(Vipul Sharma/Mint )
(Vipul Sharma/Mint )

Investors hope KEC’s diversification plans are the answer to sluggish growth

  • The declining contribution of the power T&D business has been a catalyst for KEC’s stock
  • The company’s order book of 20,307 crore at the end of FY19 was 17% higher than the previous year

KEC International Ltd’s shares have risen about 33% from its lows in mid-February. This is far higher than the 8% rise in the Nifty Midcap 150 index during the same period.

The sharp rise in shares has come about as investors are enthused about the diversification plans of the company, which has been among the market leaders in the power transmission and distribution (T&D) business. Investors hope that KEC’s foray into railways and civil construction, along with greater focus on international markets for power T&D, may help deal with challenges of a slowdown in the domestic power segment.

The company’s order book of 20,307 crore at the end of FY19 was 17% higher than the previous year. This is about 1.8 times its FY19 revenue.

More important was the shift away from the power business, given that orders from its key customer, Power Grid Corp. of India Ltd , started reducing about two years ago with competition becoming tougher. Power Grid orders have fallen from nearly one-fourth its order book to 7% over the last three years.

Business from the railways has, meanwhile, doubled annually during the same period. The firm is also diversifying across industries for civil construction.

However, it remains to be seen if the increase in order book will translate into better revenues, especially as there was a steep decline in revenue growth from 17.2% in FY18 to 9.4% in FY19. For now, the steady flow of orders from new segments has improved investor sentiment.

Apart from the revenue ramp- up, the diversification will help sustain profitability, according to analysts. KEC has seen significant margin expansion from the newer business segments over the last four years, as a result of the completion of legacy projects, said a report by Reliance Securities Ltd.

The cable and power transmission segments are relatively low-margin businesses.

Ebitda (earnings before interest, tax, depreciation and amortization) margin has been hovering between 10% and 10.5% in the last few years. KEC has also been getting orders from overseas. The Saarc (South Asian Association for Regional Cooperation) region has emerged as the new growth engine, Motilal Oswal said in its recent note on the company. The order book has grown by 29% between FY14 and FY18 with strong contribution from overseas regions.

One sore point in this business is the heavy reliance on working capital, which translates into higher interest cost as a percentage of sales. This eats into profitability even as revenue grows. During FY19, interest costs rose by 50 basis points to 2.8%. A basis point is 0.01%.

On the whole, the declining contribution of the power T&D business has been a catalyst for KEC’s stock. At 314.50, the stock trades at 12 times one-year forward earnings.

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