Inside Companies: KEC bets on new businesses, buyouts

ALSO READ See latest News about KEC Int See previous management interviews See what other Experts & Brokerages are saying about KEC Int KEC Int BSE | NSE 28/05/12 Are Mutual Funds betting on KEC Int?

Nachiket Kelkar
moneycontrol.com

Power Infrastructure and engineering company KEC International is betting big on new businesses like railways and water, even as it continues to chase orders in the power transmission sector, which accounts for a major share of its revenues.

The RPG-group company is also open to acquiring companies in India and overseas to fuel its growth ambitions, said Vardhan Dharkar, its CFO.

KEC International had in September 2010 acquired US-based SAE Towers Holdings for USD 95 million. The acquisition opens it doors to North American and Latin American markets, where transmission and distribution spends are increasing and SAE is amongst the largest company in the sector there. The acquisition also made KEC among the largest global transmission tower player.

"Our experience of acquisitions as far as SAE Towers goes has been very good. They have delivered more than that was expected during the time of acquisition. So in that sense KEC is more than satisfied with the acquisition that we did. We will look for acquisitions, but we will be careful in what we acquire and what price we pay, because it must deliver value to KEC," Dharkar told moneycontrol.com.

The acquisitions, if any, would be in the company's existing businesses, he said. Apart from power transmission, KEC Internationl has a presence in power systems, cables, telecom, railways and water infrastructure, which it aims to consolidate and grow further.

The power sector in India has seen a slowdown over the last one year over issues such as land acquisition, expensive fuel (coal) and high interest rates, which in turn puts pressure on companies like KEC International.

Fitch in a report this month said that the power sector would remain exposed to fuel availability and price risks in 2012.

"Launch of new generation projects will slow down in 2012 because of lower investor interest over fuel availability, softening of merchant power prices, higher fuel costs, higher interest rates and slow progress on reforms at distribution level," the global ratings agency said.

Despite a majority of its orders coming from the power transmission sector, KEC is not impacted much and remains unfazed as many of its orders are from international markets and its order book in other businesses is also growing fast.

"If you look at KEC's order book today, we started with an order book of around Rs 7,800 (crore) and today as we enter 2012, we are sitting on an order book of Rs 9,000 crore. So there has been a good growth in order book from the beginning of the year. And the orders have come in all segments of the business. Whether, it is transmission, whether it is railway, whether it is power system, or water. In each of the businesses, we have received good order flow," said Dharkar.

Almost 30% of the orders are from the businesses KEC entered in the last three years, he points out. For instance, it has orders of over Rs 350 crore in the Railways segment and more than Rs 200 crore in Water segment. Also at least half of the company's orders come from overseas markets spread across West Asia, Central Asia, Africa, North America and Latin America.

KEC's order book has grown over 15% this year, with over Rs 1,900 crore worth orders announced in January alone.

However, KEC's net profit for the first half of this year fell 21% year-on-year to Rs 54.28 crore, even as net sales for April-September rose near 24% to Rs 2,285.54 crore.

The company's margins have been under pressure for some time now given the increasing competition and the overall slowdown in the transmission business. Dharkar also pointed out that the company was bidding and executing projects in the new businesses at lower EBITDA margins. In future, he said margins would improve as the company will bid for projects at higher margins.

Earlier this month, Kotak Institutional Equities initiated coverage of KEC International with a "buy" rating on the stock, citing among other reasons its strong order backlog, well diversification across segments and geographies and benefits from rupee depreciation, given its overseas project executions. But it is cautious on the sector as well as the company in the near-term.

"We build in relatively conservative estimates for KEC with revenue CAGR of 6-7% over fiscal 2012-14. We expect margins to remain subdued at sub-10% over the next few years on increased competition and revenue contribution from new businesses," analysts Supriya Subramanian and Lokesh Garg said in the report.

The analysts further added that incremental orders from state electricity boards looked uncertain due to relatively "unhealthy financial conditions." Also rising competition has led to sharp price corrections in transmission and distribution markets, squeezing potential margins, Subramanian and Garg added.

KEC International shares have appreciated 45% in the last one month, on the back of the several large order wins. The stock though is still down 49% since January 2011.

Here is the verbatim transcript of Moneycontrol.com's interview with Vardhan Dharkar:

Q: There are a lot of headwinds in India - inflation, high interest rates, overall growth is also slowing down... What's your assessment as far as your sector is concerned and the overall trend?

A: Let me first wish a very happy and prosperous 2012. Coming to your question, I think inflation is trending downwards now, and I expect as we move forward now in this quarter and the next quarter, the inflation and consequently interest rates, both will show a declining trend. So what we saw and experienced in last two quarters, I hope will be a thing of past and we should see positive developments taking place. RBI has made positive noises...So that's also an encouraging sign. So my expectation is both on inflation and interest rates, there will be positive developments taking place and by the time we end the current year, that is December 2012, the interest rates would have come down significantly.

Q: If we come to KEC as a business, major share of your orders come from power sector, where the scenario is not very encouraging to say the least. What's your assessment? Are you seeing any pickup going ahead?

A: I think the one factor that was hampering investment in the power sector, that is high capital or interest cost, over a period that should not be a major factor, that should come down. But there are other factors, which I think India needs to address, and those are issues related to land acquisition, issues related to environment, issues related to the fuel linkage. And I am confident that as we move forward, India will address those issues, because, ultimately all are the issues, which if we don't address, will result in slowdown of investment in infrastructure and consequently a slowdown in the GDP growth. So I am sure India will address these issues.

Come to KEC, one good thing for KEC is that consistently almost half or more than half of our order book has come from business outside of India. And even there we have a well diversified geographical spread. We have good business interest in Americas, Middle East, Central Asia and Africa. So in a way for KEC that risk has been managed very well, and we are able to grow our business, irrespective of one geography not doing well.

Q: Are you looking more now for international orders, given that everyone is talking of more slowdown in India, especially the power sector?

A: The way KEC is structured, we look at business globally. And we are not focused on geography or that so much percentage of business should come from this geography. What we are focused upon is a sustainable business and a business, which is robust and giving good potential to KEC. And in that sense, whether that business comes from Africa or USA, is a secondary factor for us. So if today for example, everybody is expecting India to slowdown, maybe there will be more proportion of orders coming from international. But that is not because we have strategically decided that we will focus more on international. It's simply that the business is there.

Q: You have recently forayed into new projects like waterways, railways... How's the growth there?

A: We at KEC are happy with the way we have progressed in the new initiatives we have taken in last three years or so. Each of the businesses that we got into, whether it is power systems, whether it is cables, railway or water, each of them has done very well. Railway, which we got into couple of years back, has an order book of almost Rs 350 crore plus. Water, which we entered last year, in a very short span of twelve months has order book, which is I think Rs 200 crore plus. So all in all I think the investment we are making is resulting into a good progress for KEC and today if you look at our order book composition, almost 30% of our orders come from the businesses we have started in last three years. So that is a pretty encouraging sign. In fact, the biggest order in KEC's history came from not transmission, but actually power systems. So that's also very positive indication that the focus that we are giving to new businesses is resulting into a good payback to KEC.

Q: So does that mean KEC is slowly moving away from its traditional power transmission business to these new ventures?

A: KEC is not moving away from power transmission business. Our focus and attention that we give to power transmission continues to remain there. The investment that is required in power transmission business is fully made. Like for example, last year we acquired SAE Towers, that's a transmission business. So its not that we are moving away from transmission, but along with transmission we have looked at businesses, which we believe we have core competency and we can leverage our competency and strength built over the years and growth those business successfully. That's the focus and that's how we have selected each of these businesses very carefully. We believe that we will be able to do a value add over there and grow those businesses.

Q: What's your overall order book position and have you seen any slowdown in orders? Lot of companies, especially in the engineering side have been talking about it.

A: If you look at KEC's order book today, we started the year with an order book of around Rs 7,800 (crore) and today as we enter 2012, we are sitting on an order book of Rs 9,000 crore. So there has been a good growth in order book from the beginning of the year. And the orders have come in all segments of the business. Whether, it is transmission, whether it is railway, whether it is power system, or water. In each of the businesses, we have received good order flow.

Q: If we look back at second quarter results and I quote from a research report - Impressive top line but disappointing bottomline. Your margins were also under pressure. How are you seeing the third quarter and the year ahead?

A: I think we have to analyze the results in perspective. There are a couple of factors we need to keep in mind when we are looking at the second quarter results. One is the mark-to-market, the hedging that we had done for commodity, which is entirely notional and it will get reversed in subsequent quarters. And that impacted our profitability by almost a percentage point. So that's something we have to keep in mind.

Second is that as we have been saying in the past, is that the new businesses that we got into, today we are bidding and executing those projects at lower EBITDA margins. But as we move into the future, we will start bidding at a higher margin and that will result in better margin profile for those businesses as well. If you look transmission business as a whole, my margins have been consistent at what we have been saying, and what it had been in the past.

So margin profile has to be seen in the context of the new businesses that we are getting into, where in I have to invest and acquire the prequalification, plus the mark-to-market losses, which came into the second quarter, which is completely reversible impact. And third impact has been the rising interest cost. If you compare current year's interest cost with same period last year, interest rates have more than doubled in India. And that's something that is impacting not only KEC but all the companies in India.

Q: You mentioned about hedging. Are you seeing any impact from depreciating rupee? Increasingly more of your orders are now coming from international markets.

A: Impact will be there in a sense that last year when I was executing a project of USD 100, maybe I was getting at the rate of Rs 45-46, today I will get at Rs 52-53. So that will definitely result into a higher turnover. But our policy has been to stay hedged, both in commodities as well as currency. So it doesn't result into any favourable or adverse impact as far as our profitability is.

Q: What could be your typical margins? Is 9-10% kind of margins you look for in projects that you bid?

A: I think, if we analyze the profitability of a project companies, EPC companies, like KEC, whether in India our outside of India, sustainable margins have been in the region of 9-10-11%. And I think that is the trend that will continue to be there in the future also. You will always have deviations from that. Sometimes, you will find better margins then that, and sometimes, you will find that your margins are impacted because you executed couple of projects, which you bided at lower margins. Overall, I think, over a period you will find margins in this range.

Q:. The markets have been volatile for the past one year. What's your sense? Are you still open to acquiring companies in India and global markets?

A: Our experience of acquisitions as far as SAE Towers goes has been very good. They have delivered more than that was expected during the time of acquisition. So in that sense KEC is more than satisfied with the acquisition that we did. We will look for acquisitions, but we will be careful in what we acquire and what price we pay, because it must deliver value to KEC. And that's something, which is a predominant and prerequisite for any acquisitions for KEC to get into. So we will be open for growth through inorganic means.

Q: Would it be in the business that you are currently into, or it could be a new business area as well?

A: I think in the last three years we have got into this three or four new businesses. Our strategy today would be to consolidate and grow those businesses. So today we will look for growing into the businesses that we are currently into rather than getting into and acquiring a company, which is not in our portfolio today.

Q: Are you in talks with companies as far as acquisitions go?

A. I think, that's a continuing process. So as and when something happens, discussions are always going on. But...as and when something happens then we will discuss and then we will come to you.