power transmission towers

Power Equipment

1

FY07 only a curtain raiser

Expansion of power transmission and distribution (T&D) capacity in India has fuelled growth

of the power T&D EPC industry in the last two years of the Tenth Plan period (FY02-07).

Historically, activity levels are much higher in the later years of five year plans. Power Grid

Corporation (PGCIL) is likely to invest INR 65 bn in FY08E (~INR 20 bn in Q4FY08E), ~INR

85 bn in FY09E, and ~INR 300 bn from FY10-12E to upgrade India’s power transmission

network. Hence, in the Eleventh Plan period, we are likely to see heightened activity in

power T&D EPC industry from FY10-12E.

Africa and Middle East to supplement demand from PGCIL

Addition in generation capacity in Africa and Middle East will facilitate expansion of regional

transmission network. We believe capacity expansion in the African and Middle Eastern

power sectors will positively impact our coverage universe. The integration of regional grids in

the above geographies will supplement domestic demand and emerge as a large business

opportunity for domestic T&D companies, leading to strengthening of their order books.

Margins likely to decline

While demand for experienced and qualified power T&D EPC players is increasing,

competition is also on the rise simultaneously, which is likely to keep margins under

pressure. The industry posted peak margins in FY07, however, we believe the EBITDA

margins of ~12%, in line with global standards; are likely to be sustainable in the long term.

Working capital: Bane of the industry

RoCEs of the industry have improved from FY01, which, back then, had been driven down

by low margins and working capital turnover. We believe due to high working capital

requirement, companies in the power T&D EPC industry go in for frequent dilution. Working

capital requirements in the industry are governed by the business models and EPC

services offered across different companies. Of the top three players in the industry, KEC

International (KECI) has the highest working capital turnover, primarily due to its outsourced

business model while Jyoti Structures (JYS) has higher working capital requirement due to

higher component of sub stations business. Hence, we believe it is more susceptible to

dilution risks compared to KECI or Kalpataru Power Transmission (KPP).

Outlook and valuations: Positive; KPP is our top pick; downgrading JYS

While the revenue growth and profitability remains impressive across the industry we prefer

companies which have lower risk profile and superior working capital management.

International geographies are likely to grow at a high rate, however we believe they increase

the risk profile of the business due to fixed price contracts and exchange rate variations.

Hence, KPP is our top pick, as we believe it has an optimal revenue mix from domestic and

international geographies and sound working capital management. On our current

estimates KPP is trading at a P/E of ~13x and ~10x our FY09E and FY10E, respectively.

We maintain our ‘BUY’ recommendation on the stock. We like KECI primarily because it

has the highest RoCE’s driven by higher than industry working capital turnover. KECI is

trading at a P/E of ~16x and ~13x, while JYS is trading at a P/E of ~15x and ~11x our

FY09E and FY10E, respectively. We maintain our ‘BUY’ recommendation on KECI, while

we are downgrading JYS to ‘ACCUMULATE’.

February 26, 2008 Misal Singh +91-22-2286 4316 [email protected] Pawan Parakh +91-22-4019 4995 [email protected]

India Equity Research | Power Equipment Sector Update

POWER TRANSMISSION TOWERS

What lies beneath

Edelweiss Research is also available on Bloomberg EDEL <GO>, Thomson First Call, Reuters and Factset.

Power Equipment

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Power Equipment

3

Investment Rationale

FY07 only a curtain raiser

Expansion of power transmission and distribution (T&D) capacity in India has fuelled growth of

the power T&D EPC industry in the last two years of the Tenth Plan period (FY02-07); growth in

the power T&D EPC industry was below average in the initial years of the Tenth Plan period.

Fortunes of the power T&D EPC industry are governed by the capacity expansion plans of

Power Grid Corporation of India (PGCIL) to a large extent, as it is the central transmission utility

in India. PGCIL added more than twice the transmission capacity in FY07 compared to FY03,

which has directed the revenue growth pattern of the industry as demonstrated in table 1.

Table 1: Historical revenues and EBITDA growth

Average FY01-04 Average FY05-07

CompanyRevenues

growth (%)EBITDA

growth (%)Revenues

growth (%)EBITDA

growth (%)Kalpataru Power Transmission 29.4 27.0 67.8 104.5 KEC International 15.8 NM 28.8 45.1 Jyoti Structures 4.1 0.4 51.2 74.8

Source: Edelweiss research

From FY05 onwards, the industry started posting robust growth with Kalpataru Power

Transmission (KPP) posting a revenue growth of ~81%, KEC (KECI) of ~18%, and Jyoti

Structures (JYS) of ~39% in FY07.

Table 2: Relative size of leading EPC transmission companies in FY07

(INR mn)

Company Revenues EBITDACapital

employedKalpataru Power Transmission 15,987 2,563 7,453KEC International 20,406 2,518 6,824Jyoti Structures 9,708 1,254 4,325


Historically, activity levels are much higher in the later years of five year plans. PGCIL is likely to

invest INR 65 bn in FY08E (~INR 20 bn in Q4FY08E), ~INR 85 bn in FY09E, and ~INR 300 bn

from FY10-12E to upgrade India’s power transmission network. Hence, in the Eleventh Plan

period, we are likely to see heightened activity in the sector in FY11E and FY12E.

Besides PGCIL, Damodar Valley Corporation (DVC) and various state electricity boards (SEBs)

also undertake transmission capacity expansion in India. However, their plans are less

dependable than PGCIL’s, as most of the SEBs are crunched for funds. Further, their poor

payment record does not make them preferred customers.

Power Equipment

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Table 3: Power transmission spend in Tenth and Eleventh Plans

(INR mn)

Year to March 2003 2004 2005 2006E 2007EXth plan

total 2008E 2009E 2010E 2011E 2012EXI th plan

total

Central sector 28,004 24,849 32,815 41,985 57,660 185,313 91,020 146,092 175,714 179,556 164,394 756,775

PGCIL 27,649 24,212 32,224 41,336 56,446 181,867 64,650 110,140 130,840 130,090 109,790 545,510

% change (12.4) 33.1 28.3 36.6 - 14.5 70.4 18.8 (0.6) (15.6) Others 355.3 637.1 591 649.2 1213.7 3,446 26,370 35,952 44,874 49,466 54,604 211,265

% change 79.3 (7.2) 9.8 87.0 - 2,072.7 36.3 24.8 10.2 10.4 State sector 32,863 36,235 43,194 50,109 90,454 252,854 94,238 134,993 149,043 100,898 82,449 561,622

Northern region 8,008 8,559 12,191 14,932 15,361 59,050 21,291 20,409 24,322 22,042 17,076 105,139

% change 6.9 42.4 22.5 2.9 - 38.6 (4.1) 19.2 (9.4) (22.5) Western region 3,597 3,997 3,708 3,554 15,951 30,806 15,576 33,315 52,685 37,825 22,431 161,832

% change 11.1 (7.2) (4.1) 348.8 - (2.3) 113.9 58.1 (28.2) (40.7) Southern region 10,173 12,479 12,944 13,501 33,352 82,448 36,665 39,125 17,100 15,171 25,563 133,625

% change 22.7 3.7 4.3 147.0 - 9.9 6.7 (56.3) (11.3) 68.5 Eastern region 10,585 10,643 13,150 16,869 23,407 74,655 15,944 35,164 48,108 19,075 11,963 130,254

% change 0.5 23.6 28.3 38.8 - (31.9) 120.5 36.8 (60.4) (37.3) North eastern region 501 557 1,201 1,253 2,384 5,896 4,762 6,980 6,829 6,785 5,415 30,771

% change 11.2 115.6 4.3 90.2 - 99.8 46.6 (2.2) (0.6) (20.2) Total All India 60,868 61,084 76,009 92,094 148,113 438,167 185,258 281,085 324,757 280,453 246,844 1,318,397

Source: Central Electricity Authority, PGCIL

Besides transmission projects initiated by PGCIL and others, power T&D EPC companies are

also present in power distribution upgradation projects for which the nodal agencies are Power

Finance Corporation (PFC) and Rural Electrification Corporation (REC). Also, some distribution

upgradation projects are initiated by SEBs. The outlay for distribution upgradation projects is

~INR 800 bn, equally divided between rural electrification (Rajeev Gandhi Grameen Viduytikaran

Yojna) and Accelerated Power Development Reform Programme.

While power transmission EPC primarily involves transmission lines and substations, power

distribution EPC entails strengthening of the distribution network. Transmission lines entail tower

and conductor supplies, civil construction, engineering, and testing. Substation projects include

procurement of electrical equipment, civil construction, engineering, and testing.

Table 4: Capital expenditure break up for transmission and substation projects

Transmission line towers (%) 65.0 Tower supplies 19.5 Conductors 19.5 Civil construction 19.5 Engineering and testing 6.5

Substations (%) 35.0 Electrical equipments 22.8 Civil construction 8.8 Engineering and testing 3.5


Given PGCIL’s capacity expansion plans, we have arrived at the likely spend on each of the

above components of power transmission EPC.

Power Equipment

5

Table 5: Breakup of T&D spend

(INR mn)

Central sector 2008E 2009E 2010E 2011E 2012E XI th plan

total PGCIL 64,650 110,140 130,840 130,090 109,790 545,510 Transmission line towers 42,023 71,591 85,046 84,559 71,364 354,582

Tower supplies 12,607 21,477 25,514 25,368 21,409 106,374 Conductors 12,607 21,477 25,514 25,368 21,409 106,374 Civil construction 12,607 21,477 25,514 25,368 21,409 106,374 Engineering and testing 4,202 7,159 8,505 8,456 7,136 35,458

Substations 22,628 38,549 45,794 45,532 38,427 190,929 Electrical equipments 14,708 25,057 29,766 29,595 24,977 124,104 Civil construction 5,657 9,637 11,449 11,383 9,607 47,732 Engineering and testing 2,263 3,855 4,579 4,553 3,843 19,093


As is evident from table 5, revenue visibility in the sector is high and likely to remain so over the

long term. Quarterly volatility in order accretion is likely, however, the power situation in India is

so grim (per capita annual consumption of ~660 kwh) and the need to correct the same is so

crucial that we have seen increased emphasis on rectifying the situation from the government in

the first year of the Eleventh Plan itself.

High margins too good to last; RoCEs likely to improve

While demand for experienced and qualified power T&D EPC players is increasing,

simultaneously, competition is also on the rise.

Table 6: Key power T&D EPC companies

Name Factory location Capacity (MT)Kalpataru Power Transmission* Gandhinagar 84,000 KEC International* Butibori and Jaipur 60,000 Jyoti Structures* Nasik and Raipur 96,000 Larsen & Toubro Pondicherry and Pitampura 60,000 Associated Transrail Baroda, Butibori 45,000 ICOMM Hyderabad 45,000 Hyundai Butibori 25,000 Amitasha Nagpur 24,000 Karamtara Tarapur 24,000 Maan Structures Jaipur 19,200 Emco* Baroda 20,000

Source: PGCIL, Edelweiss research

Besides the above players, there are also likely to be a few private companies catering to power

distribution EPC jobs being floated by SEBs. Increase in competition is likely to limit margin

expansion. The industry posted peak margins in FY07, but the same are unlikely to be repeated

in the medium to long term. However, the RoCEs are likely to improve given the improvement in

working capital turnover.

Power Equipment

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Table 7: RoCE trends over the years (%)

CompanyAverage FY01-

04Average FY05-

07Average FY08E

10E

Kalpataru Power Transmission 12.0 33.8 27.7 KEC International 1.8 23.7 43.3 Jyoti Structures 11.2 27.6 29.7


Working capital: Bane of the industry

RoCEs of the power T&D EPC industry have improved from FY01, which, back then, had been

driven down by low margins and working capital turnover. The improvement in the operating

performance of the industry coincided with increase in PGCIL’s capital expenditure.

Of the top three players in the industry, KECI has the highest RoCE, primarily due to its distinct

business model. Since the company has a history of troubled labour relations, it outsources its

tower manufacturing capacities. The two key issues in an outsourced business model are that

outsourced tower manufacturing capacities need to be preapproved by PGCIL and the issue of

steel accounting, which implies higher wastes. However, we believe, over the years, KECI has

mastered this business model and hence, it is earning higher returns on its capital employed

than peers. The company also has higher working capital turnover than KPP and JYS, which is

driven by higher creditors/revenues compared to peers. We believe this is primarily driven by its

outsourced business model.

Table 8: Key performance ratios

Company RoCE (%)EBIT /

Revenues (%)

Asset turnover net PPE/

Revenues (x)

Operating working capital/

Revenues (x)Creditors/

Revenues (x)Tax rate

(%)Kalpataru Power Transmission 27.7 16.2 13.7 35.2 29.8 26.5 KEC International 43.3 10.7 20.1 13.4 46.7 34.2 Jyoti Structures 29.7 12.3 5.8 38.7 26.9 36.2

RoCE (FY07)


Due to high working capital requirement, JYS’s cash flow requirements are higher than the

others and hence, the cash flow situation of KPP and KECI is better than that of JYS. The same

is also reflected in JYS’s capital history, wherein it has gone in for frequent dilutions compared

to KPP or KECI.

Table 9: JYS—Capital history

(INR mn)

Year Remarks Equity capital % dilution

Opening capital for FY01 49.1 -

FY01 Right issue 49.1 99.9

FY04 Private placement 20.0 20.4

FY05 Private placement 20.0 16.9

FY07 ESOP 0.7 0.5

Conversion of warrants 7.0 5.1

New issue for cash 15.5 11.2 Source: Edelweiss research

Power Equipment

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Table 10: KPP—Capital history

(INR mn)

Year Remarks Equity capital % dilution

FY07 Opening capital for FY07 * 217.2

QIB placement 47.8 22.0

265.0 Source: Edelweiss research Note: * Adjusted for bonus issue in FY07

However, in a high growth environment, investors prefer to look at growth opportunities and

hence, revenue and PAT growth become key focus areas. We believe this is likely to be the

case in the power T&D EPC industry as well, as the industry is currently in a high growth phase

and JYS is likely to show higher growth than KPP and KECI and hence, negative cash flows due

to low working capital turnover are likely to be overlooked. However, we believe negative cash

flows make JYS more susceptible to dilution risks than KPP and KECI.

International geographies: Overview

Africa

The African market’s power generation capacity in FY07 was ~84 GW and demand growth in

the continent has significantly outpaced supply, leading to frequent blackouts and disruptions in

the country’s key mining sector. Growth in demand has been driven by the rising mining and oil

prospecting activities in the continent.

Chart 1: Electricity production in Africa in 2005

-

7,000

14,000

21,000

28,000

35,000

Sou

th A

frica

Egy

pt

Alg

eria

Nig

eria

Mor

occo

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Ken

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re

Cam

eroo

n

Sud

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(MW

)

Source: Central Intelligence Agency, Edelweiss research

Power generation is concentrated majorly in the northern and southern parts of the continent.

South Africa contributes ~50% of the total electricity production in the continent And Eskom

(South Africa) dominates power generation in the region. It generates, transmits, and distributes

electricity to industrial, mining, commercial, agricultural, and residential customers and

redistributors and generates ~95% of electricity used in South Africa and ~45% of electricity

used in Africa. Among other countries, Egypt, Algeria, Nigeria, Morocco, and Libya are major

producers of electricity in the continent; they, together, contribute ~38% of the total electricity

produced in the continent.

Power Equipment

8

As the generation capacity in the continent is concentrated, countries have formed pools (such

as South Africa Power Pool–SAPP; West African Power Pool–WAPP, among others) to build a

robust inter-regional power transmission system. These regional pools have planned a series of

priority projects in generation and transmission segments. Over 2004-06, SAPP commissioned

1,140 MW of new capacity.

Table 11: Generation capacity over 2004-06

Country Plant Capacity (MW)

Angola Capanda -1 260

Tanzania Ubongo 80

Zambia Kariba North 30

RSA Camden 380

Zambia Kariba North 30

RSA Camden 190

RSA Arnot 120

Swaziland Maguga 20

Zambia Kafue Gorge 30

1,140 Source: SAPP reports, Edelweiss research

The SAPP region’s available capacity in FY07 stood at ~41 GW. It is estimated that the South

African regional demand will grow by ~3.6% annually to ~57 GW in 2010.

Chart 2: SAPP capacity details

30,000

38,000

46,000

54,000

62,000

70,000

FY05

FY06

FY07

E

FY08

E

FY09

E

FY10

E

FY11

E

FY12

E

FY13

E

FY14

E

FY15

E

(MW

)

Capacity planned Capacity required Peak demand forecast

Source: Central Intelligence Agency, Edelweiss research

To bridge the demand-supply gap, SAPP is working on short term generation projects to be

commissioned before 2010 and long term generation projects to be implemented after 2010.

Under short term projects, it plans to commission ~13 GW over FY07-10.

Power Equipment

9

Table 12: Generation capacity (MW) addition during 2007-10E

Country Capacity (MW)

Angola 343

Botswana 600

DRC 1,136

Lesotho 28

Malawi 104

Mozambique 912

Namibia 800

RSA 6,639

Swaziland 20

Tanzania 260

Zambia 1,350

Zimbabwe 1,315

13,507 Source: SAPP reports, Edelweiss research

Over the long term, SAPP will add ~32 GW of power generation capacity to bring the total

available capacity to ~82 GW. Outlay for this project stands at ~USD 43 bn over the next 8-10

years. Of the USD 43 bn, Eskom plans to spend ~USD 39 bn, which includes 70% in the power

generation space and the balance in transmission and distribution systems.

The total installed capacity in the western region is ~8 GW as in 2003. The per capita

consumption of electricity in the region is among the lowest in the world. Economic and

population growth, with ~70% of the population currently off grid, has led to a strong demand

for electricity. Power demand in the region is expected to grow at 7.6% annually till 2020.

WAPP has identified following projects for first phase of regional network development to be

executed over the next five years.

Table 13: WAPP priority projects

(USD mn)

Country Details No.of substations Value

Nigeria - Benin - Niger - B.Faso 330kV, 715 km 5 443

Aboadze-Prestea-Kumasi-Han in Ghana 330kV, TBDS 4 TBDS

Tunu-Han-Wa in Ghana TBDS 3 TBDS

Ghana - Cote d’Ivoire 225kV, 200 km 2 TBDS

Ghana - B.Faso - Mali TBDS TBDS TBDS

Bobo Dioulasso –Ouagadougou in B. Faso 225kV, 360 km 2 130

Laboa (CI) – Ferke (CI) –Sikasso (Mali)- Segou(Mali) TBDS TBDS TBDS

Aboadze - Volta in Ghana 330kV, 215 km 2 38

Ghana - Togo - Benin 330kV, 340 km 3 105

Benin - Nigeria 330kV, 70 km 2 40

Cote d’Ivoire - Ghana 225kV, 220 km 2 TBD Source: WAPP, Edelweiss research Note: TBDS- To be determined by study

Middle East and North Africa (MENA) The total installed power capacity in the MENA region stood at ~162 GW (as of end 2005),

representing ~4.5% of the world’s total installed capacity. Demand in the region is expected to

grow at ~7% annually for the next 8-10 years.

Power Equipment

10

According to the World Energy Council, the Gulf Cooperation Council (GCC) region will require

100 GW of additional power over the next 10 years to meet the growing demand. As stated in

table 14, GCC countries plan to invest ~USD 36 bn for power generation projects by 2010. It is

expected that ~USD 57 bn will be spent over the next five to six years in the MENA region for

installing new capacity.

Table 14: Country-wise power generation capacity addition by 2010

(USD bn)Countries Capacity (MW) Estimated costSaudi Arabia 20,000 15.0 UAE 6,600 5.1 Qatar 800 0.6 Oman 1,100 0.9 Lebanon 350 0.2 Kuwait 3,400 2.5 Jordan 750 0.4 Iran 20,000 10.0 Bahrain 1,200 0.9

54,200 35.6 Source: MEED, Edelweiss research

The GCC countries are in the midst of implementing a regional power grid project at an

estimated cost of ~USD 3 bn to be completed by the end of 2010. The states have established

the GCC Interconnection Authority, aimed at linking power grids of all the six GCC countries (viz.,

Saudi Arabia, Qatar, Bahrain, Kuwait, Oman, and UAE). The GCC Interconnection Grid will be

developed in three phases: First phase will form the north grid, interconnecting Kuwait, Saudi

Arabia, Bahrain, and Qatar. Thirteen contracts worth USD 1.25 bn will be awarded in this phase.

In the second phase, the south grid interconnection of the independent system in the UAE as

well as Oman will be completed. Third phase will interconnect the south and north grids, which

will complete the interconnection of the six Gulf states.

We believe the addition in generation capacity will facilitate expansion of regional transmission

network and inter regional capacity to transmit power. We expect the African and Middle

Eastern power sectors to have a positive impact on our coverage universe. The integration of

regional grids will emerge as a great business opportunity for domestic T&D companies, leading

to strengthening of their order books in case of any slow down in domestic (PGCIL majorly)

spending as had happened in H1FY08.

KEC already has a strong foothold in foreign markets compared to peers; KPP and JYS have

also increased exposure in the export market, with both the companies receiving key orders in

the following regions:

Power Equipment

11

Table 15: Details of recent international orders

Agency Brief details Order value (INR mn)

Company Country

NamPower Contract for execution of approximately 650 km of 350 kV HVDC transmission line.

2,963 Jyoti Structures Namibia, Africa

Saudi Arabian Mining Company (MA'ADEN)

Turnkey job of 380 kV DC transmission lines of 123 kms.

2,600 KEC Saudi Arabia

NamPower Turnkey job of 350 kV double circuit bipolar HVDC transmission line of 306 kms.

1,400 KEC Namibia, Africa

GRTE Sonelgaz Turnkey job of laying 400 KV transmission line project

1,550 Kalpataru Algeria, Africa

Ethiopian Electric Power Corporation & Electricity De Djibouti

Turnkey job for construction of 230 kV & 63 kV transmission lines of Ethiopia-Djibouti power interconnection

1,580 Kalpataru Ethiopia& Djibouti, Africa


Power Equipment

12

Valuation

In the power T&D EPC space, KPP is our top pick, notwithstanding its disappointing Q3FY08 results.

We like the company due to its historical record, significant revenues coming from the Indian market,

diversified business model, and robust return ratios.

Table 16: Peer comparison

Company Price EPS P/E (x) RoCE (%)(INR) FY07 FY08E FY09E FY10E FY07 FY08E FY09E FY10E FY07 FY08E FY09E FY10E

Kalpataru Power Transmission 1,236.0 60.9 72.9 93.5 120.4 20.3 17.0 13.2 10.3 31.6 26.3 28.6 30.2KEC International 710.0 27.8 33.6 44.4 56.0 25.6 21.2 16.0 12.7 37.1 42.3 44.1 43.5Jyoti Structures 209.1 6.8 10.7 13.9 18.5 30.7 19.5 15.1 11.3 33.3 31.5 28.4 29.4 Source: Edelweiss research

If we look at five year total returns to shareholders (TRS), KPP has performed better than peers; also

its three years’ TRS have been better than JYS and KECI. However, one year TRS for KPP are low,

primarily due to the share price reaction to poor Q3FY08 results.

Chart 3: Company-wise yearly CAGR returns

- 50 100 150 200

Jan 07-08

Jan 06-08

Jan 05-08

Jan 03-08

CAGR returns (%)

KEC Jyoti Structures Kalpataru


Kalpataru Power Transmission

Kalpataru Power Transmission (KPP) did not incur losses in FY01 or FY02, even when the rest

of the industry posted losses. Its margins have always been higher than the industry average.

Power Equipment

13

Chart 4: KPP—Share price triggers

-

500

1,000

1,500

2,000

2,500

Apr

-02

Aug

-02

Jan-

03

Jun-

03

Nov

-03

Apr

-04

Aug

-04

Jan-

05

Jun-

05

Nov

-05

Mar

-06

Aug

-06

Jan-

07

Jun-

07

Nov

-07

(INR

)-

5,000

10,000

15,000

20,000

25,000

(Sen

sex)

Kalpataru Power Transmission BSE SENSEX

Bio mas s po wer plant o f 7.8 MW

co mmences o pera tio n

Acqn o f J MC pro jec ts

QIB placement (INR 3.5 bn)1:1 bo nus

anno uncement


Apart from power T&D EPC, KPP has presence in power generation EPC, EPC for pipelines,

and also in the construction sector through JMC Projects. It is also entering the power

generation utility space, wherein it has bagged a ~150 MW hydel power plant order. KPP is also

likely to bid for power transmission BOT projects.

To fund expansion, the company has announced plans of raising INR 5 bn capital. While we

believe KECI and JYS also offer substantial upsides, KPP is our favourite bet in the sector. On

our current EPS estimates of ~INR 94 and ~INR 120, the stock is trading at a P/E of ~13x and

~10x for FY09E and FY10E, respectively. We believe the stock offers upsides from current

levels, and maintain our ‘BUY’ recommendation.

Chart 5: KPP—P/E band

0

400

800

1,200

1,600

2,000

Apr-03 Nov-03 Jun-04 Jan-05 Aug-05 Mar-06 Oct-06 May-07 Dec-07

(INR

)

8x

10x

14x

12x

16x

18x

20x


Power Equipment

14

Key risks Slowdown in the scale up of the EPC business pipeline.

KEC International

KEC International (KECI) has made stupendous progress compared to the turbulent years of

FY01 and FY02. We like the company’s business model. It has successfully initiated the

outsourcing concept in the industry and this business model has resulted in superior working

capital turnover for the company. Further, by virtue of being active in the international geography,

the company procures equipment from locations close to its project sites. However, rupee

appreciation is likely to negatively impact its revenue growth.

Chart 6: KECI—Share price triggers

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KEC INTERNATIONAL BSE SENSEX

Strong Q3FY07

Shareholders approve arrangement between RPGT and NITEL


On our current EPS estimates of ~INR 44 and ~INR 56, the stock is trading at P/E of 16x and

13x for FY09E and FY10E, respectively. KECI aims to be the leading power T&D EPC contractor

in the world, with presence in Africa, Central Asia, and the US. While operations in the

international market are risky due to fixed price contracts, we believe KECI is better placed than

JYS or KPP to handle the complexities of the international market due to its long standing

record in the international market. We maintain our BUY recommendation on the stock.

Key risks

Adverse movement in rupee and commodity inflation.

Jyoti Structures

We like Jyoti Structures (JYS) as it is more of an India power T&D EPC play compared to KPP

or KECI. Hence, the company offers higher scope for growth at a lower risk profile. However,

we are concerned about the company’s negative cash flows in the foreseeable future as it goes

for further expansion. Also, JYS is looking at growth opportunities outside India, more precisely

Africa and the Middle East, which increases the company’s risk profile, even as it increases

revenue visibility. Further, JYS has to frequently raise capital due to negative cash flows, which

increases the risk of dilution in the future. Due to lower working capital turnover, JYS also has

lower RoCEs than KPP and KECI.

Power Equipment

15

Chart 7: JYS—Share price triggers

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SAF venture anno uncemen

Duba i J V anno uncement


On our current EPS estimates of ~INR 14 and ~INR 19, the stock is trading at a P/E of 15x and

11x for FY09E and FY10E, respectively. We do not expect any significant re-rating from current

levels over the medium term. We are downgrading our recommendation to ‘ACCUMULATE’

from ‘BUY’.

Chart 8: JYS—P/E band

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Key risks

Lower-than-expected margins and higher-than-expected working capital requirement in

international geographies.

Power Equipment

16

Pure play on power T&D EPC space

Jyoti Structures (JYS) is a pure play on the power T&D EPC space, unlike KEC and KPP—

the former has significant international presence and the latter concentrates on various

business verticals besides power T&D EPC. Hence, we believe for investors keen to play

the power T&D story in India, JYS can be the preferred choice.

High growth will compensate negative cash flows

JYS has negative operating cash flows due to higher working capital requirement. We

prefer companies with positive operating cash flows and hence, we believe, JYS runs the

risk of frequent dilution. However, revenue visibility continues to point towards high revenue

and PAT growth over the long term.

Dilution plans scrapped for now

The company plan’s to raise ~ INR 4 bn through a mix of equity, debt, and quasi-debt

instruments has been withdrawn. Now, JYS plans to raise ~25% of the initially estimated

capital through debt, while further dilution will likely be done at a later date. Hence we have

maintained the expanded capital base leading to equity dilution in our calculations till further

clarity emerges on the requirement in funds. We believe, going ahead, JYS’s working

capital is likely to come under further pressure as the company has few orders from the

Middle East geography where the payment terms are a bit more stringent.

Outlook and valuations: Dilution concerns persist; downgrading to ‘ACCUMULATE’

JYS has a robust order book (~2x its FY08E revenues) which provides good revenue

visibility. However, its high working capital requirement increases the dilution risk going

forward. On our current EPS of INR 14 and INR 19, the stock is trading at P/E of 15x and

11x FY09E and FY10E, respectively. We do not expect any significant re-rating from

current levels over the medium term. We are downgrading our recommendation to

‘ACCUMULATE’ from ‘BUY’.


Reuters : JYTS.BO

Bloomberg : JYS IN Market Data

52-week range (INR) : 328 / 152

Share in issue (mn) : 81.1

M cap (INR bn/USD mn) : 17.3 / 435.8

Avg. Daily Vol. BSE/NSE (‘000) : 171.3 Share Holding Pattern (%)

Promoters : 27.0

MFs, FIs & Banks : 16.9

FIIs : 27.8

Others : 28.3

India Equity Research | Power Equipment Company Update

JYOTI STRUCTURES INR 209

Two steps ahead, one step back ACCUMULATE


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Year to March FY07 FY08E FY09E FY10E

Revenue (INR mn) 9,708 14,906 19,938 25,955

Rev. growth (%) 39.1 53.5 33.8 30.2 EBITDA (INR mn) 1,254 1,918 2,493 3,193

Net profit (INR mn) 545 989 1,228 1,637

Basic shares outstanding (mn) 81 88 88 88

Adjusted diluted EPS (INR) 6.8 10.7 13.9 18.5

EPS growth (%) 98.7 57.6 29.5 33.3 P/E (x) 30.7 19.5 15.1 11.3

EV/ EBITDA (x) 15.8 10.3 8.0 6.2

ROAE (%) 27.7 22.2 19.4 21.5

ROACE (%) 33.3 31.5 28.4 29.4

Power Equipment

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Pure play on power T&D EPC space

PGCIL is likely to invest INR 65 bn in FY08E (~INR 20 bn in Q4FY08E), ~INR 85 bn in FY09E, and

~INR 300 bn from FY10-12E to upgrade India’s power transmission network. We note that the

activity level increases in the later years of five year plans. Hence, JYS’s revenue growth profile is

likely to be substantially higher in the last two-three years of the Eleventh Plan period.

Table 1: JYS—Revenue growth vis-a-vis PGCIL’s capex

Year to March FY04 FY05 FY06 FY07 FY08EPGCIL capex (INR mn) 24,212 32,224 41,336 56,446 64,650

growth (%) 33.1 28.3 36.6 14.5 JYS revenue (INR mn) 2,983 4,245 6,978 9,708 14,906

growth (%) 42.3 64.4 39.1 53.5 Source: Edelweiss research

High growth to compensate negative cash flows

Power T&D EPC companies generally have negative operating cash flows. We believe, JYS will

rank lower than peers on this metric, as its working capital turnover is lower than peers. Further,

while JYS and KPP have almost similar metrics on the current asset side, lower creditor/revenues

of JYS, reduce its working capital turnover. We believe this is likely due to higher contribution from

sub station business for JYS.

Table 2: JYS—Key operational parameters

(INR mn)

RoCE tree FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08E FY09E FY10E

Operating working capital/Revenues (%) 55.2 42.7 36.2 30.2 34.6 32.9 38.7 38.0 38.0 38.0

Receivables/Revenues (%) 36.9 31.3 46.2 50.5 43.3 35.6 37.4 38.3 38.3 38.3 Inventories/Revenues (%) 19.9 14.9 15.6 17.6 21.6 17.4 7.9 7.9 7.9 7.9 Other current assets/Revenues (%) 19.6 19.5 14.6 15.9 12.7 9.1 9.3 9.3 9.3 9.3 Loans and advances/Revenues (%) 15.7 15.0 14.3 11.0 10.7 7.4 11.0 11.0 11.0 11.0 Creditors/Revenues (%) 36.9 37.9 54.5 64.8 53.6 36.7 26.9 28.4 28.4 28.4


JYS has negative operating cash flows due to higher working capital requirement, and hence,

we believe JYS runs the risk of frequent dilution. The company had recently planned to raise

~ INR 4 bn through a mix of equity, debt, and quasi-debt instruments which was withdrawn to

be done at a later date.

Table 3: JYS—Fund raising details

(INR mn)Particulars No of shares/ warants Rate AmountPref warrants * 4,200,000 NM 1,000 Shares 7,605,000 287 2,183 FCCB 985 Total 4,168

Source: Edelweiss research Note: * Edelweiss estimates

After scrapping its fund raising plans, JYS now plans to raise ~25% of the initially estimated

capital through debt. We believe, going ahead, JYS’s working capital is likely to come under

further pressure as the company has few orders from the Middle East geography where

payment terms are stringent.

Power Equipment

18

Lower returns due to higher tax rate

JYS has lower RoCEs than KPP and KECI due to higher tax rate and lower working capital

turnover. The company’s pre tax RoCE was almost at level with KPP in FY07, however, higher

tax rate depressed the same.

Table 4: JYS—RoCE tree


RoCE (%) 13.6 1.3 12.5 17.5 20.9 28.6 33.3 31.5 28.4 29.4

EBIT/Revenues 9.8 0.8 7.5 8.8 8.7 10.0 12.3 12.4 12.0 11.9

Direct costs/Revenues (%) 67.6 77.8 76.0 60.9 64.7 61.1 60.6 60.0 59.5 57.5

Employee costs/Revenues (%) 5.0 5.3 4.6 3.8 3.4 2.7 2.7 2.8 2.8 2.8

Other expenses/Revenues (%) 16.1 14.9 10.4 25.3 22.2 25.6 23.8 24.4 25.3 27.4

Revenues/Capital employed (x) 1.4 1.7 1.7 2.0 2.4 2.9 2.7 2.5 2.4 2.5



Net PPE/Revenues (%) 17.8 14.2 15.8 14.0 10.4 7.8 5.8 4.5 4.0 3.7

Cash tax rate on EBIT (%) 14.8 241.3 31.0 23.4 32.2 36.5 36.2 36.5 36.5 36.7 Source: Edelweiss research

Outlook and valuations: Dilution concerns persist; downgrading to ‘ACCUMULATE’

Chart 1: JYS—Share price triggers

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We believe JYS’s order intake is likely to increase from Q4FY08E onwards, given sharp uptick in

order flow from PGCIL as well as increase in distribution order flow. We do not have concerns

on the revenue visibility front; in fact, it is one of the key factors in power T&D EPC companies

and one of the main reasons why companies have re-rated over the past two years. However,

we are concerned about JYS’s negative operating cash flows due to high working capital

requirement. We believe the working capital requirement is likely to increase further given the

company’s entry in international geographies. On our current EPS estimates of ~INR 14 and

~INR 19, the stock is trading at a P/E of 15x and 11x for FY09E and FY10E, respectively. We

do not expect any significant re-rating from current levels over the medium term. We are

downgrading our recommendation to ‘ACCUMULATE’ from ‘BUY’.

Power Equipment

19

Company Description

Incorporated in 1975, JYS is a leading turnkey/EPC player, providing solutions in the field of high

voltage power transmission lines and substations. The company has uniquely positioned itself to pre-

qualify for transmission lines up to 800 KV, substations up to 400 KV, and distribution projects. JYS is

amongst the very few companies in the world capable of executing turnkey jobs that involve setting up

both transmission lines and substations. The company has three business segments—power

transmission towers, rural electrification and substations. Power transmission contributes ~60%,

substations contribute about 15% and rural electrification contribute the rest to the revenues.

Investment Theme

India’s inter-regional power transmission capacity is likely to increase from ~11,500 MW currently to

~16,450 MW at the end of the tenth plan (FY07-end) and to ~37,150 MW at the end of the eleventh

plan (FY12-end). Progress on planned power T&D infrastructure upgradation is driving the current

phase of growth. Further, we expect an investment of ~INR 1,400 bn for the expansion of the

transmission infrastructure during the eleventh plan. Consequently, the addressable market for the

power transmission tower industry from this opportunity is likely to increase manifold over the eleventh

plan period. We believe JYS, with its execution capabilities, is well-placed to leverage this opportunity.

Key Risks

Since power T&D investments are executed by state utilities, any change in the political environment

can potentially impact the pace of execution in the industry, which in turn, could impact the timing of

revenue growth. Additionally, the customer concentration risk is high in this business, which affects the

bargaining power of transmission tower companies adversely.

Power Equipment

20

Financial Statements (Consolidated) Income statement (INR mn)

Year to March FY06 FY07 FY08E FY09E FY10E

Income from operations 6,978 9,708 14,906 19,938 25,955

Direct costs 4,261 5,882 8,946 11,858 14,937

Employee costs 185 267 410 548 714

Other expenses 1,784 2,306 3,632 5,039 7,112

Total operating expenses 6,230 8,454 12,987 17,445 22,763

EBITDA 748 1,254 1,918 2,493 3,193

Depreciation and amortisation 48 58 77 92 110

EBIT 700 1,195 1,841 2,401 3,082

Interest expenses 258 329 405 533 568

Other income 21 8 4 3 2

Profit before tax 462 875 1,440 1,871 2,516

Provision for tax 185 325 539 700 942

Extraordinary items (0) (5) 40 - -

Associate income - - 47 58 62

Reported profit 276 545 989 1,228 1,637

Adjusted net profit 277 550 949 1,228 1,637

Basic shares outstanding 69.1 80.7 88.3 88.5 88.5

Diluted shares outstanding 80.8 80.8 88.5 88.5 88.5

Face value 2 2 2 2 2

Dividend per share 0.4 0.6 1.0 1.2 1.6

Dividend payout (%) 11.1 8.9 8.9 8.9 8.9

Common size metrics- as % of net revenues


Operating expenses 89.3 87.1 87.1 87.5 87.7

Depreciation 0.7 0.6 0.5 0.5 0.4

Interest expenditure 3.7 3.4 2.7 2.7 2.2

EBITDA margins 10.72 12.92 12.9 12.5 12.3

Adjusted net profit margins 4.0 5.7 6.4 6.2 6.3

Growth metrics (%)


Revenues 64.4 39.1 53.5 33.8 30.2

EBITDA 82.2 67.7 53.0 29.9 28.1

PBT 155.1 89.3 64.6 29.9 34.5

Net profit 140.0 98.7 72.5 29.5 33.3

EPS 140.0 98.7 57.6 29.5 33.3

Power Equipment

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Balance sheet (INR mn)

As on 31st March FY06 FY07 FY08E FY09E FY10E

Equity capital 138 161 177 177 177

Share warrants 15 0 0 0 0

Reserves & surplus 1,063 2,597 5,593 6,700 8,174

Shareholders funds 1,216 2,758 5,770 6,877 8,351

Secured loans 1,203 1,515 1,500 2,600 3,000

Unsecured loans 406 80 80 80 80

Borrowings 1,609 1,595 1,580 2,680 3,080

Sources of funds 2,825 4,353 7,350 9,557 11,431

Gross block 853 936 1,125 1,336 1,611

Depreciation 322 375 452 543 654

Net block 531 561 674 793 957

Capital work in progress 15 2 - - -

Total fixed assets 546 563 674 793 957

Investments 166 185 185 185 185

Inventories 1,213 763 1,172 1,568 2,041

Sundry debtors 2,487 3,635 5,703 7,629 9,931

Cash and equivalents 38 92 1,196 1,479 1,029

Loans and advances 517 1,065 1,635 2,187 2,847

Other current assets 633 905 1,390 1,859 2,420

Total current assets 4,889 6,461 11,096 14,721 18,268

Sundry creditors and others 2,558 2,607 4,234 5,663 7,372

Provisions 141 196 318 426 555

Total CL & provisions 2,699 2,803 4,552 6,089 7,926

Net current assets 2,190 3,658 6,544 8,632 10,341

Net deferred tax (78) (77) (77) (77) (77)

Others 1 23.85 23.85 23.85 23.85

Uses of funds 2,825 4,353 7,350 9,557 11,431

Book value per share (BV) (INR) 18 34 65 78 94 Cash flow statement (INR mn)


Net profit 276 545 989 1,228 1,637 Add: Depreciation 48 58 77 92 110

Add: E.O.adjustments (0) (5) 40 - -

Add: Deferred tax 9 (1) - - -

Gross cash flow 333 598 1,106 1,320 1,747

Less: Dividends 31 48 88 109 145

Less: Changes in W. C. 626 1,141 1,298 1,336 1,598

Operating cash flow (324) (592) (280) (126) 4

Less: Change in investments 79 19 - - -

Less: Capex 137 70 189 211 275

Free cash flow (539) (681) (470) (337) (271)

Power Equipment

22

Ratios


ROAE (%) 25.6 27.7 22.2 19.4 21.5

ROACE (%) 28.6 33.3 31.5 28.4 29.4

Current ratio 1.8 2.3 2.4 2.4 2.3

Debtors (days) 130 137 140 140 140

Fixed assets t/o (x) 14.1 17.5 24.1 27.2 29.7

Average working capital t/o (x) 3.7 3.3 2.9 2.6 2.7

Average capital t/o (x) 2.9 2.7 2.5 2.4 2.5

Net debt/Equity 1.0 0.7 0.2 0.1 0.2

Gross debt/Equity 1.3 0.8 0.4 0.3 0.4

Valuations parameters


Adjusted diluted EPS (INR) 3.4 6.8 10.7 13.9 18.5

Y-o-Y growth (%) 140.0 98.7 57.6 29.5 33.3

Diluted CEPS (INR) 4.0 7.5 11.6 14.9 19.7

P/E (x) 61.1 30.7 19.5 15.1 11.3

Price/BV(x) 11.9 6.1 3.2 2.7 2.2

EV/Sales (x) 2.9 2.0 1.3 1.0 0.8

EV/EBITDA (x) 26.5 15.8 10.3 8.0 6.2

Power Equipment

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Changing business mix to lower risk profile

Kalpataru Power Transmission (KPP) is present in power T&D EPC, pipeline EPC, power

generation, logistics, and intends to get into private BOT transmission projects as well. We

believe, over the long term, KPP is likely to graduate to a company with a business mix of

EPC and assets from a purely EPC company. We believe this will lower the risk profile of

the business and thus impact valuations positively.

The winning edge: Higher margins and cash flows

KPP is the front runner in the power T&D EPC sector. The company has higher margins

than the industry, superior cash flows, and higher working capital turnover. We firmly

believe in the power T&D EPC business, working capital management is the key factor on

which hinges the long term success of a company. We are comfortable with KPP’s

business model which has positive operating cash flows compared to other domestic

power T&D EPC companies.

Gas pipeline: Leveraging on project management skills

India has less than 15,000 km of oil and gas pipeline. Industry expects around 18,000 km

of pipeline to be built in the next five-six years to meet the growing crude oil and natural

gas demand. We believe the order intake in the gas pipeline business in likely to increase

with roll outs planned by the Gas Authority of India (GAIL) in the near term.

Outlook and valuations: Positive, maintain ‘BUY’

We believe, KPP’s Q3FY08 results were an aberration, primarily due to slowdown in

execution in distribution orders due to inspection delays by a few select utilities. The

company is a leading contractor in the power sector and has higher capital efficiency than

its peers and the growth scenario for KPP in the medium to long term is on a fundamentally

strong footing. On our consolidated EPS estimates of ~INR 94 and ~INR 120, the stock is

trading at P/E of ~13x and ~10x FY09E and FY10E earnings, respectively. We continue to

maintain our ‘BUY’ recommendation on the stock.

February 26, 2008 Misal Singh +91-22-2286 4316 [email protected] Pawan Parakh +91-22-4019 4995 [email protected] Reuters : KAPT.BO

Bloomberg : KPP IN Market Data

52-week range (INR) : 2,039 / 957


M cap (INR bn/USD mn) : 32.7 / 841.4


Promoters : 63.7


FIIs : 8.1

Others : 8.4


KALPATARU POWER TRANSMISSION INR 1,236

Waiting in the wings BUY


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Revenue (INR mn) 15,987 26,981 36,623 48,522


Net profit (INR mn) 1,630 2,070 2,683 3,494

Shares outstanding (mn) 26 27 27 27

EPS (INR) (adjusted for split) 60.9 72.9 93.5 120.4

EPS growth (%) 98.8 19.8 28.3 28.7 P/E (x) 20.3 17.0 13.2 10.3

EV/ EBITDA (X) 13.3 9.8 7.5 5.8

ROAE (%) 25.0 24.0 23.7 24.0

ROACE (%) 31.6 26.3 28.6 30.2

Power Equipment

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Changing business mix to lower risk profile

KPP is present in power T&D EPC, pipeline EPC, power generation, logistics, and intends to get

into private BOT transmission projects as well. We believe, over the long term, KPP is likely to

graduate to a company with a business mix of EPC and assets from a purely EPC company. We

do not expect this to happen immediately, but we definitely see the trend. The change in the

business mix is likely to lower the company’s risk profile as purely EPC businesses generally have

a higher risk profile. It recently bid for a hydel power project in Himachal Pradesh, has embarked

into the logistics business, and participated in the bidding of WRSS transmission project along

with Tata Power, which was eventually won by Reliance Energy. We believe all these initiatives

point to the change that we are drawing attention to.

The winning edge: Higher margins and cash flows

Disappointing Q3FY08 results not withstanding, KPP remains the front runner in the power T&D

EPC sector. The company has higher margins than the industry, superior cash flows, higher

working capital turnover resulting in robust RoCEs, and has been ahead of the industry in

diversifying into different businesses. We believe the company’s management is proactive and in

the past has demonstrated superior management skills, which has resulted in KPP being ahead of

the curve.

Table 1: KPP—RoCE tree


RoCE (%) 10.1 10.0 13.6 14.5 26.9 38.6 35.9 25.5 28.0 29.6

Pre tax RoIC (%) 10.3 10.0 13.4 14.2 26.0 38.0 43.2 33.5 36.2 37.2

EBIT/Revenues (%) 8.8 10.4 9.6 8.6 10.7 14.3 16.2 14.6 14.1 13.8







Net PPE/Revenues (%) 19.3 19.7 20.8 17.3 13.1 18.1 13.7 10.8 7.8 5.7

Cash tax rate on EBIT (%) 19.3 24.3 30.1 18.3 32.4 29.5 26.5 27.4 26.8 27.0 Source: Edelweiss research

KPP’s higher RoCEs over the cycle are a result of better margins and lower working capital

compared to JYS. Further, lower tax rate also results in higher RoCEs. Due to superior RoCEs

and business model compared to the industry, KPP has historically traded at a premium to

other companies in the sector. The changing business profile, which in effect complements the

EPC business, is likely to result in KPP getting superior valuations compared to the past. Hence,

we expect the current mispricing to correct as investors gain confidence as further clarity

emerges post Q4FY08 results.

Power Equipment

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Gas pipeline: Leveraging on project management skills

India has less than 15,000 km of oil and gas pipeline. Industry expects around 18,000 km of

pipeline to be built in the next five-six years to meet the growing crude oil and natural gas

demand. KPP is currently working on the Bina Wadinar pipeline worth ~INR 2.3 bn and the

Reliance Gas Transportation Infrastructure pipeline worth ~INR 240 mn. We believe the order

intake in the gas pipeline business in likely to increase with roll outs planned by the Gas

Authority of India (GAIL) in the near term.

Outlook and valuations: Positive; maintain ‘BUY’

Chart 1: KPP—Share price triggers

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Kalpataru Power Transmission BSE SENSEX

Bio mas s po wer plant o f 7.8 MW

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anno uncement


KPP is our top pick in the power T&D EPC segment. We believe the company’s Q3FY08 results

were an aberration, primarily due to slowdown in execution in distribution orders due to

inspection delays by a few select utilities. The company is a leading contractor in the power

sector and has higher capital efficiency than peers. Further, we continue to like KPP’s

expansion plans in project management and utilities space in the power sector as further

diversification is likely to reduce the risk profile of its business model, which otherwise is

primarily driven by expansion in the power transmission and distribution segment. On our

consolidated EPS estimates of ~INR 94 and ~INR 120, the stock is trading at P/E of ~13x and

~10x FY09E and FY10E earnings, respectively. We continue to maintain our ‘BUY’

recommendation on the stock.

Power Equipment

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Company Description

KPP designs, fabricates, erects, constructs, and commissions power transmission lines and sub station

structures on a turnkey basis in India and overseas. It is also in the business of laying pipelines and

construction of biomass power plants.

Investment Theme

India’s inter-regional power transmission capacity is likely to increase from ~11,500 MW currently to

~16,450 MW at the end of the Tenth Five Year Plan (FY07-end) and to ~37,150 MW at the end of the

Eleventh Plan (FY12-end). Progress on planned power T&D infrastructure upgradation is driving the

current phase of growth. We expect an investment of ~INR 2,475 bn for the expansion of the

transmission infrastructure during the Eleventh Plan. Consequently, the addressable market for the

power transmission tower industry from this opportunity is likely to be ~INR 250 bn over the Eleventh

Plan period. We believe KPP is well placed to leverage from the opportunity. Further, KPP’s pipeline

business is relatively easily scalable and going forward it is likely to become a strong player in the

pipeline business.

Key Risks

Power T&D investments are executed by state utilities, which, in turn, are mandated by the government.

Hence, any change in the political environment can potentially impact the pace of execution in the

industry, thus impacting the timing of revenue growth. Additionally, customer concentration risk is high

in the business and this in turn impacts the bargaining power of transmission tower companies.

Power Equipment

27

Financial Statements (Consolidated) Income statement (INR mn)



Direct costs 6,188 8,037 16,648 22,821 30,597

Employee costs 389 777 1,494 2,075 2,770

Other expenses 517 4,609 5,359 7,200 9,300


EBITDA 1,310 2,563 3,480 4,526 5,855


EBIT 1,222 2,381 3,112 4,054 5,281


Other income 33 123 274 288 313

Profit before tax 944 2,220 2,902 3,734 4,894

Provision for tax 279 590 833 1,052 1,400

Reported profit 665 1,630 2,070 2,683 3,494

Adjusted net profit 665 1,630 2,070 2,683 3,494

Less MI 17 137 204 303

Reported net profit after MI 665 1,613 1,932 2,479 3,191

Shares outstanding 10.9 26.5 26.5 26.5 26.5

Face Value 10 10 10 10 10


Dividend payout (%) 16.3 12.2 9.6 7.4 5.7




Depreciation 1.0 1.1 1.4 1.3 1.2


EBITDA margins 15.6 16.0 12.9 12.4 12.1

Net profit margins 7.9 10.1 7.2 6.8 6.6

Growth metrics (%)


Revenues 55.1 90.2 68.8 35.7 32.5

EBITDA 107.0 95.7 35.8 30.1 29.4

PBT 117.2 135.2 30.7 28.7 31.1

Net profit 131.7 142.4 18.5 19.8 18.9

EPS 131.7 98.8 19.8 28.3 28.7

Power Equipment

28

Balance sheet (INR mn)

As on 31st March FY06 FY07 FY08E FY08E FY10E

Equity capital 109 265 265 265 265



Minority interests 625 708 1,052 1,329

Secured loans 2,328 3,954 3,539 3,539 3,539

Unsecured loans 0 32 356 656 1,156

Borrowings 2,328 3,986 3,896 4,196 4,696

Sources of funds 4,007 11,053 12,639 15,684 19,326

Gross block 1,594 3,915 4,733 5,733 6,833

Depreciation 354 817 1,174 1,646 2,220

Net block 1,240 3,098 3,559 4,087 4,613

Capital work in progress 284 51 0 0 0

Total fixed assets 1,524 3,149 3,559 4,087 4,613

Goodwill on consolidation 0 83 83 83 83

Investments 294 1,392 1,397 1,397 1,397

Inventories 1,387 1,890 2,369 3,169 4,159

Sundry debtors 2,973 6,999 9,347 12,670 16,772

Cash and equivalents 166 1,367 1,731 2,139 2,538

Loans and advances 1,482 1,458 1,985 2,677 3,532

Other current assets 1,747 2,072 2,703 3,487



Provisions 361 780 915 1,196 1,539


Net current assets 2,246 6,587 7,758 10,275 13,391

Net deferred tax (58) (158) (76) (76) (76)

Others 1 0 (82) (82) (82)

Uses of funds 4,007 11,053 12,639 15,684 19,326

BV per share (INR) (adjusted for split) 155 243 303 394 502 Cash flow statement (INR mn)


Net profit 665 1,630 2,070 2,683 3,494

Add: Depreciation 88 182 368 472 574

Add: Misc expenses written off 0 1 82 - -

Add: Deferred tax 3 100 (82) 0 0

Gross cash flow 757 1,913 2,438 3,155 4,068

Less: Dividends 124 228 228 228 -

Less: Changes in W. C. 656 1,393 483 1,478 1,933

Operating cash flow (23) 292 1,727 1,449 2,135

Less: Change in investments 193 1,098 5 - -

Less: Capex 899 2,088 767 1,000 1,100

Free cash flow (1,115) (2,894) 955 449 1,035

Power Equipment

29

Ratios


ROAE (%) 39.6 25.0 24.0 23.7 24.0

ROACE (%) 39.1 31.6 26.3 28.6 30.2

Current ratio 1.6 2.0 1.8 1.8 1.8

Debtors (days) 129 160 126 126 126

Fixed assets t/o (x) 5.5 5.1 7.6 9.0 10.5



Net debt/Equity 0.7 0.2 0.1 0.1 0.1




EPS (INR) (adjusted for split) 30.6 60.9 72.9 93.5 120.4

Y-o-Y growth (%) 131.7 98.8 19.8 28.3 28.7CEPS (INR) (adjusted for split) 69.4 68.4 86.8 111.3 142.1

P/E (x) 40.4 20.3 17.0 13.2 10.3

Price/BV(x) 8.0 5.1 4.1 3.1 2.5

EV/Sales (x) 4.0 2.1 1.3 0.9 0.7

EV/EBITDA (x) 25.9 13.3 9.8 7.5 5.8

Power Equipment

30

Play on global power T&D EPC space EPC

Substantial investments have been planned in emerging markets, primarily Africa and

Middle East, in the power T&D EPC space. KEC International (KECI), with significant

presence in Africa, Central Asia, and the Middle East, apart from India, is likely to be one of

the beneficiaries of the global power T&D expansion.

Strong project management capabilities

KECI has executed projects in diverse terrains—across Kazakhstan, Saudi Arabia, Iraq,

and Afghanistan. While this kind of project profile does raise the risk profile of the business,

we believe, over the years, KECI has acquired the necessary skills to manage projects in

difficult terrains. It is currently working on ~60 projects simultaneously, which denotes its

superior project management capabilities.

Diversifying into EPC for railways

In the Eleventh Plan, Indian Railways has an ~INR 430 bn outlay for expanding capacity. KECI has pre qualifications from Indian Railways as the company was earlier been involved

in setting up infrastructure for it. KECI has recently bagged two railway electrification

projects from Northern and Central Railways. We believe entry into EPC for railways is likely

to further raise revenue visibility for the company.


We continue to remain positive on KECI on the back of strong revenue growth visibility.

Further, merger with National Information Technologies Ltd (NITEL) gives KECI presence in

the high-growth telecom towers market. The company is currently trading at a premium to

KPP and JYS, which was not the case historically. At our current EPS estimates of ~INR 44

and ~INR 56 the stock is trading at a P/E of ~16x and ~13x for FY09E and FY10E,

respectively. We believe scope for valuation re-rating is unlikely from current levels.

However, the growth story remains encouraging. We continue to maintain our ‘BUY’



Reuters : KECL.BO

Bloomberg : KECI IN Market Data

52-week range (INR) : 922 / 478


M cap (INR bn/USD mn) : 35.0 / 897.9


Promoters : 34.6


FIIs : 15.1

Others : 15.5


KEC INTERNATIONAL INR 710

At the fore front BUY


Financials


Revenue (INR mn) 20,406 26,786 36,305 43,890


Net profit (INR mn) 1,046 1,656 2,192 2,764

Shares outstanding (mn) 38 49 49 49

EPS (INR) 27.8 33.6 44.4 56.0

EPS growth (%) 112.3 20.9 32.4 26.1 P/E (x) 25.6 21.2 16.0 12.7

EV/ EBITDA (X) 15.3 11.1 8.7 7.2

ROAE (%) 45.6 43.9 38.4 35.7

ROACE (%) 37.1 42.3 44.1 43.5

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Power Equipment

31

Play on global power T&D EPC space

KECI has significant presence in Africa, Central Asia, and the Middle East, apart from India. It has

executed orders in ~40 countries and is currently working on ~60 projects simultaneously. Exports

contribute to ~65% of the merged entity’s order backlog. These numbers point to the vast scale

on which the company operates. With substantial investments planned in the power transmission

space in emerging markets, KECI is one of the best placed domestic players to leverage on the

same. We believe the company offers a good opportunity for investors looking to play the global

power story.

Table 1: KECI’s and RPG Transmission’s consolidated order backlog over past six quarters

KEC International & RPGT (INR bn)

Qtr ended International Domestic TotalJun-06 21 11 32

Sep-06 23 11 33

Dec-06 20 13 33 Mar-07 23 12 35

Jun-07 25 12 37

Sep-07 37 15 52

Dec-07 30 20 50 Source: Edelweiss research

Strong project management capabilities

KECI has executed projects in diverse terrains—across Kazakhstan, Saudi Arabia, Iraq, and

Afghanistan. While this kind of project profile does raise the risk profile of the business, we believe,

over the years, KECI has acquired the necessary skills to manage projects in difficult terrains.

Further, the company outsources its tower supplies requirements, unlike JYS and KPP. Hence,

KECI’s creditors/revenues are higher than others in the industry. Consequently, its working capital

requirement per unit of revenue is lower, which results in higher RoCE.

Table 2: KECI—RoCE tree


RoCE (%) (2.1) (5.0) 3.9 10.3 13.5 20.5 37.1 42.3 44.1 43.5

EBIT/Revenues (%) 0.0 (9.6) 4.9 10.8 8.9 7.8 10.7 11.6 11.2 11.2






Receivables/Revenues (%) 105.8 108.2 80.2 72.1 68.6 39.4 44.3 45.5 41.7 41.7Inventories/Revenues (%) 7.8 6.4 6.0 6.2 8.7 7.2 7.4 8.1 7.5 7.5Loans and advances/Revenues (%) 69.4 81.8 55.8 53.4 40.3 9.4 8.4 9.9 9.1 9.1Creditors/Revenues (%) 60.7 68.2 68.2 68.9 85.5 53.6 46.7 47.3 43.3 43.3

Net PPE/Revenues (%) 28.2 27.5 26.4 18.3 12.7 24.8 20.1 15.7 11.6 8.8

Cash tax rate on EBIT (%) 100.0 (23.3) 51.8 5.3 35.9 34.6 34.2 33.3 33.1 32.0 Source: Edelweiss research

Power Equipment

32

Diversifying into EPC for railways

In the Eleventh Plan, Indian Railways has an ~INR 430 bn outlay for expanding capacity. The

basic skill set that KECI brings to the table is project management capability, the mainstay for

securing contracts from Indian Railways. Further, KECI has pre qualifications from Indian

Railways as the company has earlier been involved in setting up infrastructure for it. The

company has recently bagged two railway electrification projects from Northern and Central

Railways. The diversification will also lend KECI the opportunity to participate in the dedicated

freight corridor (DFC) plan of Indian Railways, the outlay for which is ~INR 350 bn.

Upside from telecom business

Merger with NITEL gives KECI presence in the high-growth telecom towers market. NITEL

provides EPC solutions in building communication networks and owns 384 telecom towers in

four clusters of Mizoram, Meghalaya, and Chattisgarh. Simply put, it is a play on telecom

infrastructure in India. We believe the domestic telecom infrastructure sector is undergoing a

high growth phase, with the country’s teledensity expected to increase from ~15.7% currently

to 32.7% in FY10E.

Aggressive order accretion

In the past two quarters, KECI has had a higher order accretion than peers. This can be

attributed to the company’s significant presence in international markets compared to peers,

who are more active in the domestic market. Higher order accretion in 9mFY08 lends KECI

higher revenue visibility compared to JYS and KPP. Key order wins in the past few quarters are

given below.

Table 3: KECI—Key orders received

Agency Brief detailsOrder value

(INR mn) CountryPGCIL Turnkey contract for supply and construction of 400 kV DC

transmission line569 India

PGCIL Turnkey contract for supply and construction of 132 kV SC and DC transmission line

407 India

Saudi Arabian Mining Company (MA'ADEN) Turnkey job of 380 kV DC transmission lines of 123 kms. 2,600 Saudi Arabia

NamPower Turnkey job of 350 kV double circuit bipolar HVDC transmission line of 306 kms.

1,400 Namibia, Africa

TRANSCO Turnkey job of 400 kV DC and quad circuit transmission lines of 173 kms.

3,910 Abu Dhabi

SONELGAZ Turnkey job of 380 kV DC transmission lines of 123 kms. 2,460 Algeria

Afghanistan's Ministry of Energy & Water Turnkey construction of 2 X 110 kV transmission lines over l00 kms; 4 sub stations and; 8 power distribution systems of 20 kV each.

NA Afghanistan

Rajasthan Rajya Vidyut Prasaran Nigam Ltd Turnkey job of 400 kV DC circuit transmission line of 220 kms. 915 Rajasthan


Power Equipment

33


Chart 1: KECI—Share price triggers

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KEC INTERNATIONAL BSE SENSEX

Strong Q3FY07

Shareholders approve arrangement between RPGT and NITEL


KECI’s stock started moving upwards after the merger with RPG Transmission and NITEL was

proposed. We believe the merger is positive as it will provide KECI added visibility in the

domestic power T&D and railway electrification segments. Hence, we believe the valuation

expansion post the merger is logical. KECI is currently trading at a premium to KPP and JYS,

which was not the case historically. At our current EPS estimates of ~INR 44 and ~INR 56 the

stock is trading at a P/E of ~16x and ~13x for FY09E and FY10E, respectively. We believe

scope for valuation re-rating is unlikely from current levels, however, we remain positive on the

stock given the revenue visibility and growth profile. We continue to maintain our ‘BUY’


Power Equipment

34

Company Description

KECI was incorporated in 1945 as Kamani Engineering Corporation by the RPG group. It is in the

business of designing and manufacturing power transmission towers and telecom infrastructure.

Nearly, ~60% of KECI’s revenues come from the international market. The company’s order backlog

was ~INR 42 bn, with ~890% contributed by transmission projects, and ~10% by distribution

projects at the end of Q3FY08.

Investment Theme

The Middle Eastern and North African (MENA) power sectors installed power generation capacity of

~151GW in FY05. It is estimated that the regional power demand will grow 6% annually till 2010, to

increase the total installed power generation capacity to ~230GW. On the power T&D side, Gulf

Cooperation Council (GCC) countries are currently working on the first phase of the Gulf Electricity

Interconnection Grid that is likely to cost INR 53 bn and is expected to be completed by mid-2008.

We view the MENA power T&D upgradation in positive light for our coverage universe. Additionally,

the US market size is likely to grow to ~INR 450 bn over the next four years. KECI is the most active

player in the MENA and US market in our coverage universe and is likely to be positively affected by

the up-gradation in the power T&D infrastructure in the MENA and US markets.

Key Risks

Power T&D investments are executed by state utilities, which in turn, are mandated by the

government. Hence, any change in the political environment can potentially impact the pace of

execution in the industry, thus impacting the timing of revenue growth. Additionally, the customer

concentration risk is high in the business, which in turn, impacts the bargaining power of

transmission tower companies.

Power Equipment

35

Financial Statements

Income statement (INR mn)



Direct costs 13,047 14,564 18,876 25,684 30,474

Employee costs 838 955 1,370 1,896 2,306

Other expenses 1,765 2,370 3,066 4,289 5,775


EBITDA 1,623 2,518 3,474 4,435 5,335


EBIT 1,353 2,184 3,117 4,048 4,925


Other income 4 7 4 5 2

Profit before tax 765 1,599 2,484 3,272 4,048

Provision for tax 272 552 827 1,080 1,284

Reported profit 493 1,046 1,656 2,192 2,764

Adjusted net profit 493 1,046 1,656 2,192 2,764

Shares outstanding 38 38 49 49 49

Face Value 10 10 10 10 10


Dividend payout (%) 9.2 16.2 18.4 16.5 16.1




Depreciation 1.6 1.6 1.3 1.1 0.9


EBITDA margins 9.4 12.3 13.0 12.2 12.2

Net profit margins (adjusted) 2.9 5.1 6.2 6.0 6.3

Growth metrics (%)


Revenues 40.4 18.1 31.3 35.5 20.9

EBITDA 35.7 55.2 37.9 27.7 20.3

PBT 13.0 109.0 55.4 31.7 23.7

Net profit (adjusted) 16.6 112.3 58.3 32.4 26.1

EPS 16.5 112.3 20.9 32.4 26.1 Cash flow statement (INR mn)


Net profit 493 1,046 1,656 2,192 2,764

Add: Depreciation 269 334 358 387 410

Add: Deferred tax 201 89 - - -

Gross cash flow 964 1,470 2,014 2,580 3,174

Less: Dividends 52 198 301 398 502

Less: Changes in W. C. (3,536) 2,087 1,507 979 1,012

Operating cash flow 4,448 (815) 206 1,203 1,661

Less: Change in investments (669) 1 3 - -

Less: Capex 1,967 140 962 350 80

Free cash flow 3,150 (957) (760) 853 1,581

Power Equipment

36

Balance sheet (INR mn)As on 31st March FY06 FY07 FY08E FY09E FY10E

Equity capital 377 377 493 493 493

Preference capital 130 130 117 117 117



Secured loans 3,325 3,863 3,349 3,589 3,589

Unsecured loans 1 1 1 1 1

Borrowings 3,326 3,864 3,351 3,590 3,590

Sources of funds 5,198 6,584 8,168 10,202 12,464

Gross block 4,499 4,676 5,661 6,011 6,091

Depreciation 269 600 1,450 1,811 2,248

Net block 4,230 4,076 4,211 4,199 3,843

Capital work in progress 60 23 0 0 0

Total fixed assets 4,290 4,099 4,211 4,199 3,843Investments 205 206 209 209 209

Inventories 1,249 1,506 2,179 2,717 3,284

Sundry debtors 6,803 9,041 12,191 15,145 18,310

Cash and equivalents 636 214 49 1,116 2,724

Loans and advances 1,619 1,717 2,656 3,321 4,015



Provisions 136 370 495 615 744


Net current assets 905 2,569 3,912 5,958 8,577

Net deferred tax (201) (290) (165) (165) (165)

Uses of funds 5,198 6,584 8,168 10,202 12,464Book value per share (BV) (INR) 50 72 98 134 180

Ratios


ROAE (%) 19.3 45.6 43.9 38.4 35.7

ROACE (%) 20.5 37.1 42.3 44.1 43.5

Current ratio 1.1 1.3 1.3 1.4 1.4

Debtors (days) 144 162 166 152 152

Fixed assets t/o (x) 4.0 5.0 6.4 8.6 11.4



Net debt/Equity 1.3 1.3 0.6 0.3 0.1




EPS (INR) 13.1 27.8 33.6 44.4 56.0

Y-o-Y growth (%) 16.5 112.3 20.9 32.4 26.1CEPS (INR) 20.2 36.6 40.8 52.3 64.3

P/E (x) 54.3 25.6 21.2 16.0 12.7

Price/BV(x) 14.3 9.8 7.3 5.3 3.9

EV/Sales (x) 2.2 1.9 1.4 1.1 0.9

EV/EBITDA (x) 23.7 15.3 11.1 8.7 7.2

Power Equipment

37

Buy

Buy BuyBuy

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KEC International Recent Research

BuyBuy

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Naresh Kothari Co-Head Institutional Equities [email protected] +91 22 2286 4246

Vikas Khemani Co-Head Institutional Equities [email protected] +91 22 2286 4206

Shriram Iyer Head Research [email protected] +91 22 2286 4256

Coverage group(s) of stocks by primary analyst(s): Power: Apar Industries, Emco, Jyoti Structures, Kalpataru Transmission, KEI Industries, KEC International, ABB, BHEL, Crompton Greaves, L & T, Siemens,

Transformers and Rectifiers, Tehhno Electric, Thermax, Voltas, Voltamp Transformer

Jyoti Structures Kalpataru Transmission

Edelweiss Securities Limited, 14th Floor, Express Towers, Nariman Point, Mumbai – 400 021, Board: (91-22) 2286 4400, Email: [email protected]

Date Company Title Price (INR) Recos 07-Feb-08 Kalpataru A one off, growth story 1,389 Buy Power on track; Transmission Result Update 1-Feb-08 KEC Leading the pack 702 Buy International Result update 1-Feb-08 Elecon Flat results; but strong 200 Buy Engineering order book; Result update 29-Jan-08 Larsen & Moving from strength to 3,770 Buy Toubro strength; Result update


Buy

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Power Equipment

38


Edelweiss Securities Limited, 14th Floor, Express Towers, Nariman Point, Mumbai – 400 021, Board: (91-22) 2286 4400, Email: [email protected]

This document has been prepared by Edelweiss Securities Limited (Edelweiss). Edelweiss and its holding company and associate companies are a full service, integrated investment banking, portfolio management and brokerage group. Our research analysts and sales persons provide important input into our investment banking activities. This document does not constitute an offer or solicitation for the purchase or sale of any financial instrument or as an official confirmation of any transaction. The information contained herein is from publicly available data or other sources believed to be reliable, but we do not represent that it is accurate or complete and it should not be relied on as such. Edelweiss or any of its affiliates shall not be in any way responsible for any loss or damage that may arise to any person from any inadvertent error in the information contained in this report. This document is provided for assistance only and is not intended to be and must not alone be taken as the basis for an investment decision. The user assumes the entire risk of any use made of this information. Each recipient of this document should make such investigation as it deems necessary to arrive at an independent evaluation of an investment in the securities of companies referred to in this document (including the merits and risks involved), and should consult his own advisors to determine the merits and risks of such investment. The investment discussed or views expressed may not be suitable for all investors. We and our affiliates, officers, directors, and employees may: (a) from time to time, have long or short positions in, and buy or sell the securities thereof, of company (ies) mentioned herein or (b) be engaged in any other transaction involving such securities and earn brokerage or other compensation or act as advisor or lender/borrower to such company (ies) or have other potential conflict of interest with respect to any recommendation and related information and opinions. This information is strictly confidential and is being furnished to you solely for your information. This information should not be reproduced or redistributed or passed on directly or indirectly in any form to any other person or published, copied, in whole or in part, for any purpose. This report is not directed or intended for distribution to, or use by, any person or entity who is a citizen or resident of or located in any locality, state, country or other jurisdiction, where such distribution, publication, availability or use would be contrary to law, regulation or which would subject Edelweiss and affiliates to any registration or licensing requirements within such jurisdiction. The distribution of this document in certain jurisdictions may be restricted by law, and persons in whose possession this document comes, should inform themselves about and observe, any such restrictions. The information given in this document is as of the date of this report and there can be no assurance that future results or events will be consistent with this information. This information is subject to change without any prior notice. Edelweiss reserves the right to make modifications and alterations to this statement as may be required from time to time. However, Edelweiss is under no obligation to update or keep the information current. Nevertheless, Edelweiss is committed to providing independent and transparent recommendation to its client and would be happy to provide any information in response to specific client queries. Neither Edelweiss nor any of its affiliates, directors, employees, agents or representatives shall be liable for any damages whether direct, indirect, special or consequential including lost revenue or lost profits that may arise from or in connection with the use of the information. Past performance is not necessarily a guide to future performance. The disclosures of interest statements incorporated in this document are provided solely to enhance the transparency and should not be treated as endorsement of the views expressed in the report. Edelweiss Securities Limited generally prohibits its analysts, persons reporting to analysts and their family members from maintaining a financial interest in the securities or derivatives of any companies that the analysts cover. The analyst for this report certifies that all of the views expressed in this report accurately reflect his or her personal views about the subject company or companies and its or their securities, and no part of his or her compensation was, is or will be, directly or indirectly related to specific recommendations or views expressed in this report. Analyst holding in the stock: no.

Copyright 2007 Edelweiss Research (Edelweiss Securities Ltd). All rights reserved

Rating Interpretation

Rating Expected to

Buy appreciate more than 20% over a 12-month period

Accumulate appreciate up to 20% over a 12-month period

Reduce depreciate up to 10% over a 12-month period

Sell depreciate more than 10% over a 12-month period


Distribution of Ratings / Market Cap

Edelweiss Research Coverage Universe

Buy Accumulate Reduce Sell Total

Rating Distribution* 112 44 11 1 188

* 14 stocks under review / 6 rating withheld

> 50bn Between 10bn and 50 bn < 10bn

Market Cap (INR) 88 74 26

power transmission towers

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