Facebook Pixel Code

The heat is on

We initiate coverage of Voltas with an Underperform rating and a target price of R83, implying 23% potential downside. Expect MEP order inflow decline trend to reverse: Order inflows in Voltas?s Electro- mechanical Projects (MEP) segment that constitutes 62% of its sales fell 37% over FY10-12.

Disappointing earnings growth; margins to come under strain

We initiate coverage of Voltas with an Underperform rating and a target price of R83, implying 23% potential downside.

Expect MEP order inflow decline trend to reverse: Order inflows in Voltas?s Electro- mechanical Projects (MEP) segment that constitutes 62% of its sales fell 37% over FY10-12. Domestic order flows (55% of MEP order flows) were muted, while overseas order flows continued to decelerate. However, we expect order flow growth to rebound to 30-35% led by the company?s diversification into industrial and infrastructure business segments in India, and new GCC (Gulf Cooperation Council) geographies.

Voltas has already met with initial success in the domestic market led by new orders from power generation, airports, metro and waste water treatment projects post-diversification and a recent order win in Saudi Arabia (its new growth market). According to a study by the MEED (consultants), the construction sector in GCC countries is poised for a rebound with $286 bn of projects planned to be awarded between CY12 and CY16. However, we expect MEP segment?s execution cycle to get elongated led by an increase in the share of longer-duration infrastructure orders and continued postponement of capex spends by its domestic clients, implying a muted 6% CAGR (compound annual growth rate) in sales over FY12-15.

Expect recovery in UCP sales: Revenues for the Unitary Cooling Products (UCP) segment (30% of sales) represented by ACs (70% of UCP sales) and other cooling products declined marginally in FY12 after years of growth during FY05-11 (a 24% CAGR). This was led by a 20% decline in industry AC volumes due to mild summers, but Voltas managed to arrest the decline at 10%, gaining market share (currently among Top 2 players with a 16.9% share).

We note that AC revenues are highly seasonal with about 70% of sales recorded in the first and fourth quarter of a fiscal year. Short/mild summers or extended monsoons result in poor volumes as customers postpone their buying decisions. We expect industry volumes to grow 10-15% driven by structural drivers such as harsh temperatures, growing urbanisation, rising disposable incomes and declining maintenance costs.

However, given aggressive competition, especially from the Japanese, we expect no incremental market share gains for Voltas. We expect UCP sales to see an 11.5% CAGR (FY12-15).

Margin to contract across segments: We expect margins to decline across business segments in FY13. For the MEP segment, given the dearth of orders and rising competitive intensity, Voltas is bidding incremental orders at 4-5% margins (vs over 7-10% over FY09-12). In the UCP segment, increased competition restricts its ability to take price increases, and input costs are rising as components are mostly sourced from China but the rupee depreciated 26% versus the CNY in FY12.

We expect Engineering Products & Services (EPS) margins to decline led by the rising share of the low-margin after-sales service business. However, we optimistically factor in a margin rebound over FY13-15 led by an increase in order flows for the MEP segment and the optimisation of procurement strategy for the UCP segment. Overall, we expect a 90 bp (basis point) margin contraction in FY13 but margins to recover by 111 bp over FY13-15.

Valuation and price target: We see Voltas delivering a flat EPS CAGR over FY12-15, which is disappointing . While we expect its FY13 EPS (earnings per share) to decline 18%, EPS CAGR over FY13-15 would be muted at 8.6%. We expect working capital to rise for Voltas led by an increase in the share of infra projects and a lack of product differentiation forcing better credit terms in a tough macroeconomic environment, impacting free cash flow growth, despite minimal capex.

Voltas? margins and asset turns are very sensitive to business cycles, depressing RoE (return on equity) further to 17-18% (25% in FY12). Given a weak EPS CAGR of 8.6% over FY13-15e, we value the stock at 9x P/E (price-to-earning) on FY14e EPS, in line with its mid-cycle valuations. A sharp recovery in ME/India capex and writebacks from Sidra project are key risks to our rating.

Credit Suisse

Get live Share Market updates, Stock Market Quotes, and the latest India News and business news on Financial Express. Download the Financial Express App for the latest finance news.

First published on: 18-06-2012 at 01:22 IST
Market Data
Market Data
Today’s Most Popular Stories ×