Our recent meeting with the management of KEC International highlighted the company’s increasing focus on profitability and return ratios. Reduction in working capital would be a key tool to achieve the targets. Other supporting steps include stringent tender review process with the top management, right incentive structure for business heads and supporting IT infrastructure. Increasing opportunities from railways and ramp-up in the civil segment would further improve earnings. We increase our estimates by 7-14% and roll forward to 15X December 2019E target price of Rs 405/share (from Rs 345 previously). Retain ‘Add’. Process improvements implemented by the company include a strict bidding matrix to evaluate each tender opportunity against a threshold score and a detailed review by the top management, executive incentives aligned to PBT from their divisions (versus earlier focus on EBITDA) and capital allocation efficiency, and supporting IT infrastructure to improve execution. As a result, the company is now better-placed to evaluate business opportunities and has started realizing the profits/margins as envisaged at the time of bidding.
Incremental opportunities for KEC exist in railways, civil division and international operations. The management expects Rs 20 billion of orders from railways in FY2018 (electrification and composite projects). Further opportunities are seen from expansion of civil division into residential realty EPC and large tendering of $2-2.5 billion per annum for the next few years in Brazil. Moderating ordering in T&D could be compensated by non-T&D segments. Over the past five years, trade receivables for KEC have increased sharply to 242 days of sales as of FY2017 (versus 179 days of sales as of FY2013) and the net working capital has increased to 141 days of sales (versus 119 days of sales as of FY2013).
We model a conservative 20-day education in receivables by FY2020E in our estimates. A 60-day reduction in receivables by FY2020 could potentially wipe out the debt on the company’s balance sheet, reduce interest costs and improve the bottom-line. Expected reduction in working capital leads to a sharp reduction in our debt and interest cost estimates. We also increase order inflow and margin assumptions to reflect ramp-up in railways and civil segments. We thus increase EPS estimates by 7-14% in FY2019-20E and roll forward to December 2019E target price of Rs 405/share (from Rs 345 previously).