The global economic slowdown may prove to be a dampener for many, but there are a few companies that may go relatively unscathed. One of them is KEC International, a leading engineering, procurement and construction (EPC) player in the power transmission and distribution (T&D) space, which generates about 65 per cent of its revenue from international markets including 25 per cent for the Middle East region. Among reasons that will help the company tide over the current crisis is its strategy of diversifying into other geographies across the world, as well as increasing focus on the domestic market, where the growth potential is immense.
Expanding markets
Given the global slowdown, most of the analysts prefer to stick to domestic consumption plays, whether it is in the transmission or any other sector. The reasons are not surprising, in light of the possible impact on the fortunes of companies with high exposure to the global markets, including the oil producing countries. However, says Ramesh Chandak, managing director and CEO, KEC International, “The falling crude oil prices are bound to have an impact on the overall capex in the middle-east, but that is not the case with every other country.” Giving an example, he mentions about the company’s recent overseas orders of Rs 678 crore received from customers in Egypt (Rs 636 crore; its biggest international order) and Australia (Rs 42 crore), which is a result of KEC’s focus on geographical diversification. He further adds, “Even in the case of oil producing countries, it is not as bad as projected. These countries are still preparing their budgets taking into account oil prices at about $60-70 per barrel rather than the current oil prices.”
For now, thanks to its effort to diversify, the company is catering to about 20 countries globally, including some of the potential markets like Africa, Central Asia and North America. Notably, many of these markets are underdeveloped in terms of power infrastructure and thus offer significant opportunities. Also, many of these projects are backed by funding from international development agencies like World Bank and Asian Development Bank, which suggests that money should not prove to be a hindrance. To sum up, the company is expecting its international business to grow at about 15-20 per cent, which is a result of growing demand and its strategy to keep on adding new markets in its international portfolio.
Domestic focus
Even as a large part of KEC’s revenue comes from the international markets, it is well focused on the domestic market, which currently contributes about 30 per cent to its total revenue. In the domestic market and during April-September 2008, Power Grid Corporation issued orders, of which, the company bagged about 14 per cent of the total, giving it the largest share of the orders. The merger of RPG Transmission (in 2008), a dominant leading player in domestic power transmission market, will help KEC in bidding for larger projects and thus further consolidate its position. All these, thus, point towards the company’s stronghold in the domestic operations as well as its ability to seize emerging opportunities in the power transmission space in India.
Long-term prospects
While the thumb rule says that every megawatt of new power generation capacity requires an investment of Rs 4-4.5 crore, another Rs 1.5 crore is required as investment in T&D infrastructure if the power generated has to efficiently reach the point of consumption (household, industry, etc). In this light and given that India has plans to add 78,000 mw in the 11th five-year plan (2008-12) and 80,000 mw in the 12th plan (2013-17), there is enough growth visibility for companies in the T&D infrastructure space. The government’s focus to electrify every village and the huge investments being made in setting up the ultra mega power plants (4,000 mw each) provide further comfort in terms of growth potential.
According to industry estimates, government owned, Power Grid Corporation has capital expenditure plans of Rs 55,000 crore on T&D during the 11th five-year plan. Out of this, Power Grid will spend about Rs 8,500 crore in FY09 and about Rs 9,000-10,000 crore in FY10. Importantly, a similar amount will be spent by various State Electricity Boards and under schemes like rural electrification and APDRP.
| POWER PACKED | |||
| in Rs crore | FY 08 | FY 09E | FY10E |
| Sales | 2,815 | 3,400 | 4,150 |
| EBITDA (%) | 12.6 | 10.5 | 10.5 |
| Net profit | 148 | 172 | 210 |
| EPS (Rs) | 29.9 | 35.1 | 42.9 |
| PE (x) | 5.5 | 4.7 | 3.5 |
| E: Analysts estimates | |||
In the near term viz. over the next 2-3 months, there are expectations that the pending orders for FY09 worth Rs 2,500-3,000 crore will be announced and issued by Power Grid. Being among the leading players in this segment, KEC International should emerge as a key beneficiary from this move. Besides, the increasing emphasis on electrification of the railways, thrust on railway modernisation and development of the dedicated freight corridors could be good future growth drivers for companies operating in the T&D space. To grab a large chunk of the emerging opportunities in the sector, KEC is now nearly doubling its combined (outsourced and own) manufacturing capacity from 110,000 tonne to 200,000 tonne per year.
Investment rationale
Developments in the recent past suggest that things are set to improve for the power transmission sector as well as companies like KEC. For instance, the falling interest rates, lower commodity prices and the likely increase in domestic inflow of power transmission orders in H2, FY09 augurs well for the company. “Our average cost of borrowing is in the range of 10-10.5 per cent, which should gradually come down going forward. Also, the impact of falling commodity prices will be marginally positive improving operating margins by about 100 basis points,” says Vardhan Dharkar, chief financial officer, KEC International. The latter should help offset half of the 186 basis points fall in margins (excluding forex related provisions) in Q2, FY09.
Notably, the company’s current order book of about Rs 5,000 crore, which is about 1.8 times its FY08 revenue and to be executed over the next 18 months, provides good earnings visibility. In terms of valuations, the stock is trading at historically low levels. At Rs 165, the stock is trading at 4.7 times its FY09 estimated earnings and 3.5 times FY10 earnings; dividend yield works out to a shade over 3 per cent. Considering the robust earnings prospects over the next few years and attractive valuations the stock offers good investment opportunity.
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