Rabin Ghosh

Mumbai: High steel prices are likely to dampen profit margins for KEC International, India’s largest power transmission engineering, procurement and construction (EPC) company.

Raw material costs, which account for over 70% of KEC’s sales, have risen sharply over the last few months and the trend is likely to continue for a while. High concentration of fixed price contracts means the risks of raw material price volatility rests with the company, according to analysts.

Analysts Abhishek Tyagi and Rajesh Panjwani of brokerage house CLSA Asia Pacific Markets have cut KEC’s earnings estimate by 12-14% over FY08-11, on account of hardening in the commodity prices and the increased competition in transmission EPC space. For FY08 (April-March), KEC’s operating margins stood at 12.6%, against 12% for FY07.

“KEC has 70% of its order book from overseas projects. The execution period of these orders vary from 18-24 months and these are usually fixed price contracts. The recent run-up in the prices of commodities (especially steel) will impact the margins of these projects. With coking coal and iron ore contracts being finalised at record highs the steel prices are expected to remain strong in near to middle term,” they said. CLSA expects KEC’s operating margin to dip to 10.5% going forward.

CLSA has changed its target price on the stock to Rs 692 from Rs 785 it had two months ago. The stock closed at Rs 600 on the National Stock Exchange on Wednesday.

“I won’t say margins will come down. I would say margins would be what they should be. We have always maintained that margins would be between 10-11%. Last year we had a spurt in margins which should be treated as a bonus,” Ramesh Chandak, managing director and chief executive officer, KEC International said.

Chandak said he doesn’t expect steel prices to rise beyond 5-7% going forward. “About 40% of our projects have an escalation clause built in,” he said.

Another brokerage that has lowered its rating - from ‘buy’ to ‘reduce’ —on KEC International post its January-March quarter results is Edelweiss. It downgraded its earnings estimate by 15% and 17% for FY09 and FY10. A ‘reduce’ rating means the brokerage expects the stock to decline by up to 10% over the next 12 months.

“Increase in competition and rising raw material prices are likely to negatively impact margins. Margin decline is likely to be significant in the case of companies having a higher percentage of fixed price contracts. While we believe KECI is likely to report robust revenue growth numbers in FY09E; decline in margins is likely to depress PAT growth,” analysts Misal Singh and Pawan Parakh said in their report.

Singh and Parekh see operating margins decline to 11.4% and 11.2% for FY09 and FY10 respectively.

Analysts don’t see any concerns on long term revenue growth. The company hopes to grow at 25% annually for the next 2-3 years. Its order book stands at Rs 4,200 crore and with another Rs 800 in L1 (lowest bidder in unawarded projects) position.

Abhishek Puri of JM financial also has cut his earning estimate by 15% and 9% for FY09 and FY10 respectively. Puri has downgraded the price target at Rs 725 from Rs 775 earlier.

Source : DNA