The Hindu Business Line : KEC International: Buy

INVESTORS with a penchant for risk can consider taking exposure in the KEC International stock with a one/two-year perspective. At the current price of Rs 258, the stock trades at about 17 times its expected FY-06 earnings.

A strong order-book, de-risked business profile and expansion through outsourcing augur well for earnings growth.

KEC International is an RPG group company. The company specialises in turnkey power transmission lines projects, optical fibre cable installations, telecom infrastructure and railway electrification projects.

Growing order-books

KEC International has an order-book of about Rs 2,800 crore now. The order value is more than twice its turnover for FY-05. The order-book is likely to ensure a healthy bottomline. The company has a strong presence in West Asia and Africa.

The focus on integration and strengthening of power grids in these countries will ensure further order flows. In the domestic market, open access to transmission and distribution of power (brought about by the Electricity Act 2003) is likely to fetch turnkey orders from local players.

Of the total orders, transmission projects account for about 80 per cent and distribution projects the rest. As margins from transmission projects are higher, the combination may help sustain, if not improve, the operating margin of 8-10 per cent seen in the last three years.

De-risked business model

KEC International has traditionally derived a majority of its revenues from exports. A couple of years ago, only 10 per cent of KEC's orders were from the domestic market. The company made a loss in 2002 and has since de-risked its revenue model. It now derives about 30 per cent of its revenues from the domestic market.

It has been able to capitalise on the power reforms in the country and has contracts from Power Grid Corporation and orders through the Accelerated Power Development Reforms Programme, for rural electrification projects and State electricity board distribution projects.

KEC is also striving to move up the value chain through services such as hotline stringing, GPRS/satellite surveys and tower testing. The company has orders worth Rs 400-crore through such value-chain expansion. It expects better margins from such services.

Expansion through outsourcing

KEC has been able to augment its business in various countries through outsourcing or subcontracting. This strategy appears to have yielded good results as the company has managed to expand without building capacities. This has also helped prevent uneconomical resource deployment since the projects, especially export orders, are executed at remote places.

Corporate restructuring

KEC International recently got court approval for a restructuring exercise through which it will sell its investments and advances portfolio to a newly-formed subsidiary — KEC Holdings. The transmission business will be transferred to a new company — KEC Infrastructure — and both the companies are to be listed. Post-restructuring, shareholders will get shares in proportion to their existing shareholding in both the companies. This restructuring is also likely to unlock some value.

For the quarter-ended September 2005, KEC's revenues rose 55 per cent to Rs 413 crore and sustainable profits-after-tax 68 per cent to Rs 15.5 crore over the corresponding previous period.

The current order-book will ensure sustained growth for the next couple of years. The company's debt position has improved after its pruning by about Rs 250 crore. Short-term working capital requirements continue to be high, given the nature of the industry.

Risks

Steel is one of the major raw materials for the company. Any steep hike in steel or aluminium prices is likely to affect margins. In spite of de-risking the business model, the company's export-centric revenue carries foreign exchange-related risks. The risk is mitigated to some extent by limited hedging resorted to by the company.

While the healthy order-book is likely to sustain growth for a couple of years, it may become imperative for the company to add capacities in the medium term.

Though outsourcing has worked well for international markets, there is a risk of the company losing out domestic opportunities if it fails to build up capacities.

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