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Free cash flow rebound seen the most in Havells, Thermax and Voltas: Barclays

Cash generation tends to receive more investor attention than the use of the cash.

Cash generation tends to receive more investor attention than the use of the cash. In our view, cash use dictates a company?s future earnings profile and valuation range. In this report, we study both historical (past ten years) and future cash generation, as well as the cash usage patterns of seven key capital goods companies we cover. We highlight five key conclusions, which support our OW (overweight) ratings on Havells and Voltas (raise PT?price target– to R149). L&T and Voltas are our current top picks.


Capital Goods

Havells, Voltas, L&T: Over weight

Thermax, BHEL: Under weight

Cummins, Crompton Greaves: Equal weight


(i) Pace of operating cash generation: Over the past decade, Havells has seen the fastest operating cash flow growth, followed by Voltas (OW), Thermax (UW-under weight) and Cummins (EW-equal weight). Thermax has achieved the best working capital management, followed by Havells. On our assumption of a slower pace of deterioration in working capital metrics, we expect OCF (operating cash flow) to recover at L&T (OW), BHEL (UW), Voltas and Thermax.

(ii) Historical cash use: In terms of cash allocation, the sector has focused on capex and dividends over the past ten years, followed by investments. Dividends skew (57% of cash generated) was largest for Cummins, while investment skew was greatest for Havells, and then L&T. Although Crompton Greaves (EW) has acquired several companies (some via debt), equity allocation has been limited relative to cash generated.

(iii) Poor investment track record: Companies in general have not managed to drive good returns through investments (acquisitions). Crompton Greaves, Havells (Sylvania), Thermax (B&W JV, absorption cooling JV), Voltas (Rohini Electricals) have all acquired companies in the past, but returns have been low. L&T?s track record has been mixed ? with success in Finance and Infotech, but has yet to see returns on IDPL, MHI JV, Forgings JV. We expect the sector?s weak investment returns profile will continue to impact ROE (return on equity) for the sector until the cycle revives.

(iv) Some companies venturing into non-core activities: Of the seven companies we analysed, Crompton Greaves is the only one that has invested in non-core activities in the past ? it invested in two aircraft that were sold back to the promoter group, and invested in Avantha Power, a utility owned by the promoter group. Because of its investments in office buildings, we expect cash use at Cummins to deteriorate, impacting its asset turns and ROE.

(v) Free cash flow to rebound for some stocks: Over the next three years, we expect Crompton Greaves and Cummins to be capex heavy, L&T to be investment heavy and BHEL to be both investment and capex heavy (to help it diversify). Free cash flow will likely be limited for these companies and, in fact, L&T could even see an equity funding gap (the potential sale of its stake in IDPL to help bridge that). Given limited use of cash generated, Havells, Thermax and Voltas should see free cash flow rebound the most.

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First published on: 10-03-2014 at 10:35 IST
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