KEC International rating: Buy – Performance in first quarter was steady

KEC International (KEC) beat our headline estimate by 10% given lower impact of Covid-19 on 80% of the company’s sites/sectors. Execution has accelerated across sites from July. Management highlighted mechanisation and digitalisation initiatives are picking up and could result in speedier execution and some cost savings–more sustainable.

Strong revenue visibility of 1.7x with Rs 500-bn tender pipeline and stable working capital (D/E at 1.2x) are comforting. That said, we advise caution, anticipating margin headwinds from fixed-price contracts given commodity headwinds, especially in SAE projects. We revise our target P/E to long term average of 12x (10x earlier) given receding execution challenges, improving liquidity and orders visibility. Maintain Buy with revised TP of Rs 325 (earlier Rs 275).

Better-than-expected execution; focus on cost optimisation: KEC’s Q1FY21 revenue declined 9% versus 15% decline estimate—while T&D revenue fell 9%, railways was flat. Ebitda margin slid 160bps to 8.8% due to: (i) negative operating leverage; and (ii) contractual cost overruns in SAE projects in Brazil (KEC is negotiating). Margin is likely to improve to ~9.8-10.0%, but unlikely to touch 10.5% given commodity headwinds. Debt management and cash collection have been key focus areas, reflected in flat net debt at Rs 33 bn in Q1FY21.

Order book and bidding pipeline comforting: Mgmt indicated the bidding pipeline is fairly healthy at Rs 500 bn (Rs 250 bn already bid for and Rs 300 bn to be tendered). In India, there is a strong traction in railways and civil orders. However, T&D ordering/pipeline is tepid–likely to pick up in ensuing quarters, in our view.

Outlook: Well cushioned —The stock is up 50% in the past three months and trading at 10x (FY22e earnings), and our revised 12x assigned P/E is still at 20% discount to peak multiples. We conservatively estimate 12% earnings CAGR with 20% RoE. We maintain ‘BUY/SP’.