Kalpataru Power Transmission: Buy

Steady growth, timely foray into businesses that hold potential and the ability to sustain profit margins despite pressures support an investment in the shares of Kalpataru Power Transmissions.

Investors can consider taking exposure to the stock with a time horizon of two-three years, by which time the company’s profits may start reflecting the revenue flows from recent forays.

The stock is now trading at a discount (on trailing earnings) to peers such as Jyoti Structures. The price-earnings multiple on its likely earnings for FY-2009 is 15.

Consistency

Kalpataru’s sales and net profits have seen a robust growth of 64 per cent and 122 per cent respectively over the last three years. This growth has been quite steady without sudden spikes, as sales grew by over 50 per cent and profits r by over 100 per cent in each of the last three years. It’s operating profit margin at 16 per cent now has also been consistently superior to peers.

The present order-book at Rs 2,300 crore lends visibility for revenue and earnings.

Kalpataru’s strength is predominantly in design, fabrication, construction and erection of transmission lines and sub-station structures. Backed by domestic strength, the company has been successful in winning orders in the African markets, which have also been active on power reforms.

With more players eyeing the domestic transmission and distribution segment, we view Kalpataru’s presence in overseas T&D markets as a cushion against erosion of margins as a result of increased competition and any slowdown in local spending. The company earned 25 per cent of its revenue from international markets in FY 2007.

Diversified model

In recent years, Kalpataru entered the lucrative pipeline segment and quickly bagged orders from Bharat Petroleum and GAIL. While the order flow in the pipeline sector has not been as robust as expected, this could be viewed as a mere delay than any decline in prospects.

A number of new gas and crude pipelines are being planned and Kalpataru has been increasing its investments in this segment indicating that it could well be an earnings driver in future.

The company’s foray into bio-mass power generation (using agricultural residue) has been successful with two plants running at about 93 per cent plant load factor.

While revenue contribution from these segments is now insignificant, the profit margin appears superior. Further, given the high potential for small-scale bio mass generation projects in rural areas with limited capital employment, we see this segment to buttress overall profit margins even if it does not result in high earnings accretion.

Recent forays

Kalpataru has forayed into logistics and real estate through subsidiaries. The logistics subsidiary is into high-end warehousing, cold storage and logistics activities and has already procured land in several areas of Gujarat and Rajasthan for adding more warehouses.

Increased retailing activity in the country especially in the food segment, warrants the need for integrated warehousing and transportation solutions.

While the bigger players may invest in-house for the same, a good number of mid-rung companies are likely to look at outsourcing — also called third-party logistics. If the subsidiary is able to convert its timely entry into some reasonable market share, it may add value to the consolidated picture.

JMC Projects, another subsidiary, has been a successful turnaround story after Kalpataru’s investment in the company.

This subsidiary is likely to act as a good support for the company’s foray into infrastructure projects.

Price variable clauses in domestic markets have effectively shielded Kalpataru’s operating profit margins from any hike in raw material costs. However, its increasing exposure to foreign currency could dent net margins if not effectively hedged.