Kalpataru Power Transmission Ltd...Initiating coverage with a Buy recommendation

Kalpataru Power Transmission Ltd (KPTL), with a presence across transmission, railways and construction segments, continues to benefit from the ordering pickup in capex by railways, SEBs and few private players from power transmission side. The company has seen order inflows of INR 74.50 bn in FY16, which is more than the order inflows for FY14 and FY15 combined. We expect the KPTL and JMC to further benefit  massively from the current boost to the infrastructure  sector, although JMC’s road BOT projects continue to make operational losses. We rate KPTL with a Buy rating, based on SOTP valuation of INR 322, a potential upside of 28%.

Robust order book to propel core business: Kalpataru is witnessing a substantial order wins in its core business both locally and internationally (>2.0x book to bill ratio). Such a strong order book ensures substantial revenue growth visibility. Improving prospects on railway capex provides us further comfort on the growth potential of KPTL over the longer run.

Improved  working  capital  efficiency  helping  deleverage  balance sheet: Kalpataru has been able to consistently able to cut down on its debt (3rd quarter in a row). The company’s debt stood at INR 5.3 bn at the end of Q1FY17 as against INR 7.75 bn in Q1FY16. We expect the company to benefit due to improved working capital situation with release of retention money, decline in inventory and increase in creditor days. We expect the interest expenses to also decrease going forward as the company repays debt. At consolidated level, we expect the company to benefit from sale of operational non-core assets and as the losses at Shri Shubhal logistics are cut with tweaks in the business model.

Valuation, Recommendation and Risks:

We value Kalpataru using SOTP methodology and arrive at a consolidated fair value of INR 322 per share with a potential upside of 28% from the current price of INR 252 as on October 5, 2016. We thereby assign a ‘Buy’ rating on the stock.

Risks:Geopolitical stability, Customer concentration, Execution delays due to Right of way & Environmental issues, Forex fluctuations.

Company Brief

Kalpataru  Power  Transmission  Ltd  (KPTL)  is  the  flagship  company  of  the  Kalpataru  group, with  a presence in the setting up of transmission lines, EPC (Engineering, Procurement and Commissioning) of infrastructure segments like oil/gas pipelines & railways and biomass energy (owns two power plants with combined capacity of 15.8 MW). The company is a leading EPC player in power transmission lines, offering integrated solutions from designing-to-stringing of upto 1,200 kv towers and is present in over 40 countries. In addition, under the transmission segment, KPTL owns three BOOT projects - an operational asset at Jhajjar and under-construction assets in MP and West Bengal. The company also owns two real estate development projects 1) at Thane which is completed and 2) at Indore, residential cum retail project which has been launched for sale.

KPTL holds a 67% stake in JMC Projects. With a workforce of 3000 professionals, JMC is primarily engaged in the construction of industrial buildings, government buildings, residential and commercial complexes. Recently, JMC ventured into the infrastructure segment, with projects in roads and bridges. Under JMC, KPTL owns four toll collecting BOOT assets.

Through its 80% stake in Shree Shubam Logistics, the company operates in midstream agri-commodity value chain. The company has wide network of ware houses across Rajasthan, Gujarat, Madhya Pradesh and Maharashtra.

Investment Highlights

The Government push along with the latent demand bodes well for the KPTL T&D segment

India faces irregular power availability across states. Some states in the northern and western parts of the country have surplus power, while some states in the south facing shortages. This mismatch offers a tremendous opportunity to the transmission players. In addition, the current National Democratic Alliance (NDA) government has made boosting power generation a key policy priority and is aiming to double electricity generation to two trillion units by 2019. The centre has set a target of bringing 24x7 ‘power for all’ by fiscal 2019. However, it’s the India’s T&D sector that has remained under-invested. In an ideal scenario, investment in the T&D and power generation segments should be in the 1:1 ratio. But, the long-term average ratio between investments in power generation capacity addition and T&D segment over CY51-96 has remained abysmal 1:0.45. In the X and XI Five-Year Plan also, the ratio of investments has remained in the same range. And if the Government’s power for all by FY19 is to be achieved, T&D investments have to come through. In addition, it is understood that currently there is no major problem with power generation (with enough availability of coal) but with transmission as the entire power produced does not reach the consumers due to 25% leakage in AT&C (aggregate technical and commercial) losses. The government is focused on plugging this leakage, which can be done by privatization of T&D to bring in efficiency. 

T&D spending in India is expected to be around INR1, 800bn and INR2, 500bn over 12th and 13th Plans. It augurs well for KPP which has maintained market share of 12-13% over the past 5-6 years in Power Grid Corporation of India Limited (PGCIL) ordering. KPP remains the front-runner in the power T&D EPC sector, and hence, is well-placed to leverage from the opportunity.

Furthermore, KPTL also benefits from the planned capex of US$ 135bn and US$61bn to be incurred during 2014-30 in Africa and Middle East respectively (source: World Energy Investment Outlook, 2014). The expansion in regional transmission network in Africa and Middle East will supplement domestic demand and presents a large business opportunity. Moreover, funding for these orders are pre-arranged through large international financing institutions and multilateral agencies, thus virtually eliminating the risk of defaults or payment delays. It’s worth noting that KPTL didn’t faced any cancellation/delay in transmission projects in the Middle East, which was reeling under the impact of low crude oil prices.

Robust order book momentum ensures revenue visibility

At the end of Q1FY17, KPTL’s order book stood at INR 91bn (2.08xFY16 revenues), implying nearly 2 years of strong revenue visibility. The outlook for order inflow for this year is expected to be strong as many orders are expected from PGCIL and SEB’s (Tamil Nadu, West Bengal, Karnataka and Gujarat). PGCIL has placed transmission line orders worth INR 215bn for the 12th plan (from April 2013). KPTL ranks third in terms of share of PGCIL orders after KEC International and L&T. The entry barriers at Extra High Voltage (EHV) level projects and strict working capital conditions by PGCIL has resulted in top four players accounting for more than 60% share of the orders. 

Moreover, in FY16, KPTL successfully forayed into new geographies like Malawi, Afghanistan, Botswana & Mauritania after consolidating its position in the African markets where the growth outlook remains robust. The orders from Middle East and African countries where KPTL has strong presence are further expected to get a boost and we expect order inflow from the overseas market to remain sound during FY17 as the export markets are likely to improve. The company is also witnessing healthy traction in the Railways segment as well where KPTL expects an order inflow of about INR 80-85bn in FY17e. 

The company is witnessing a respectable traction even in JMC projects. The value of the order booked during FY 2015-16 was about INR 31.55 billion and value of order on hand as on March 31, 2016 stood at around INR 61.49 bn. The order-book stands distributed in Infrastructure (Urban Infra, Water & Area Development etc.), Buildings (Housing, Commercial, Institutional, Hospital etc.) and Industrial segments. In addition, JMC also has an L1 position of INR 12 bn in mid-August (post 1Q17). Current order book along with L1, gives strong visibility of future revenue growth. We believe the company has sufficient order book position to achieve the growth in both top line as well as bottom line in the coming years. Furthermore, the company has already entered into international business by securing a road project and is looking for other opportunities in International markets.

However, the company remains stressed at consolidated level

Although the company’s financials at standalone level are impeccable with significant revenue and net income growth over the last few years, the consolidated net income has taken a hit and is de-growing since 2012.

The financials at consolidated levels are affected by loss making subsidiaries especially Shri Shubham logistics and the four BOT projects under JMC projects. As the road BOT projects and Shri Shubham logistics were incurring losses due to execution delays and trading activities respectively.

Nevertheless, all the four road projects have started generating revenues on a full stretch recently and are expected to contribute positively once the operations normalize. In addition, Shri Shubham logistics which was affected by underutilization of its warehouses is expected to benefit once utilization improves due to higher availability of crops on account of better monsoon. Also, the company has rebuilt the core team at Shri Shubham which should be in place by the end of 2QFY17. Furthermore, the company is not expected to take any incremental debt any further given the significantly improving working capital efficiency at the standalone company.

Valuation

We believe that the company and the sector are benefiting from the global trend towards increased investments in the end markets. On one hand, we expect the global transmission and distribution sector to keep growing while on the other hand, we expect the domestic construction market to see renewed interest due the current government’s push to infrastructure projects. These trends bode well for KPTL standalone and JMC projects. We also expect Shubham logistics to cut down on losses as it prunes its business model. We believe given these triggers, the stock is available at an attractive valuation wherein the current valuation factors in just the core standalone business with all the other business segments ( JMC, SSLL, Road BOT, Transmission BOT and real estate) being available for free. We recommend BUY on the stock with a target price of INR 322 based on SOTP valuation. Our target price implies a potential upside of 28% from the current levels. 

We have adopted a SOTP method to arrive at our price target of INR 322. We have valued the standalone EPC business at 13x FY18E earnings while KPTL’s BOT projects have been valued using capitalization method. We used used FCFE method for valuing Real Estate projects.

1) Jhajjar KT Transco - Asset is operational since March 13, earning INR 540 mn annuity. We have assumed on a regular basis, the asset would earn a net margin of 26%; assumed INR 340 mn annual expenses (WACC =11.5%)

2)  Kalpataru  Satpura  Transco  - The expected annuity revenues of approx INR 38 cr. We have assumed INR 28 cr annual expenses on a regular basis (WACC = 11.5%)

3) Thane Realty Project - The company is earning INR 120 mn on leased space (60%). Using FCFE (WACC =12%, growth rate (a tab above inflation = 7.5%), and then subtracting Long term debt and Long term liabilities, we arrive at a value of INR 1.11 bn for Thane project.

4) Indore Realty Project - The saleable area of the project is around 0.42 mn square feet. We have assumed a rate of INR 6,000 per square feet; we then subtracted the liabilities from value of operations and arrive at a value INR 630 mn for Indore project.

JMC Projects standalone is valued for its 67.2% ownership based on 8x FY18e standalone earnings. We value all the four JMC BOT projects at 1.0x the company’s investment in those projects.

Currently the company trades at 1 year forward multiple of 20x (on consolidated basis), which is significantly above the average multiple of 12.2x and is also more than +1sd. However, as the company monetizes the loss making BOT projects, streamlines operations at another loss making subsidiary (Shri Shubham Logistics), and with improved working capital efficiency along with decreasing interest expenses as the company deleverages, we expect the bottom-line to improve significantly going forward and thus we think the stock is available cheap even at these levels.

Risks

1)  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.

2) Customer concentration risk is high in the business, which in turn, impacts the bargaining power of transmission tower companies. Order book on March31, 2016, carries order of INR 14.30 bn crore form PGCIL which is approx. 20% of the total order size of the company at the end of FY16. PGCIL is one of the key clients of Kalpataru and any deferment or cancellation of projects could directly hit Kalpataru’s prospects.

3) Execution delays due to Right of way (ROW) & Environmental issues: Although Preservation and promotion of environment is of fundamental concern in all business activities of KPTL. Any environment issue can delay the execution time of the project which can impact revenue and margins of the company.

4) Stalled & Delayed Projects: Projects worth USD 160 Billion were stalled as of December 2015, due to delays in project approvals and raw material non-availability etc. issues. Further delays in restarting stalled projects has strained some of the infrastructure companies’ ability to meet their debt obligations, leading to a surge in banks’ gross Non-Performing Assets (NPA). The government along with the RBI has been taking initiatives to address the NPA problem.

5) FOREX rate fluctuations: Kalpatru’s T&D division realizes about 45% of its revenue from its overseas business, any adverse movement in a particular currency can adversely impact financials. In present uncertain time, it becomes more difficult to judge the market can take appropriate decision.

6)  Intense  competition: Multinational companies have made a comeback in power transmission projects in India, with parent companies of Alstom, ABB and Siemens picking up big-ticket orders following aggressive bidding. Aggressive bidding is likely to continue even in 2017, given that these companies are keen to secure more orders in India to offset the impact of slowdown in their local markets, according to sector players.

7) Volatility in raw material prices: Company’s business is significantly dependent on availability, cost and quality of the raw materials and fuels for the construction and development of projects taken. The principal raw materials include steel, zinc, aluminum conductors, copper, diesel oil, concrete, cement, metal, ballasts, reinforcement bars, electrodes and valves etc. Prices and supply of these are varied due to economic conditions, competition, production levels, and import duties etc.