Stock Market Result Update on KEC International for 2QFY2012

Stock Market Result Update on KEC International for 2QFY2012 with an Neutral recommendation. 

KEC International’s (KEC) 2QFY2012 results exceeded ours and street’s expectations on the top-line front, but the company’s performance was very disappointing on the bottom-line front. Order inflow for the quarter totaled `1,200cr and order backlog stood at `8,450cr. We have lowered our earnings estimates by 30.0%/26.7% for FY2012E/FY2013E, respectively, to factor in the margin contraction and changed business environment. We downgrade the stock’s rating to Neutral.

Strong execution continues; margin contraction a surprise: Consolidated revenue grew by 26.2% yoy to `1,263cr (`1,001cr), higher than ours and street’s estimates. On the EBITDAM front, KEC witnessed a steep contraction to 7.2% mainly due to high raw-material prices, problems in regions such as Egypt and Libya, and execution of low-margin orders. Further, higher interest cost and tax incidence dragged down KEC’s earnings (adjusted), leading to a 55.2% yoy dip to `21.7cr.

Outlook and valuation: The overall slowdown in the power sector has left transmission EPC companies to reel under pressure. In addition, competition has intensified on the domestic front, thereby leading to pricing pressures. This is the first time KEC has witnessed a sharp margin contraction, which we believe is here to stay in the coming quarters as well, given its reflection of stress in the business environment, and thereby putting pressure on earnings growth. Further, lack of positive news flows (read sector related) would keep the stock rise under check. Notably, KEC’s stock has fallen by ~28% and underperformed the BSE Sensex by ~24% over the last three months. At the CMP of `57, the stock trades 8.4x and 6.2x, FY2012E and FY2013E, EPS, respectively. Despite attractive valuations, we downgrade the stock’s rating to Neutral with a fair value of `56.