Value Investing - Kalpataru Power Transmission

The increased order flow to the power transmission sector is another signal that select sectors of the economy may be in the revival mode. Kalpataru Power Transmission, a turnkey solutions provider in transmission lines and substation structures, is among the key beneficiaries of order flows from Power Grid Corporation (PGCIL).

Aside of domestic projects, Kalpataru Power has also been successful in keeping the overseas order book in expansion mode.

Now, at beaten down valuations, the Kalpataru stock could receive a boost from the T&D revival. In the current economic scenario, the company’s diversified business profile and potential earnings accretion (on a consolidated basis) from infrastructure subsidiary — JMC Projects — makes it a superior option to other transmission and distribution contractors. Investors can consider the Kalpataru stock with a two-year perspective.

At the current market price of Rs 347, the stock trades at six times its standalone earnings for FY10. On a consolidated basis the valuation appears more attractive at about 4.5 times its estimated per share earnings for FY-10.
Beneficiary of Eleventh Plan

Since the beginning of January 2009, there has been a spurt in order flows, especially from public sector major, Power Grid Corporation.

This momentum is expected to prolong given that a good two-third of the planned capacity additions of power under the Eleventh Plan (2007-12) are expected to be commissioned over the remaining years of the Plan period.

Further, public power utilities are also looking at reviving Build-Operate-Transfer projects in T&D. Power Finance Corporation and Rural Electrification Corporation have floated tenders worth Rs 6,000 crore over the last several months.

There are already signs of Kalpataru benefiting from these initiatives — the company received Rs 770 crore of orders from PGCIL in March alone.

Besides domestic orders, Kalpataru has been actively pursuing its international business despite the global slowdown.

In this regard, it scores over its nearest peers, KEC International and Jyoti Structures. It has tapped the key markets in Africa and West Asia which are expanding their regional transmission network.

The company has won about Rs 1,650 crore worth of orders in Kuwait and Algeria in the quarter ended March 2009 alone, suggestive of the size of order flows.
WELL Diversified

Kalpataru’s revenue segments can be classified into T&D, biomass energy and infrastructure. While the first two have witnessed healthy revenue growth in the December quarter, the last segment saw a dip.

Laying of pipelines, which account for a good part of the infrastructure segment, has, however, once again seen a revival.

With the recently-won order for a crude oil pipeline for the HPCL-Mittal Energy joint venture, this segment would now have about Rs 650 crore or 13 per cent of the total orders in hand. Going forward, with increasing oil and gas finds that are required to be transported, this segment could see heightened activity.

While the company’s biomass division is not significant in terms of total revenue, its contribution to revenue has been increasing. As a result, this tax-free division has helped in reducing the company’s tax burden. Besides, this division has a high operating profit margin (OPM) of 45 per cent. Any increase in this segment’s contribution towards revenue is likely to aid the overall OPMs.

Kalpataru’s geographical diversification is also likely to come to its aid, especially in reviving the now lower OPMs. About 44 per cent of its current order book of over Rs 5,000 crore is from overseas projects.

These projects, mostly in the T&D space, have typically offered higher margins to Kalpataru in the past, giving it backward integration, apart from more lucrative deals available in export projects in this space.

Kalpataru’s subsidiary, JMC Projects, with an order basket of Rs 1,700 crore is also well-poised to tap civil work opportunities in power projects. This subsidiary too lends diversification and may aid backward integration in some large projects.
Financial concerns may ease

On a standalone basis, Kalpataru’s revenues grew a healthy 20 per cent to Rs 1,331 crore for the nine months ended December 2008 over the corresponding previous period.

However, net profits fell 28 per cent for the above period, dragged by raw material costs, interest costs and notional forex losses. But risks from the above factors may stand mitigated for the following reasons: Price of steel billets in Mumbai have plunged from Rs 40,000/tonne a year ago to less than Rs 19,500/tonne now.

Steel, which accounts for as much as 80 per cent of the material cost in a tower, however continued to hurt as a result of high inventory.

Now, with fresh inventory of steel procured at lower cost and with about 40 per cent of Kalpataru’s orders having fixed price contracts, the company will be able to retain the benefits of reduced steel prices.

This could provide some respite to profits and declining OPMs (currently at 10 per cent). Falling interest rates too can provide substantial relief on interest costs and improve profits. A shuffle in top management in early 2009 remains a point of concern. - HBL