having an all time high order book of nearly ₹30,553 crore translating into about 1.8 times its FY23 revenue providing good revenue visibility. The order book is diversified evenly into T&D and non-T&D segments.

During FY23, KEC saw a record order inflow of about ₹22,378 crore i.e. posting 30 per cent growth on a y-o-y basis, driven by 42 per cent growth in T&D and 20 per cent from railways segment. However, of the order book of around ₹28,000 crore (as of Q2FY23), about 20 per cent is fixed price-based T&D orders on which one needs to keep a tab in terms of profitability. Generally, railways and civil orders have price variation clause. Typically, KEC hedges aluminium and copper while exposure to steel remains unhedged.

Further, the management guides of ₹25,000-crore order inflow i.e. 12 per cent growth y-o-y. Considering the past experiences, management looks towards being less aggressive and focus on quality orders. Though the growth trajectory remains robust, we need to look at how the margins shape up for the company in the coming quarters, with a close watch on whether concerns regarding commodity prices and SAE Towers are easing out.

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