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Towering high

Venkatesh Rangan / Mumbai January 22, 2007

 
The recent government thrust on the power sector only reinforces the strong growth prospects for the transmission tower industry.

If you thought that the Sensex gains at an over 50 per cent y-o-y were exhilarating, consider this: the Business Standard transmission line tower index returned a whopping 141 per cent over the past year. That’s hardly surprising. While aggregate revenues for the industry (the four listed players considered) increased by a whopping 48 per cent y-o-y in the first half of FY07 , net profit margins surged from 3.6 per to 5.8 per cent in the same period.

And with the Q3 results of KEC International and RPG Transmission giving enough news to cheer, it looks like the party has just started.

 

For KEC International, while top line grew by a robust 25 per centin Q3 FY07, operating profit increased by a whopping 90 per cent from Rs 42.17 crore in Q3 FY06 to Rs 80.45 crore. 
 

TRANSMITTING VALUE

 

EPS(Rs)

P/E (x)

2007E

2008E

2009E

2007E

2008E

2009E

KEC international

24.90

34.60

45.00

19.30

13.90

10.70

Kalpataru Power Transmission

51.50

68.03

87.70

22.30

16.80

13.10

Jyoti Structures

6.80

10.90

14.70

23.10

14.40

10.60

RPG Transmission

13.50

19.80

27.60

16.80

11.50

8.30

Source: Analysts Estimates

 
RPG Transmission too has witnessed a nearly 380 basis points increase in its operating profit margin. While the completion of a substantial part of old orders and focus on new high margin projects were well reflected in these results, the prospects for the next two to three years are bright too.
 

And the good news just doesn’t stop here. The recent initiatives by the government inviting private investment in transmission networks will serve as a chief trigger for earnings prospects in the near term. 
 

CHARGED UP

Rs crore

Net Sales

Operating Profit

2007E

2008E

2009E

2007E

2008E

2009E

KEC International

2107.18

2633.96

3266.11

238.10

297.60

366.80

Kalpataru Power Transmission

1495.90

1974.60

2448.50

234.40

295.30

333.70

Jyoti Structures

1040.70

1415.30

1811.60

111.40

152.30

187.30

RPG Transmission

353.10

462.60

606.00

33.70

46.80

63.70

Source: Analysts Estimates

 

Empowering private players
When the Union Minister for power inaugurated the bidders’ conference for power transmission networks last fortnight, it was evident that the government meant business.

 

After the ultra mega thermal power projects, it is now 14 large transmission projects worth Rs 20,000 crore, which are being thrown open to private bidders on a BOOT (build, operate, own and transfer) basis. And, it’s not just the power infrastructure companies like Reliance Energy, GMR Energy and Tata Power who are smiling.

 

Waiting in the sidelines are the transmission tower EPC (engineering, procurement and construction) companies.

 

“In fact, out of the four transmission network projects amounting to Rs 11,000 crore, transmission tower companies would roughly get revenues of Rs 5000 crore,” says Pradeep Dhamdhere, ASK-Raymond James Securities.

 

Most tower companies are entering into joint ventures or partnership agreements with big transmission players like Reliance and Tata Power.

 

 
As an industry source puts it, “Our technical and project execution skills and the partner’s financial muscle and operating skills make it a great combination.” Moreover, large scale of projects and expected accelerated implementation means good top line growth for EPC companies in the next two-three years.

But analysts are divided over the exact implications on margins. “The aggressive competitive bidding could make BOOT operators negotiate more firmly as regards tower prices, given the negotiating leverage of the partners,” opines an analyst.

Other factors could also offset any possible pressure on margins. The new contracts given by Power Grid Corporation (PGCIL) and state electricity boards (SEBs), which still remain key clients, entail higher margins than previous ones. “Besides, as capacity utilisation increases and operating leverage kicks in, margins are likely to improve,” opines another analyst.
 

Overall, even if margin pressure does exist, it would not be of significant proportion and would be more strongly felt on players which have a stronger dependence on the domestic market.

 

Connecting loose ends
The privatisation initiatives aside, the government’s ambitious targets of 200,000 MW generation capacity by 2012 from the present 114,000 MW, as also the existing and anticipated regional disparities in power availability provide a compelling growth environment for the sector.

 

The power deficit in the northern and western regions, currently around 18 and 20 per cent, in cpntrast to the surplus situation in the eastern and north eastern region at 26 and 5 per cent have meant an increasing focus on upgradation and expansion of inter-regional transmission capacity.

 

The consequent expected ramp-up of inter-regional capacity from about 11,500 MW in December 2006 to 16,750 MW by March 2007, and finally to 37,150 MW by 2012, would provide a fat order book for tower companies in the next three to four years. Including the projects under direct implementation of PGCIL, over Rs 75,000 crore of investment is envisaged in the central sector alone.

 

The rural electrification programme is another demand driver. The Rajiv Gandhi Vidyutikaran Yojana (RGGVY) introduced in April 2005, aims at providing electricity in all villages and habitations in four years. Rural electrification already forms a substantial chunk of about 16-30 per cent of the order books of the top three tower companies.

 

As Priyanko Panja, vice president, institutional equities, Edelweiss Securities, adds, “Assuming that transmission tower manufacturers would address 20 per cent of the value of these contracts, we expect orders of Rs 1400 crore from the RGGVY for these companies over a period of three-four years.”

 

APDRP (Accelerated Power Deevelopment and Reform Programme) scheme which envisages strengthening sub-transmission and distribution networks and hence checking losses of SEBs could also further add to the order tally.

 

As Panja puts it, “We could expect orders up to Rs 12,200 crore from the remaining APDRP projects in the near future.”

 

Global power
Most players are fixing their eyes keenly on the Middle Eastern and African markets. The implementation of the Gulf Electricity interconnection grid and huge multilaterally funded projects in Africa are key triggers.

 

Though international contracts do not include price escalation clauses entailed in domestic negotiations, players have evolved different strategies to post healthy order books abroad.

 

While KEC International, which derived nearly 70 per cent of its FY06 revenues from overseas negotiates fixed price contracts with built in estimates for cost upsides.

 

Jyoti Structures has generally favoured a case by case planned foray into the international arena. In recent times, the visibility of Indian players like KEC, Kalpataru and Jyoti has increased in both these key markets.

 

There are a few concerns though. Even after privatisation, a major portion of the contracts would still be routed through PGCIL and SEBs.

 

In the past poor financial condition of SEBs have been a problem. Moreover, given the diversity of terrain, project costs may run into overruns.

 

The valuation story…
Given that the sector trades at a range of 19 to 23 times its estimated FY07 earnings analysts are divided over the extent of potential upside.

 

Dhamdhere opines, “Despite increased visibility, the prospects for immediate upside are limited, especially looking at the rally in recent times.”

 

Panja however differs, “We believe that although sector valuations have expanded over the past twelve months, the sector still offers potential upside in the backdrop of continued strong earnings growth.”

 

Among the stocks, KEC and RPG Transmission, both RPG group companies, trade at a significant discount to their peers. With a strong established presence in key overseas markets, KEC looks the best bet to reap the demand boom in the Middle East and African regions.

 

As an analyst says, “Strong project execution skills coupled with geographically diversified revenue streams, unique business policy and marked international visibility makes KEC our best buy.”

 

RPG Transmission is the cheapest among the four listed companies. Suman Memani, research analyst, Emkay Shares and Stock Brokers opines, “Strong order book and increased visibility in the domestic and wider SAARC arena indicates that RPG could exceed our revenue target of Rs 510 crore in FY07." Hence, the potential for further upside remains relatively stronger than peers.

 

Jyoti Structures’ strength is its strong presence in the domestic distribution market, significant insatlled capacity of 76000 tonnes and its Gulf venture. Kalpataru, by far, maintains the best margins in the industry.

 

As Panja puts it, “This is mainly due to lower amount of outsourcing and better project management skills.” Its presence in the pipeline business, given its easy scalability remains a key positive.

 

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