Kalpataru Power Transmission Limited

I have been looking at potential companies to invest in the capital goods segment and like the Transmission & Distribution (T&D) segment as this industry is already under-invested  compared to govt. spending in the power generation space and so should show momentum even if the rest of the power sector takes time to recover. 

In this space there are 3 key players, Kalpataru Power Transmission Limited, KEC International and Jyoti Structures. Here we are looking at Kalpataru Power Transmission Limited (Kalpataru). Lets look at why I like the stock....

Kalpataru Power Transmission Limited

BSE Scrip code:522287

Industry: Heavy Electrical Equipment

Marketcap: Rs14.27bn

Company Overview: Kalpataru is a leading EPC contractor in the Transmission & Distribution industry. The company also operates in oil & gas, railways, infrastructure development, civil contracting, agri-logistics and warehousing business.  Its key subsidiaries are JMC Projects India Ltd. (JMC) which is into civil and structural works for Factories and Buildings, roads and bridges, power plants, water pipelines, rail and metro infrastructure projects and Shree Shubham Logistics Ltd is into warehousing and agri-logistics. Kalpataru’s consolidated order book is of Rs120bn and standalone order book of Rs67bn as of 1H 2014. The company has a global footprint in 37 countries and its international business contributes 60% of the total order book of the company.

The company reported 35% y-o-y growth in standalone revenues to Rs.9.6bn in 2Q 14 while operating profit grew 42% y-o-y to Rs.7.4bn and operating margins expanded 40bps to 7.7%. The company’s standalone operating margins were at 8.6% levels in 1Q 14 but moderated in 2Q 14 owing to execution of the lower margin Infrastructure orders. 

Investment Overview: 

Focus on international markets pays off, leads to strong order book: The company’s strategy of expanding its international business to offset the weakness and uncertainty in domestic market has paid off. 55% of revenues clocked in 2Q 14 and 57% of the standalone order backlog of Rs67bn is from international business. Its standalone order book as of 1H 2014 is 2 times its FY 2013 standalone revenues giving good revenue visibility over the near term. The management expects to increase international contribution to 70% of the T&D business over the next 1-2 years. Furthermore, international orders tend to have price variation clause and tighter working capital management which also benefit company’s performance.

Significant domestic opportunity: The T & D industry’s fortune is linked to the power industry. India is a power deficit country and government plans to add significant power capacity to address this problem. Compared to the power sector, The T&D sector is even more under-invested. Transmission segment investment target is of Rs.1.8Tn and Rs.2.3Tn for 12^th and 13^th 5year plan. Power Grid (PGCIl) which is a major client for the T&D companies has a planned investment of bout Rs.1Tn for the 12^th 5year plan of which is nearly half of the total industry spending  for the transmission segment. Furthermore,  Kalpataru is a leading player in the Transmision & Distribution EPC business with an established execution record and as such stands to benefit.  

Consolidation in domestic industry to support order wins and margins: In the past the T&D space witnessed significant competition from Chinese players which negatively impacted order wins and margins for domestic players. However, Power grid has become has become increasingly tightened the qualifying norms for bidding for its businesses which has led to many companies been disqualified from the bidding process.  This has led to a consolidation in the industry and bodes well for Kalpataru. 

Margins have potentially bottomed-out: Consolidation in the domestic T& D industry and comparatively better margins in international T & D projects bores well for the company’s margins. Furthermore, the company has executed 95% of its low margin order backlog for JMC and hence should start seeing improvement in margins even on a consolidated level post 3Q 14. Hence, I believe that margins for the company have bottomed out.

Better working capital and debt management: The company’s consolidated cash conversion cycle and debt/equity at 52 days and approx. 0.3 (based on FY 2013) is lower than KEC’s cash conversion cycle of 74 days and debt/equity of 1.5.

Financials & valuation:

I expect the company’s standalone revenues to grow at a CAGR of 13.5% from FY 2013-FY 2015 while standalone operating margin is expected to expand steadily from 9.7% in FY 2013 to 10% in FY 2014 and 10.5% in FY 2015. Consecutively, net profit is also expected to increase at a CAGR of 19.6% from FY 2013-FY 2015.

Valuing the company at 8x FY 2015 EPS, the standalone value of the company comes to Rs101. Furthermore, the value of the JMC business is arrived at Rs 10 per share. This leads to a valuation of Rs111 per share for the company on a SOTP basis. The company has run up significantly since I started analyzing it (went up from Rs78 to Rs 93 in just the last 4 trading days) but still provides significant upside potential from CMP of Rs93.

The target price excludes company’s investment in shubham and other investments which could provide further upside. Additionally, stock is trading at a discount to its historical multiples due to relatively weaker performance and could be a potential re-rating target once it starts delivering. It is also at a discount to KEC (trading at a P/B of 0.6 compared to KEC’s P/BV of 1.6). Hence, I am positive on the kalpataru stock.