KP Energy - Lotus in muddy water


(Prasenjit Paul) #1

Let’s start with Disclaimer! I am a SEBI Registered Research Analyst running an equity advisory company and holding stake in the company that I am going to discuss. The following stock is not a part of our paid recommendation service so I can able to post about it in public forum. The purpose of this post is to invite views on an unknown high potential stock. (Google Search reveals till date there is no article/post/comment across the internet on the following stock so a healthy discussion might be a fruitful addition)

KP Energy - Lotus in muddy water

In spite of having a huge potential of renewable energy, over the last two decades, not a single renewable energy player emerged as a wealth creator in the Indian stock market. Rather, well known listed player Suzlon proved as one of the biggest wealth destroyers in the last decade! Another listed player Inox Wind generated huge negative return since its listing in 2015. All wind energy players are struggling with their balance sheet. However, a single less known small company (listed in BSE SME) from the same segment reported 45%+ average ROE over the last 3 years! For a player from Wind Energy segment, the numbers will blow your mind. Last 3 years CAGR sales and profit is growing at more than 50% while maintaining Debt to Equity ratio below 0.55! What’s more, they are generating huge operating cash flow every year. Tax rate stands around 33%! The numbers are interesting enough for digging further. While big players like Suzlon, Inox Wind are bleeding, what makes this small company KP Energy standing apart? Let’s figure it out

How KP Energy is different than peers

Big players like Suzlon, Inox Wind derive maximum revenue from the manufacturing and supplying Wind Turbine to the players those are interested to develop wind power projects. They also have their own wind power generation facility. Due to the manufacturing of wind turbine and other components, their business is capital intensive and requires huge investment and working capital. Thus, it effectively reduces the Return on Equity (ROE). On the other hand, KP Energy doesn’t manufacture Wind Turbines. They simply develop other’s project. Suppose ABC Ltd. is interested in setup a Wind power project worth 200 crores. So, ABC Ltd. directs Suzlon for supplying Wind Turbine Generator (WTG). Now, Suzlon bypasses the order of developing the project to KP Energy. “Developing” includes identification of proper site, land permit, construction work of the site, electrical works, setting up the transmission line and maintenance. In simple terms, suppose you are the owner of a residential house (equivalent to ABC limited in the above example). You are interested in interior development for your house. Although you are purchasing floor tiles from Kajaria Ceramics (consider Suzlon) but you handover the implementation i.e. tiles set up to a 3rd party interior designer (consider KP Energy). Floor tiles manufacturer Kajaria is not interested in setting up tiles on your floor because the revenue potential is minuscule compared to their overall revenue. So, Kajaria (here Suzlon) would be happy if any local interior developer (here KP Energy) set up tiles in your floor. You (ABC Ltd) had already spent around 1 crore for purchasing the house. Most likely you don’t delay the payment of few thousands to the interior developer (here KP Energy) for setting up the floor tiles. Moreover, the interior developer has no liability even if some tiles have a manufacturing defect. So, the interior developer (here KP Energy) has following advantages -

  1. Almost NIL liability. Manufacturing defects are covered by the manufacturer.
  2. Timely Payment. As the payment is very less compared to the total amount that the project owner already invested.
  3. Less working capital required, asset light business that is capable to generate huge operating cash flow as the developer has no significant initial investment.
  4. Easily scalable. If more and more people construct house then automatically interior design works would increase. Similarly, Government of India set up an ambitious target of installing 60GW Wind Power by 2022. Quantum of auction also increased a lot. So the Wind Power developers like KP Energy has a huge untapped opportunity.

Due to those above points, KP Energy is perhaps the only company across the Wind Energy segment reporting such 50%+ CAGR growth with less debt, 45%+ ROE while generating huge operating cash flow! (It is also a dividend and proper tax paying company)

KP Energy - Notes from Management Meet -

The company is so interesting that I made up my mind to meet with the management in person. I flew from my hometown Kolkata to Surat (Gujarat) and the management didn’t disappoint me. I had a long two hours conversation with the Company Secretary Karmit Sheth and the MD of KP Energy Mr Farukbhai Patel who is the architecture of the success story. Followings are the few points from our two hours long discussion-

Unique business model with a moat -

The unique asset light business model is the result of careful market study for the last two decades. Farukbhai Patel (first generation entrepreneur) is in various business since 1994. The present business model is crafted after closely studying the Wind Energy sector and big companies like Suzlon. I asked about the “moat” or “competitive advantage” of the company as it seems another company can easily replicate the same business model. The management answered that they have the land bank (all in Gujarat) capable of installing 800 MW Wind Power in the coming years. 800 MW is big enough while considering the fact that last year in FY17 they did 81 MW. (Already a 10X opportunity) Those lands are mostly unused and located very remote parts of Gujarat. So, those are leased at very cheap rate. The huge land bank capable of setting up Wind Project will act as “Competitive Advantage”. Further, from my understanding, many complex procedures are involved in developing a Wind Power project as sites are located in the remote village having very less population. They also did a project in hilly terrain where there is no commercial road connectivity. Thus, for a new entrant, it is not that much easy to copy the business model of KP Energy. Big companies like Suzlon, Inox Wind etc are also executing large projects but their primary revenue generator is the manufacturing of Wind Turbine. So, they are not direct competitors of KP Energy. In fact, over the last 3 years, KP Energy received almost all business from Suzlon itself!

Huge Scale up opportunity -

From Feed in Tariff (FIT) regime to the auction based tariff, the Wind Energy segment changed a lot. The Government of India set up an ambitious target of installing 60GW wind energy within 2022. The latest auction resulted in huge fall of wind power cost at only Rs. 3.46 KWhr. Lowering price means, the economics of scale would come into the picture. Going forward, only cash rich entities can set-up Wind Power projects. The critical mass for viable auction is around 250 MW. During FY17 KP energy did 81MW. Going forward, for their own survival they have to projects ranging from 250-500 MW as small scale projects would no more remain financially viable. So, over the next 2-3 years, they must have to scale up their operation by 5-7 times than the present scale. Otherwise, survival would be difficult. While asking about the capability of scaling up the management replied that it is difficult going from zero to hundred but once you reach hundred you can easily replicate it for making 2X, 3X and all. The statement is true indeed. Myself being a business owner realised the same. It is always difficult for the first paddle in bicycle but once it starts moving paddling becomes smooth and doesn’t require that much pressure as it was required in the first.

Preferential Allotment -

As on August 2016, KP Energy has very low liquidity (not traded every day) in BSE SME segment. Moreover, investors can’t buy a single quantity. As on current date, minimum investment lot is 3 Lacs+ (approx). Thus the stock is out of reach for maximum retail investors. To address the issue, the management is coming out with the Preferential allotment. After equity dilution, the paid up capital would be increased to more than 10 crores which is one criteria for shifting to the BSE main board (exchange). After March 2018 the company can apply for shifting to BSE main exchange. So, after few months from March 2018, KP Energy might be traded on BSE main exchange. Thus low liquidity and high investment lot related issues would be resolved. So, the stock might attract a higher number of retail investor’s interest during 2018.

Honest, Spiritual management -

Interestingly the MD Farukbhai Patel (Follower of Islam) is non-veg while the CEO who overlooks the entire Wind Energy operation, Ashish Mithani (Jain) is purely Veg. In spite of the contrast, both of them are spiritual and share a strong bonding. Farukbhai Patel was also talking about ESOP so that all of his employees can also take a part in the wealth creation journey from their own company. Many employees are associated with Farukbhai for the last few decades! On a side note, I noticed a huge number of books in the office room of Farukbhai Patel. As all of them are written in Hindi/Urdu (maybe) so I didn’t get the idea about the content. I also forget to ask about it!

Overall, I had a nice two hours long interaction with the management of KP Energy. The office visit increased my confidence about the company and business prospects! If everything goes well then the business has potential to grow by 10 times within 2020.

Risk-
Frankly speaking, I was struggling with finding out Risk. So the “Risk” part is edited later due to few requests from community members. So, here it goes -

  1. If the company fails for getting enough project development order or if they fail in scaling up then the survival itself would be difficult in the new auction based regime.
  2. Liquidity Risk - The stock is not traded every day, listed only in BSE SME. If something goes wrong, then one may not find enough buyers for selling it!

Disclaimer -

The author is a SEBI Registered Research Analyst. He has personal investment in KP Energy. So the views can be biased. The above is not a stock recommendation as there is no mention of valuation and stock price target. The author has a separate equity advisory service. KP Energy is not a part of the stock recommendation service. The primary reason is very low liquidity (stock is not traded every day) and the huge minimum required investment. One can’t purchase a single unit of the stock. As on August 2017, minimum investment lot is worth 3 Lacs+ (approx). Thus it is out of reach for the maximum retail investors and can’t be a part of the stock recommendation service.

As KP Energy is not a stock recommendation, so the author can’t be involved in the discussion of stock price valuation, target and all.

The article was first published on https://www.paulasset.com/articles/kp-energy-multibagger/


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(Alphin) #2

Even I had checked the stock and seemed to be a good one. Thanks for the detailed report and management feedback.

Only reasons I passed on the opportunity is as below.

  1. Wind Industry is facing difficult times. At some point it may affect the company.

2.Dependence on few big players in markets. They can set the pricing,example as you said suzlon gave almost all business. In future Suzlon may squeeze them of Thier profits.

  1. Geographical limitations? Why only in Gujrat?

In short it seems to be a high risk, high return stock which can be given a limited portion of portfolio, I typically do not invest in such stocks hence not invested. But company and business operations wise seems good as evident from good financials.


(Prasenjit Paul) #3
  1. As per my view, Wind Energy is not facing difficult times rather it is in the transition phase. If you read conference call from Suzlon, Inox Wind etc, you will realize the current problem due to the shift from Feed in tariff to auction based tariff opens up a huge opportunity for the next 5 years. The government of India is determined for 60 GW within 2022. Earlier only 6 windy states produce and consume wind power. Now, although 6 windy states can produce but it would be transmitted (consumed) to the every states of India! Thanks to the policy from Power Ministry that mandates every state for purchasing a certain portion of renewable energy. Now transparent auction coming more regularly. Foreign players are showing more interest for renewable projects. Needless to say the BJP government did a great job for transforming Power sector including renewable energy segment.
    2.Till date, they were getting projects only from Suzlon. However, going forward it would automatically reduce due to the financial viability of 250+MW projects only. They will keep getting small sized projects from Suzlon, but for executing 250+MW projects that offered through auction, they have to partnered with big domestic/foreign firms. If they can’t do it then survival would be difficult. So for their own survival they have to scale up.
  2. The current size of the company is so small that Gujarat itself offers them 10X growth opportunity. Last year they did only 81 MW. Now, within Gujarat itself they can do 800MW due to their land bank. So, while there is 10X opportunity in their home state, so it would be a foolish idea of going to other states.

(ASG) #4

As mentioned on this forum, most of their orders come from Suzlon. What if Suzlon decides to no longer give KP Energy orders from tomorrow? Isn’t this a huge risk?


(Kritesh Abhishek) #5

The financials of the company is good.
However, I am also concerned with the liquidity of the stock and the future growth aspects. Further, as mentioned above, the company is dependent on the big players for the orders. However, we need to study more about the company as if it has multiple sources for taking the orders. In such case, it will have multple customers and a single souce like Suzlon will not be able to affect the company’s future much if it decides to not give orders anymore because of any reason.


(Bheeshma Sanghani, PhD) #6

Dear @prasenjitp04

You have not mentioned the risks in your thesis for a balanced discussion

Best
Bheeshma


(Ashok) #7

the cost of production in case of solar is coming down drastically. today cost of 1MW plan of solar has come down to 5.5 cr. and it is expected to get lower in future. further solar can be installed in close proximity to load. so capital of transmission is also less. It will be difficult for wind energy to compete in future.


#8

Hi, You run a paid advisory service. Can you please disclose if you have already recommended this your customers? if not why would you disclose a good pick before recommendation.


(Prasenjit Paul) #9

Kindly read the write-up before posting comments as it results in repetation. Whether it is recommended or not to our paid members and associated reasons are already there is Disclosure.

In fact, the Disclosure is more than sufficient covering every possible angle!


(Prasenjit Paul) #10

Cost of Solar and Wind both dropped drastically over the last 2 years. In the latest auction, Solar stands at 2.44/unit while Wind is at 3.46/unit. This is why Government has the target of 100GW solar while only 60GW Wind by 2022 (existing wind around 30GW in 2017). Solar must outpace the growth compared to Wind.

However, Wind and Solar must go hand in hand. Solar can’t be produced across the year 247 but Wind Energy are now produced across the year 247 due to better technology. The issue is not Solar vs Wind. Issue is renewable vs non-renewable.

Again, Thanks to the policies of NDA government, over the last 2 years, government ensured that minimum 6 GW/year Wind is almost certain till 2022. The current size of KP Energy is so small that even if it capture 10% of the 6GW/year which comes 600 MW/year then also a huge opportunity considering in FY17 they did only 81MW. (Out of the 6GW/year opportunity Suzlon and Inox Wind combined will capture 50%-60% market share)

P.S - I would suggest reading Annual Report, Investors Presentation and Conference Call of Suzlon and Inox Wind for the clarity on prospects of the Wind Sector.


(phreak) #11

You may want to go through the following. Hopefully these will temper your optimism for the sector and also your impression of the govt. policies.

The current size of KP Energy is so small that even if it capture 10% of the 6GW/year which comes 600 MW/year

You think 10% market share is that easy? Their current market share is 81MW/5400MW in FY17 which comes to 1.5%. 1.5% to 10% jump is that easy considering how local they are?


(phreak) #12

Also, I think KP Energy is very comparable to Ujaas energy which is a similar EPC player in the Solar energy sector. They do the exact same thing as KP Energy. Their margins have taken a serious hit with falling Solar auction prices. Take a look at the OPM drop for Ujaas energy in the last two quarters to get an idea. KP Energy is bound to take a similar hit going forward under the auction based regime. To add to the woes, FY18 Wind volumes might be abysmal.


(Prasenjit Paul) #13

[quote=“phreakv6, post:11, topic:12355”]
You may want to go through the following. Hopefully these will temper your optimism for the sector and also your impression of the govt. policies.
[/quote]All those are true for FY18 because the Wind Sector itself is in transition phase from Feed in Tariff to Auction based tariff. I am optimistic for minimum 6GW/year addition from FY19 onwards. You need to read Annual Report, Investor Presentation, Concall of Suzlon, Inox Wind and Govt of India’s directive for the clear picture. The primary mistake that maximum investors do is focusing on the past too much while predicting future! (On a sider note, stocks like Suzlon, Inox Wind also will do great in the coming future. All negatives are already factored. Price is near bottom! Obviously personal view, not a stock recommendation!)

[quote=“phreakv6, post:11, topic:12355”]
You think 10% market share is that easy? Their current market share is 81GW/5400GW in FY17 which comes to 1.5%. 1.5% to 10% jump is that easy considering how local they are?
[/quote] It is possible due to the fact that they already have land bank capable to do 800 MW.

[quote=“phreakv6, post:12, topic:12355”]
I think KP Energy is very comparable to Ujaas energy which is a similar EPC player in the Solar energy sector. They do the exact same thing as KP Energy
[/quote] EPC in Solar is completely different than EPC in Wind. You can get the idea only if you visit the project sites and notice how things are actually done. Seating from home browsing screener.in won’t help much!

It would be better if your visit the company management directly for clearing all doubts or you can also mail them. They will most likely answer any kind of queries.


(phreak) #14

I don’t think even the power ministry can “guarantee” things like that.

I happen to have been invested in Suzlon recently and have read Annual Reports and Investor Presentations of Suzlon and Inox Wind. You might want to re-read Inox Wind’s presentation again also read Sanghvi Movers’ investor presentation from Aug 9th or so to get an idea of how dire the situation is.

Having land bank doesn’t automatically translate to orders. Considering the fact that this is all in Gujarat and assuming 20% of the 6GW orders are from Gujarat, you get 1.2 GW for Gujarat. Assuming Suzlon has a market share of 40%, you get 480 MW in that. Even if KP Energy bags all of it, you can’t get to 800 MW am afraid.


(Prasenjit Paul) #15

Nobody is denying the present bleak situation in the Wind Energy segment which is a result of the transition.(Although in the current bleak scenario KP Energy is doing good due to the PPA) My point is stock price doesn’t move based on the past/present scenario, it moves based on the future. The better one can predict the future the more rewarding would be the investment.

Anyways, views must contradict. Only the future can tell in which way the things will move for KP Energy!


(phreak) #23

@prasenjitp04 - Here are some risks

  1. FiT to Auction regime and lack of clarity on Wind power volumes for FY18.

  2. Pace of auctions very slow.

  3. No visibility on Order book situation in their Annual Report for FY17

  4. Receivables quite high - Almost 30% of their FY17 Sales. This has been a problem plaguing similar small renewable energy EPC players like Ujaas energy.

  5. With the govt. having withdrawn GBI and reduced AD and auction unit prices of Rs.3.46 and the more recent Rs.3.42, the IRR of Wind developers could fall as low as 12% from the previous 18% under FiT regime. IPPs may pressurise WTGs and also EPC players like KP energy to take a hit on their margins to protect their IRR to some extent.


(Manish Vachhani) #24

All members are requested to do their own diligence about this stock story before taking any investment decision. Please do not get carried away by the immediate price movement in the stock.


(us121) #25

I believe this is most relevant and shortest possible comment, which i was also worried about for the possible behaviour of many!


(ANANT JAIN) #26

From FY16 AR:

The company had freehold land worth 1.26 cr. and plant and equipment worth 22.29 cr.

From FY 17 AR:

The freehold land

It would be very interesting if you can question the management as to how a land bank of 2.46 cr is a moat and competitive advantage.

What is very interesting is that the company is operating cash flow +ve but if you dig a little deeper you will see that the company’s assets have gone up significantly. From an asset base of 9.85 cr in FY15, the FY17 assets have gone upto 50.28 cr and a Capital work in progress of 17.85 cr a total of 68.13 cr. The very obvious question that comes to mind is if the company is moving its working capital into fixed assets thereby showing a +ve operating cash flow. What beats me is why does a company which is pretty much an EPC company needs so much of asset base.

A little more into assets and it shows that the company has this

a Wind Power Generation plant which is worth 25.75 cr (12.53 cr last year). A very obvious question is why is this plant there in the company assets. Is the company into WInd Power based plants or is it into WInd power erection and if the plant is for a customer why is it not sitting in inventory and if so why is the company buying this since as per initial thesis

the company ABC should be owning Wind Power equipment,.

The other very interesting asset is Switch Yard and Transformer:

What is the company doing with 16 crore worth of this asset (FY 16 it was 8 crores)

Two key questions arise now
a) Are these assets real and if so why do company need these assets?
b) If the assets are real do they really belong to the asset side or to the inventory side of the balance sheet?

Just to continue with the above theme in capital work in progress:

Coming to taxation:

There is a provision for taxation and a Deferred tax, has the company really paid to the taxmen or is it has just created accounting entries? I would have expected some current tax here.

Coming to service tax:

The company says it has to Service Tax expenses of 34 lacs. Now coming to other current liabilities:on page 87 of AR:

The company has 4.28 cr of service tax payable.

To conclude I have absolutely no take on the business but the entire accounting treatment is beyond me. Just a little digging and it feels there is a lot that the company and the auditor need to explain.

Discl: No holding, never held.


(Mayank Narula) #27

I am a banker and have dealt with renewable energy projects of almost all top developers in the country in last 2 years. As an equity investor, looking for ~30% CAGR on my portfolio, I would stay away from power sector and especially wind. Reasons being:

  1. heavy buyer’s concentration mostly to state discoms. Some discoms are good, like Gujarat, Punjab, or Bangalore but they are very few. Ultimately, discoms sell a huge chunk of power to farmers and Agri sector which will always be dominated by politics. UDAY may shift the debt of discoms to state govts, but it won’t solve problems as long as power is being sold in free.
  2. in my view, off shore wind is purely a luxury and soon will be taken over by onshore wind farms where PLFs are much higher.
  3. Wind has a in-build flaw. Wind projects generate 70% of power during monsoon months and that too mostly during night time. So most of the power is being generated during non-peak hrs. That’s why even wind heavy states are now moving away from wind projects and not hitting their targets. In the future, wind projects may face huge back-downs by Discoms which means that Discoms can ask them not to run plants due to less demand.
  4. due to lumpy nature of wind project output, payments are heavily concentrated. So if a 100 Mw project generates 120 crs of revenue, 70-80 crs is concentrated in 3-4 months. This puts pressure on cashflows of discoms. compared to wind, solar is better as cash flows are evenly distributed. That’s why if one looks closely, debtor aging is far more severe in wind than solar.
  5. we are equity investors, not PE or VC. Our focus should be on continuity of business and not on change. Right now, renewable energy industry dynamics are changing a lot. Specially when ur end consumers (discoms) are notorious for inefficiencies. Let govt. run this show for sometime and wait for things to stabilize.