It’s not surprising KEC International Ltd’s stock has fallen 18% since a high reached in October, as it continued to disappoint on margins in the September quarter. Net profit margin contracted 220 basis points (bps) to 3.5% from 5.7% in the year earlier. One basis point is one hundredth of a percentage point. Margins have declined for the third consecutive quarter. As a result, operating profit was down an annual 18% to Rs.57 crore.
KEC continued to languish on margins because of execution of lower-margin orders for power and transmission projects, for which the company had bid aggressively a year ago. Margins were also under pressure from diversification into new segments—cables, railway, telecom and water—which contributed around 16-20% of the total order book as of September quarter, against less than 10% at the end of March. Margins in the new businesses were close to zero because of entry pricing strategy and partnering with established players, IIFL Institutional Equities said in a 31 October note.
The brokerage cut 2013-14 fiscal year margin estimates for the company by 60-100 bps, resulting in an 8-18% cut in earnings estimates.
Net profit plunged 22% to Rs.16 crore because of weak margins and interest costs increased 10% year-on-year. Net sales growth was robust, buoyed by strong orders from domestic and international markets. Order inflow was up 22% annually and order backlog was decent, up 11% to Rs.9,386 crore, indicating strong revenue visibility.
There is, however, a silver lining. The working capital cycle declined to 91 days at the end of the second quarter against 110 days in the year-earlier period. The management has said margins will improve to 8-9% in the coming quarters, but this will depend on the overall scenario in the power sector and competition for Power Grid Corp. of India Ltd (PGCIL) bids.
Transmission continues to be KEC’s mainstay business and contributes around 70% to revenue. Analysts said recent PGCIL bids suggest competition from new entrants have reduced. Moreover, diversification into cables, railway, telecom and water segments may pay off as KEC is already pre-qualified for the projects in this space.
KEC shares gained 77% in 2012 and have outperformed the power index on the BSE, which has risen 8%. After the recent correction, the stock trades at 8.4 times one-year estimated price to earnings multiple and any further upside hinges upon an improvement in profit margins.
