.png)
KERNEX MICROSYSTEMS (INDIA) LIMITED
Published on: 29 June 2024
CMP: ₹396
Target Price: ₹ 2100
Horizon: 4 Years
THREE SENTENCE SUMMARY:
A push from the government for Kavach implementation across the existing and growing rail network of currently ~70,000km in the country brings a 35,000cr opportunity for the three currently approved OEMs of Kavach. Tenders are expected to be equally distributed and Kernex being one of them is the only pure rail safety listed play at the moment with two more vendors waiting for approval. Forecasts by the management paint a very optimistic view of 2700cr revenues by FY27 which has to be taken with a pinch of salt.
TL;DR (OVERVIEW):
Several accidents in the recent past such as Kanchanjunga Express collision in West Bengal in 2024 and Coromandel Express collision in 2023 have been provocative for rail safety
Indigenously developed Kavach is the only solution at the moment to prevent such accidents
Cost is INR 50 lakh per km for Kavach versus INR 2 crore per km for international counterparts
Substantial tenders expected in the coming years as the BJP manifesto stated that they want to implement Kavach in a “mission mode” as they electrified the railways
Only three government approved vendors at the moment – Kernex Microsystems Ltd., HBL Power Systems Ltd. and Medha Servo Drives Pvt. Ltd.
Two more vendors are in the process of getting approved
Tenders shall be distributed evenly upon completion of technology upgrade of Kavach to LTE
6000km of DPR (Detailed Project Report) is about to be completed for launching tender
By FY27, the target price in a bull case is INR 3866; the target price in a bear case is INR 1288
Kernex has partnered with KEC International for execution part of their Kavach units
There are some management issues such as the promoters getting old that may be boom or bust for the company, making it a high-risk high reward investment
FRESH STORMS BREWING:
On a fresh Monday morning of 17 June 2024, two trains- Kanchanjunga Express and a goods train- collided near New Jalpaiguri railway station
in West Bengal. At least 10 people died and more than 40 were injured. The fact that the Second Class Luggagevan and the two parcel compartments situated at the rear of the Kanchanjunga Express took the brunt of the impact of the fast-moving goods train, restricted the number of casualties. About exactly a year ago, 2 June 2023 was another day to remember for the country as that was when three trains namely Coromandel Express, a goods train and Bengaluru-Howrah Superfast express collided in the Balasore district in Odisha. 296 people were killed and more than 1200 were injured. These tragic incidents lately led to a much-needed push from the government and public towards rail safety and adoption of Kavach i.e. the indigenously developed Train Collision Avoidance System (TCAS). There are some allegations that the government’s focus on projects such as Vande Bharat trains, whose tickets are more revenue generating, eats into the focus that rail safety requires.
As of now there are only three qualified Original Equipment Manufacturers (OEMs) in India for Kavach namely Kernex Microsystems Ltd., HBL Power Systems Ltd. and Medha Servo Drives Pvt. Ltd. RDSO of Indian Railways along with the 3 OEMs owns patent for Kavach and new vendor approval for Kavach takes two years. Two more vendors - Quadrant Future Tech (which is carrying out trails), and Seimens are being considered for approval.
HUMBLE BEGINNINGS AND STATUS QUO:
Kernex was started with the object of designing, developing, installing and maintaining software packages for domestic and international markets. The entry into the railway sector was with the development of Intelligent Data Acquisition System and its installation on Konkan Railways in 53 stations from 1997 to 1999. Railway Safety systems were developed after that in technical collaboration with Konkan Railway Corporation Limited (KRCL). Having an employee strength of 300+, Kernex presently has a production capacity of 100 Kavach units/month and can be scaled up to 250 units/month.
Kernex operates in other segments as well and the management forecasts these non-Kavach verticals to contribute at least as much as Kavach by FY27. The overview of all the sectors it operates in are:
1. Railway Safety Systems Design & Development
1. Telecom & Defence
2. Water Management Solutions
3. Turnkey Project Execution
4. Embedded & IOT Products design, development services
The core product offerings of Kernex in Railway Safety Systems Design & Development are:
Train Protection System: TrainSHIELD (Train Collision Avoidance System); ACD (Anti Collision Device)
Level Crossing Protection: LxGuard (Level Crossing Protection System); SAFELx
(Train Actuated Warning Device); SENTINEX (Low-cost level crossing warning system).
Figure: Level Crossing system in the EU Yard Protection System: CASRY (Collision Avoidance System for Yards and Terminals); ATRW (Automatic Timing Recording Device for Railway Wagons)
Information System: KTPIS (Train Passenger Information System)
Kernex also offers some services to leverage synergies from its product offerings. The company provides turnkey product development, electronic product design, embedded software design, electronic manufacturing, ESS testing, offshore development, quality control and training.
THE KAVACH FACTOR:
Kavach is developed for Indian passenger and freight trains. It complies with SIL 4 (highest safety standards). The heart of Kavach, TrainSHIELD is a microprocessor based embedded product designed to prevent over speeding and Signal Passing at Danger (SPAD) in train operations and thus prevent dangerous accidents. It integrates and interlocks the train information with data from track-based sensors to create a safety overlay for train operations. Kavach implementation costs INR 50 lakh per km versus INR 2 crore per km for the European counterparts. The cost of providing Kavach trackside equipment, including station equipment, is around INR 50 lakhs per km, while providing Kavach equipment on locomotives costs around INR 70 lakhs per loco.
The Kavach implementation projects are sanctioned zone-wise and not state wise as Indian Railway’s projects may span across state boundaries. Kavach is currently covered in 1465km and sanctioned for 36,545km. Kavach tenders have been awarded for Delhi – Mumbai & Delhi – Howrah corridors (approximately 3000 Route km) and work is in progress on the routes in West Bengal (229Rkm), Jharkhand (193Rkm), Bihar (227Rkm), Uttar Pradesh (943Rkm), Delhi (30Rkm), Haryana (81Rkm), Rajasthan (425Rkm), Madhya Pradesh (216Rkm), Gujarat (526Rkm), Maharashtra (84Rkm) States. Indian Railways is preparing Detailed Project Report (DPR) and detailed estimate for another 6000 RKm.
The Railways currently have the capacity to install Kavach over 1,500 km route annually, a figure expected to increase to 2,500 km in FY25 and 5,000 km in FY26 as new vendors receive approval. Allocated budget was 557cr in interim budget FY25 and 710cr in budget FY24. Works are in place for enhancing the current and future setups with LTE (long-term evolution) technology, which will enable the system to operate on 4G or 5G networks.
Mission Raftaar (speed enhancement program for freight and passenger trains) will also aid in the implementation speed of Kavach as trains can be run at higher speed with very low chances of accident. Moreover, there is an acute shortage of operation staff and a lot of vacancies. The drivers and other workers are not getting adequate rest. This increases the likelihood of accidents in trains and calls for a relatively faster implementation of Kavach over the rail network.
The only way currently to reach mission zero accidents in railways is through Kavach implementation over the entire railway network of ~70,000km which presents a 35,000cr opportunity out of which only 2,400cr worth tenders are awarded till date. Indian railways has a running track length of 99,235 kms. The total trackage including yards, sidings etc. is at 1,26,366 kms. Significant tenders expected to be awarded until 2029. The Railway ministry aims to implement Kavach on at least 4,000-5,000km per year.
Latest news reveals that after the recent accident, 10,000km of tender will be announced soon. This is not an official statement from the railways. In the 2024 Lok Sabha elections, the BJP manifesto also highlighted that if the party is voted to power, “in the next few years, we will expand the manufacturing, design and installation of Kavach Systems in a mission mode just as we electrified the railway network”. Tenders will be awarded in EPC form. ETCS L2 tenders from Europe were scrapped for Made in India Kavach. Railway ministry and Finance ministry have acknowledged the importance of rail safety and have already planned execution of Kavach in their pink book for the next 5 years.
Kernex has operations in Far East, Africa and Middle East providing headroom for expansion. Some of the existing clients include Egyptian National Railways, Indian Railways, North Frontier Railway, Konkan Railway, Richard Bay Coal Terminal (South Africa) and Sri Lanka Railways. Kavach can be exported to regions such as Africa as the technology is recognized globally now. They have on hand projects 561cr (TCAS/Kavach) and 40cr (non-TCAS). In the latest investor presentation released in February 2024, the company shared that they have also started venturing into other avenues for diversifying their revenues.
As shown in the chart above, the equipment manufactured by Kernex covered 60% of the total consolidated kilometre run by all OEMs combined since July 2021. This marks a big achievement in the sunrise sector as this may give a head start for the company to command preference for being allotted future tenders. 92.47% of the trips with Kernex’s primary Kavach system had no Kavach issues so far in 2.1 lakh kilometre of run. They have partnered with KEC International for implementation of Kavach systems.
The three ongoing projects of Kernex are:
Project 1- NCR-A (North Central Railway)- Supply, installation and commissioning of Kavach (TCAS) in 48 stations and 139 Locomotives spanning 409 km worth 269cr to be completed by August 2024.
Project 2- NCR-B (North Central Railway)- Supply, installation and commissioning of Kavach (TCAS) in 51 stations and in 158 Locomotives spanning 342 km worth 269cr to be completed by September 2024.
Project 3- ICF (Integral Coach Factory, Chennai)- Supply, installation and commissioning of onboard TCAS equipment in Vande Bharat Express EMUS worth 35cr to be completed in 2024-25.
FINANCIAL ANALYSIS:
The most important highlight is the financial outlook given by the company in the presentation in which they forecast their revenues as 130cr (120cr Kavach and 10cr other) in FY24; 900cr (500cr Kavach and 400cr other) in FY25; 1900cr (1000cr Kavach and 900cr others) in FY26; 2700cr (1200cr Kavach and 1500cr others) in FY27. To fulfil the orders already received by Kernex, funds were raised recently through preferential issue of 13,00,000 convertible warrants at a price of INR 403. Considering current developments of pending LTE upgrade, these projections by the management seem a bit far fetched. In the bull case scenario, considering a 12% PAT margin on revenues of 2160cr for FY27 with a forward PE multiple of 25, the valuation comes at 6480cr or INR 3866 per share, 9.7 times the current market price of INR 396. In the bear case scenario, considering a 8% PAT margin, if the company achieves 1500cr revenues for FY27 with a forward PE multiple of 18, the valuation comes at 2160cr or INR 1288 per share, 3.2 times the current market price of INR 396. In any case, there is a substantial upside forecasted in the next three years.
The figures in the table above present a base case scenario based on the management guidance from the investor presentation released in February 2024. It gives a target price of INR 2100.
RISKS:
The story of the company seems to be on a turnaround but there are some threats which need to be considered such as:
Tenders not being released on time.
More time needed for the upgrade of Kavach to LTE technology.
Other competitors eating away market share after getting approvals.
Product by Kernex faces problems so the government prefers other vendors.
Some other technology comes along which is cheaper/better than Kavach.
The diversification efforts by the company do not gain traction and there is muted turnover.
High customer concentration as the operations are limited to railway sector.
According to officials, deployment of the system is complex, especially since it has to be installed on existing networks without disrupting train movement.
Execution issues with partner KEC International.
Possible corporate governance issues as the company has missed filing the results on time for the last two quarters. In the latest quarter it was because of clarifications sought by the board of directors.
