Transmitting gains

Bulging order books, low competition and robust global demand make transmission tower stocks attractive, says R Sree Ram.

R Sree Ram        Print Edition: May 1, 2008

WHAT MAKES THEM ATTRACTIVE

• Huge outlay for power in 11th Plan

• Order books full for next two years

• Recession-proof industry that’s not affected by inflation or interest rates

• Forays into lucrative global markets

• Limited competition

BUT WATCH OUT FOR

• Working capital crunch

• Over-dependence on overseas markets

• Poor financial health of SEBs

It’s a classic case of shortfalls creating scope for windfalls. The ramping up of power generation capacity in the country to overcome the acute shortage of electricity is creating a huge demand for expansion of transmission network.

The Planning Commission has chalked out plans to increase power generation by 50% in the next five years. India produces around 1,50,000 MW of power in a year. Another 78,555 MW would be added to this in the 11th Plan (2007-12).

Even if the target is not fully achieved, this presents a tremendous opportunity to transmission tower companies engaged in engineering, procurement and construction (EPC).

The industry: Transmission tower companies are considered the backbone of the power transmission industry. These companies design and set up transmission networks and build sub-stations for power utility companies. The government’s increased emphasis on the power sector and the guaranteed investments by utilities to augment their transmission network have led to renewed interest in EPC companies.

“This industry can grow by around 30% over the next two years. Order backlogs along with planned investments of Rs 1,40,000 crore in transmission during the 11th Plan and thrust on rural electrification are the growth drivers,” says Bhavesh Shah, vicepresident (research) at Asit C Mehta.

The biggest and most valued client for EPC companies is the Power Grid Corporation, which manages the central transmission network. State electricity boards also award contracts, but they have an inconsistent payment record. EPC companies are also exploring overseas opportunities in West Asia and in African countries.

Most companies have their order books full for the next two years. Several factors make them good defensive stocks in these uncertain times. “This sector is not impacted by rising inflation or interest rates. There is clear visibility of earnings growth as they primarily get orders from government agencies,” says Mukul Jain, research analyst at Prabhudas Lilladher. Jain reckons that transmission tower companies will see a huge spurt in orders in the next two-three years as most of the planned ultra mega power plants are expected to seek connectivity with the rest of the country.

But that shouldn’t make you rush in. Experts rule out exemplary returns in the short term. They expect these stocks to give steady returns over the longer term considering consistent margins of 11-12% and a visible order pipeline. “Investors should adopt the strategy of investing at dips with a medium-to long-term view. In the power value chain, this sector offers better prospects for investors as well as companies,” says Shah.


The stocks: Edelweiss is very bullish on Kalpataru due to its optimal revenue mix from domestic and global operations. “Kalpataru is our top pick because most of its revenues come from domestic market. With superior working capital management and demand for experienced and quality EPC players’ increasing, in future the company is expected to post robust EPS growth rate of around 25%,” says Misal Singh, research analyst at Edelweiss Capital.

Jyoti Structures is the most recommended stock among EPC companies for its in-house capacity and strong order book. It has set-up 33,000 tonne per annum tower manufacturing capacity in West Asia and has recently bagged a Rs 296-crore order in Namibia. “We like Jyoti Structures due to its huge order book and presence in lucrative overseas markets,” says Jain.

Click to see list of stocks to watch out for



With an order book backlog of about Rs 5,050 crore, KEC International derives majority of its revenues from the overseas markets. The company executes projects in risky countries like Afghanistan and countries belonging to the Commonwealth of Independent States. Notwithstanding the risks, KEC International is seen as a good longterm bet considering its lucrative margins and huge order book.

“We believe the company has continuously improved its EBITDA margin. The valuation discount to peers like Jyoti Structures and Kalpataru will narrow,” says HSBC. It has a target price of Rs 870 for the stock.

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