KEC International scores on margin growth despite flat revenue

KEC International’s profitability has been climbing in spite of the economic slowdown mirrored in its subdued revenue growth


The sustainability of the operating margin has gone down well with investors and the stock has, in the last three-six months, beaten the returns given by the benchmark S&P BSE Capital Goods index.
The sustainability of the operating margin has gone down well with investors and the stock has, in the last three-six months, beaten the returns given by the benchmark S&P BSE Capital Goods index.

In the last few quarters, stocks of power transmission firms in the listed capital goods universe have displayed better performance than those in the business of power generation. KEC International Ltd is one such company, whose profitability has been climbing in spite of the economic slowdown mirrored in its subdued revenue growth.

The sweet spot in its recently announced March quarter earnings was the 8.7% consolidated operating margin. This came 140 basis points higher than a year ago, besides being pegged as the highest in the last 19 quarters. A Religare Research report says this was the outcome of better execution, completion of legacy orders and softer commodity prices. A basis point is 0.01%.

Better still, the management echoed confidence that it would cruise through fiscal year 2017 too with no dent to its operating margin, despite rising commodity prices. The sustainability of the operating margin has gone down well with investors and the stock has, in the last three-six months, beaten the returns given by the benchmark S&P BSE Capital Goods index. Add to this is the turnaround in its overseas subsidiary—SAE Towers—with an operating margin of 5-5.5% versus a loss in fiscal year 2015.

Therefore, March quarter’s operating profit grew by 20% year-on-year, completely overshadowing the rather flat growth in net sales.

Surprisingly, the weak order intake during the quarter did not dampen sentiment on the Street. Perhaps this was offset by the Rs.9,400 crore order book KEC International carries as on end-March 2016, which is equivalent to one year’s revenue. Besides, the firm is the lowest bidder in nearly Rs.4,000 crore worth of orders, which the management feels could be finalized in the next few months.

However, a few risks exist to the business. One, KEC International’s presence in West Asian markets where the oil price slump is an overhang on macroeconomic and industrial orders. But, the firm is reaching out to new markets such as South-East Asia to compensate for this.

Besides, KEC International like other infrastructure firms has had to battle rising working capital needs due to sluggishness in economic activity and the resulting payment delays. But analysts are not perturbed given the stable debt profile of the firm compared with peers with highly leveraged balance sheets. Also, analysts believe that improving cash flow from operations in the quarters ahead will offset the interest cost.

Yet, the positives outweigh the risks in the near-to-medium term, with analysts pegging a 20-25% compound annual growth rate in earnings over the next two years. At the current market price of Rs.128 apiece, shares of KEC International have little downside, with the stock trading at a price-to-earnings ratio of 14 times the estimated earnings for fiscal year 2018.

The writer does not own shares in the above-mentioned companies.

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