There was little to complain about in KEC International Ltd’s March quarter (Q4) performance, but its shares have corrected 5% after the results announcement. Perhaps investors are worried about the small shortfall in Ebitda (earnings before interest, tax, depreciation and amortization) margins. March quarter’s margin at 10.1% was a tad lower than the year-ago period. This came on the back of a 27% jump in net revenue, which raises questions about cost pressures.
By itself, revenue growth was impressive and should have pleased investors. Power transmission and distribution (T&D), its largest business segment, posted a 20% year-on-year growth in the quarter. What thwarted a rise in margins was new business verticals such as railways and civil. According to the management, these segments are in a nascent growth phase in KEC. So, it may be a while before the resources mobilized to build capabilities in these new areas translate into profitability and higher cash flows.
Staff costs and direct costs (contracting and material) soared both in absolute terms and as a percentage of sales during the quarter. Another factor that may have peeved investors is the significant drop in operating cash flows during FY18 compared to the previous year, in spite of revenue and Ebitda growth.
Further, although the quarter ended with a 33% jump in order flows and a 32% jump in the order book when compared to a year back, there are concerns whether a higher proportion of long-cycle projects is likely to result in higher volatility in margins going forward. To top it, in the analysts’ call, the management’s guidance that it would only maintain current profit margins in FY19 was a dampener.
In other words, strong order flows and revenue ramp-up may not bring in better profit margins.
That apart, weakening order flow from Power Grid Corp. of India Ltd, which was KEC’s mainstay, is a concern. While the management is confident that orders will see a shift towards private-public sector participation in power T&D, investors are not convinced yet.
Then there are other questions worrying investors. Will future T&D orders expected from states and the company’s diversification into new areas come at the cost of margins? Would it imply longer working capital cycles, which KEC had just reined in this year? “Sustainability of working capital cycle is a key factor to monitor," says a report by Edelweiss Securities Ltd.
Be that as it may, one cannot dispute that the March quarter performance closed the year for KEC on a high note. Brokerage firms have pegged earnings growth rate at 20% compounded over the next two years, on the back of the order flows in the domestic and overseas markets. Meanwhile, the slow yet steady transition into an infrastructure firm from a pure power T&D solutions provider until a couple of years ago may see a rerating in valuation too. KEC’s current market price of Rs388 a share discounts the FY20 earnings at around 15 times.