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01 August, 2012

Light Electricals THEMATIC

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Analyst contact

Bhargav Buddhadev Tel: +91 22 3043 3252 [email protected]

Harshit Vaid Tel: +9122 3043 3259 [email protected]

Havells India BUY

CMP: `537

Target Price (12 month): `602

Previous TP: NA

Upside (%) 12

EPS (FY13E): `34.1

Change from previous (%) NA

Variance from consensus (%) -7

Stock Information

Mkt cap: `67bn/US$1.2bn

52-wk H/L: `616/313

3M ADV: `179mn/US$3.2mn

Beta: 0.9

V-Guard Industries BUY

CMP: `301


Previous TP: NA

Upside (%) 24

EPS (FY13E): `19.7



Stock Information

Mkt cap: `9bn/US$162mn

52-wk H/L: `329/141


Beta: 0.9

Light electricals in the darkness McKinsey expects a threefold increase in the number of urban households by 2030 on the back of the share of the middle class increasing 10x to 40% by 2025. This augurs well for electrical companies given that housing is the biggest driver. However, in the next five years we expect the south Indian real estate developers to do well led by end user demand and affordable prices. Also, dealer checks across the country highlight marginal growth in the south and east compared to the weakness in northern and western India. Consequently, whilst we initiate with a BUY on V-Guard and Havells, we prefer V-Guard over Havells given its dominance in south India. Why prefer V-Guard over Havells?

V-Guard’s share of south India (as a percentage of its revenues) is 3x that of Havells: 78% of V-Guard's revenues in FY12 came from South India compared to less than 30% for Havells, Bajaj Electricals and Finolex Cables. This augurs well for V-Guard given the opportunity highlighted in the section titled South India real estate market preferred over North India. Also our discussions with dealers suggest V-Guard is in the top 3 for LE companies across all the south Indian states compared to Havells being in the top 3 in just Kerala and Tamil Nadu.

Virtual monopoly player in stabilizers (the most profitable product): V-Guard is a market leader in the stabilizer market given the quality of its product and the scarcity value of the product as none of the other LE companies offer this product. In fact, the only organized players which compete with V-Guard are Blue Bird and Everest. With huge power deficits continuing to dog the country thanks to the acute shortage of coal, the demand for stabilizers is likely to stay high. The stabilizer is V-Guard’s star product given that it contributed 52% to FY12 EBIT and generated 43% return on capital employed (stabilizers constitute 64% to the electronics segment).

V-Guard catching up with Havells on working capital efficiency: Havells is a pioneer as far as managing working capital efficiency is concerned. (Havells (domestic business) cash conversion in FY12 was 2 days). Having said so, whilst there is limited scope of improvement from Havells, there is an opportunity for others to catch up. V-Guard has taken up this opportunity by starting vendor financing whereby the target is to increase the creditor days by 60 days to 90 days. The advantage of vendor financing over channel financing is lower interest costs (given that the vendors are predominantly small scale units, for which the interest rates are lower) coupled with lower delinquency risk for bankers as payment is to be made by the company (i.e. V-Guard) as opposed to by the dealers in channel financing.

Valuation: Given the cash generative nature of the industry, we use a DCF based approach for Havells and V-Guard with a WACC of 13.5% for Havells standalone, 14% for Sylvania and 13.5% for V-Guard and a terminal growth of 5% for Havells standalone and V-Guard and 2% for Sylvania. We value Havells at `602 per share (implying 12% upside, 17.7x FY13 earnings, 10.8x FY13 EV/EBITDA) and V-Guard at `373 per share (implying 26% upside, 18.9x FY13 earnings and 11.2x FY13 EV/EBITDA).

Light Electricals

Ambit Capital Pvt Ltd 2

CONTENTS Indian Light Electricals industry …….…………………………………………….3 Porter analysis ………………………………………………………………………7 Why do we like Electrical companies? …………………………………………..8 Industry competitive matrix ……………………………………………………..12 South India real estate market preferred over North India… …………… .14 …hence prefer V-Guard over Havells………………………………………….16 Valuations ………………………………………………………………………….18 Company specific summaries……………………………………………………20

COMPANIES

Havells India………………………………………………………………….……21 V-Guard Industries………………………………………………………………..37

Light Electricals


Indian Light Electricals industry The Indian Light Electricals (LE) market is estimated to generate revenues of US$5.5bn with cables and wires constituting the largest share at US$3bn (3-year CAGR of 12%) followed by switchgears at US$0.8bn (3-year CAGR of 13%), lightings and luminaries at US$0.8bn (3-year CAGR of 15%), fans at US$0.7bn (3-year CAGR of 24%) and switches at US$0.2bn (3-year CAGR of 12%).

Exhibit 1: Industry has grown at 11% CAGR in the last three years

(US$mn) FY09 FY12 3-year CAGR % of pie

Domestic switchgear 211 281 10% 5

Industrial switchgear 351 526 14% 10

Switches 175 246 12% 5

Power cables and wires 2,105 2,983 12% 54

Lightings 175 351 26% 6

Luminaries 351 439 8% 8

Fans 351 667 24% 12

Total 3,719 5,493 11% 100

Source: Industry, Ambit Capital research

Housing is the biggest driver: Anecdotal evidence (based on discussions with dealers and companies) suggests that the construction of residential housing is the biggest revenue driver for LE companies as a majority of LE products are used in houses. Industry and infrastructure projects are a secondary revenue driver for the LE companies.

Exhibit 2: Average realization across the LE product portfolio

Havells V-Guard Finolex Cables Bajaj Electricals

Cables and Wires (per km) 27,322 10,058 11,416 NA

Comments Cables and wires used in houses have realizations in the range of `9,000-`22,000/km. whereas those used in infra projects have realizations of `50,000/km. The realizations of the listed firms suggest that they are largely focused on houses.

Lighting and Luminaries (per unit) 128 NA NA 51

Comments Given that the maximum retail price of luminaries used in commercial spaces is `500+ and none of the above companies have realizations close to this, we infer that a majority of their products are lightings used in houses.

Switchgears (per unit) 133 NA NA NA

Comments Havells’ switchgears realization represents the average realization of a Miniature Circuit Breaker (MCB) which is used in households (average realization for MCB is in the range `90-`150).

Consumer durables such as fans, kitchen appliances, geysers etc. (per unit)

1,319 981 NA 994

Comments Fans are the dominant product within this category.


Light Electricals


Highly fragmented: The LE market is highly fragmented with a large number of players offering unbranded goods. This is because the biggest segment in the sector – cables and wires – is probably the most fragmented. Unorganized players account for 90% of the total number of players in this segment.

Exhibit 4: Cables and wires constitute a majority of the revenues of listed players

44%

34%

76%

0% 20% 40% 60% 80% 100%

Havells

V-Guard

Finolex

Wires & Cables as % of net sales Other segments as % of net sales

Source: Company, Ambit Capital research

According to Powerline, India has more than 150 cables and wires players in the industry out of which only 15-16 are organized sector entities. The reason for the large number of unorganized players are the limited barriers to entry and limited role played by branded players in the cables and wires segment. Unlike in the developed markets, Indian consumers assume that all the cables and wires manufactured are already meeting performance specifications and hence there is no difference in quality. Furthermore, whilst the organized players have to pay excise duty of 12.36%, the unorganized players avoid this by selling unbilled products in cash. Consequently they enjoy a significant cost advantage and hence offer better pricing compared to the organized players.

One-fourths the electricals market is imports: As per the import-export data from the Ministry of Commerce, imports contributed 25% to India’s electrical market in FY11. Within this, compact fluorescent lamps (CFLs) witnessed the highest imports (57% of CFLs sold were imported), of which nearly 50% came from China. Even domestic manufacturing companies have started increasing their dependence on imports given that most of the companies have seen their share of imports (raw material + finished goods) rise as a percentage of revenues.

Exhibit 5: One-fourths the FY11 electrical market isimports (figures in `mn)

Products Market size Imports % of imports

Cables and Wires 160,000 35,246 22

CFLs 15,000 8,537 57

Fans 35,000 10,331 30

Luminaries 25,000 6,791 27

Total 235,000 60,905 26

Source: Ministry of Commerce, Ambit Capital research

Exhibit 6: Imports for LE companies have increased

(%) Havells Bajaj Electricals V-Guard Finolex

% of imports to revenues (FY11)

6 6 5 5

% of imports to revenues (FY09)

2 6 2 8


However, whilst the LE companies tracked in this report (Havells, V-Guard, Finolex Cables and Bajaj Electricals) are net importers, as a percentage of sales their net imports are marginal, ranging from 2% to 6%.

Exhibit 3: Cables and wires is anunorganized market

Companies (figs in nos.) FY11 Organized 15 Unorganized 150 Total 165 Share (in %) Organized (%) 9 Unorganized (%) 91 Total (%) 100

Source: Power line, Ambit Capital research

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Exhibit 7: Net forex exposure of LE companies is negligible

Havells V-Guard Bajaj

Electricals Finolex

Earnings in forex 1,759 0 32 394

Expenses in forex 3,158 366 1,639 950

Net exports/(imports) (1,399) (366) (1,607) (556)

Net sales 56,126 7,263 27,394 20,617

Net forex exposure as a % of sales (2) (5) (6) (3) Source: Company, Ambit Capital research, Data pertains to FY11

Within imports the bulk of it is raw materials. This is either because of lack of availability of raw material (in the case of CFLs, the entire raw material is imported) or higher import duty on finished goods relative to raw materials. For instance, whilst import duty for a ceiling fan is ~27%, the levy falls to 15% for power capacitors (a key component in a ceiling fan). However, in the case of appliances, finished goods such as induction cooktops, mixer-grinders, irons etc. get imported. This is the reason why Bajaj’s import of finished goods is the highest (98% of Bajaj’s imports is finished goods) amidst peers. Consequently, with the rupee depreciating by 11% since the start of FY12, there is likely to be some impact on the LE companies such as Bajaj Electricals which have a heavy portfolio of appliances.

The exports opportunity is limited for LE companies since they do not have an overseas distribution network. Whilst there are many project opportunities directly from builders (for which you don’t need a distribution network) especially in the Middle East and African regions, LE companies are not keen to pursue them as the margins tend to be wafer thin. This is on account of the presence of large players like Elsewedy Electric and Saudi Cable Co. in the Middle East. That being said, outsourced manufacturing for global brands is also an opportunity for Indian electrical companies but one that is not pursued by the organized sector as it may be brand dilutive for them. For example, earlier Havells used to do outsourcing for Siemens but now it has stopped this completely given that it is now a well-known brand not only in India but also globally thanks to its acquisition of Sylvania. Given their limited overseas distribution and given their reluctance to do outsourced manufacturing for the global players, rupee depreciation is not a big positive for listed LE companies.

Exhibit 8: Exports for Havells and Finolex have declined with reducing focus on outsourcing (figures are exports as a % of net sales)

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

FY09 FY10 FY11

3.00%

3.20%

3.40%

3.60%

3.80%

4.00%

Finolex

Havells

Finolex Havells

Source: Company, Ambit Capital research, Whilst V-Guard does not have any exports, Bajaj Electricals’ contribution from exports is negligible at less than 0.1% of net sales.

Light Electricals


MNCs entering India: In the last five years there have been several transactions wherein MNCs have taken major stakes in Indian electrical majors (see exhibit 17 for details of transactions). European MNCs in particular have been very aggressive (Schneider and Legrand have between them made 10 acquisitions in the last four years), arguably due to the lack of growth opportunities in Europe compared to India. Note that these MNCs are energy management firms (with products that find applications primarily in electricity distribution, power monitoring and control) and they primarily derive revenues from new projects (power capacities, factories and to some extent, houses). Given the ongoing slowdown in new projects - power capacity addition CAGR of 1% over the next 15 years in Europe (compared to 6% in India) and muted European GDP growth, the focus of the European energy management firms is shifting to India.

Exhibit 9: EU GDP growth has been sluggish in recent years (figures represent % growth in GDP )

-6.0-4.0

-2.00.0

2.04.0

6.08.0

10.0

2008-09 2009-10 2010-11 2011-12 2012-13

India EU (27 countries)


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Porter analysis Exhibit 10: Porter analysis of the Indian Light Electricals industry

Source: Ambit Capital research

Bargaining power of suppliers MEDIUM

Major raw materials are aluminum and copper where prices are set by global commodity exchanges and where the credit period offered is zero.

Given the extensive amount of outsourcing to vendors, they also qualify as suppliers. However their bargaining power is extremely weak given their dependence on LE companies (most outsourced manufacturers work with either 2 or 3 LE companies) and the nature of the work (on most occasions it is largely unskilled and mundane job work).

Bargaining power of buyers MEDIUM

The buyers for LE companies are the trade fraternity (i.e. dealers) given that ~70% of the business is done through them. The balance is done through direct selling to builders.

The bargaining power with dealers is medium. Whilst LE companies over time have built a pull factor in the minds of consumers via advertising and by improving the quality of the product, the model still continues to be a “push” model wherein the dealer pushes the brand to the end consumer via the retailer. This is the reason that LE companies have come out with innovative schemes for the dealer fraternity like channel financing. Having said so, the dealer cannot afford to not stock a particular brand as the leading LE companies have over time built brand recall.

Competitive intensity MEDIUM

Imports are not a threat for Indian LE companies as a majority of imports into India tend to be raw materials. This is because import duty on finished goods is significantly higher than on the raw material.

MNC players are not a major threat for LE companies (see page 10 for more details). Apart from Legrand and to some extent L&T, other MNC players are more focused on industrial demand. Also Legrand and L&T are focusing more on the switches and switchgear market, which is just 20% of the total opportunity.

Threat of substitution LOW

There are no substitutes available for LE products either within the cables and wires or consumer durables segment.

Imports are also not a big threat given that bulk of the LE imports in India tends to be raw materials and not finished goods.

Barriers to entry MEDIUM

There are no major technological barriers to entry.

However, building a distribution network and a well known brand are big challenges. This is evident from the punchy valuation multiples offered by MNCs to Indian companies with strong brands and strong distribution networks.

Unchanged Deteriorating Improving

Light Electricals


Why do we like Electrical companies? Demand for housing to rise: McKinsey expects a threefold increase in the number of urban households by 2030. It expects 91mn urban households to be middle class by 2030 compared to 22mn in April 2010 (implying a CAGR of 7.5%) (middle class is defined as earnings between `0.2mn to `1mn on a per annum basis). Since 1985, the share of the middle class in India’s population has quadrupled to 4% which as per McKinsey is likely to increase 10x to 40% by 2025. Furthermore, McKinsey expects the urban population’s share of the national population to increase from 46% in 1990 to 69% by 2030. All of this augurs well for the housing sector. High asset turnover: LE companies generate attractive asset turns which aids in generation of attractive RoCEs. This is aided by outsourcing to sub-contractors either in India or in China. In fact many LE companies outsource the entire production for some product categories. For instance ~60% of V-Guard’s product portfolio is fully outsourced to vendors (primarily based in India). Interestingly, despite outsourcing, operating margins continue to hold up for Bajaj Electricals and V-Guard. Bajaj Electricals which has the highest outsourcing (75% of COGS is traded goods in FY11) generated an average EBITDA margin of 10% over FY07-FY11 compared to 10.5% for Havells (16% of COGS is traded goods in FY11) and 10.7% for V-Guard (58% of COGS is traded goods in FY11). Accordingly, the player with the highest asset turnover enjoys the highest RoCE.

Exhibit 11: Companies with a strong asset turn generate higher RoCEs

18.8 17.8 16.9

21.7

4.2 5.22.69

13.8111.8

10.06.8

8.6

0

5

10

15

20

25

Havells (Standalone) V-Guard Finolex Bajaj Electricals

RoCE Asset Turnover Operating Margins

Source: Company, Ambit Capital research, Data pertains to FY11

We believe cheaper labour cost, timely delivery and longer credit periods offered by vendors are the reasons for outsourcing. Discussions with vendors in India highlight savings from outsourcing of 50% in labour cost, credit period of 90 days (which practically means that the Indian OEM operates on negative working capital. Note: LE companies hardly have any debt on their balance sheet) and lower risk of labour strikes (as there are no labour unions in China). Also quality control is not compromised given that raw material procurement is usually done by the OEM. In addition to this the company also deploys personnel at the outsourced unit to sign off on the product quality before the same gets dispatched from the factory. Lastly during recessionary periods, such as those prevailing today, there is another advantage of outsourcing, which is to delay receiving shipment deliveries citing recessionary trends. Surprisingly, there is no interest paid by the OEM for delay in receiving shipments.

Strong cash generators: LE companies have consistently delivered positive cash flow from operations. Furthermore in many instances average CFO/EBITDA has been 100%+ highlighting excellent cash conversion and healthy working capital cycles. This is aided by channel financing which has led to lower debtor days for the LE companies. In channel financing (CFS), the bank provides finance directly to

Exhibit 12: Advantages of outsourcing

Savings in labour cost (%) 50

Credit period (days) 90

Probability of slippages Lower


Light Electricals


the approved dealer under credit risk cover from an insurance company with partial or no recourse to the LE company. The LE company realizes its sales proceeds immediately and the operating funds so unlocked, can be deployed to fuel business growth. Under CFS, a dealer can avail the credit facility every time he purchases goods from the principal. The bank is paid directly by the dealer within the time limits set under the facility. The dealer gains not only in terms of obtaining hassle-free credit but also by way of getting a cash discount from the company for paying upfront. This discount can help offset the cost of credit sought from the bank.

Exhibit 13: LE companies generate stellar cash flows (figures in %) …

CFO/EBITDA Havells V-Guard Finolex Bajaj Elec

FY11 116 (22) 48 78

FY10 80 (13) 115 42

FY09 146 101* (2,608)** 112

Source: Company, Ambit Capital research, *Post FY09, the ratio witnessed a fall on the back of higher inventory as it expanded into the northern region. **The company incurred a major loss on forex transactions.

Exhibit 14: … given lower debtor days

Havells V-Guard Finolex Bajaj Elec

FY11 12 50 18 122

FY10 13 50 15 108

FY09 13 50 23 103*

Source: Company, Ambit Capital research, *Bajaj has higher days due to its engineering and projects business (accounts for 27% of revenues) wherein the debtor days are higher.

Brand and distribution act as strong entry barriers: There is a direct positive correlation between gross margins and the number of distributors and advertising spends. This is tabled in exhibit 15 and 16 below, which shows that companies spending more on ad and promotional campaigns enjoy higher gross margins relative to peers spending lower on ad spends and promotional campaigns. Note that Havells and V-Guard spend the highest in the industry and consequently enjoy the best gross margins. Conversely, Finolex Cables, which spends the least on ad spends and promotional campaigns, has the lowest gross margins.

Exhibit 15: Higher gross margins for LE companies...

15%

20%

25%

30%

35%

40%

FY06

FY07

FY08

FY09

FY10

FY11

Havells

V-Guard

BajajElectricals

Finolex

Source: Company, Ambit Capital research, figs represent gross margins

Exhibit 16: ..which have higher advertisement spends

0%

1%

2%

3%

4%

5%

6%

FY06 FY07 FY08 FY09 FY10 FY11

Havells V-Guard

Bajaj Electricals Finolex

Source: Company, Ambit Capital research, figs represent ad spends as a percentage of sales

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Exhibit 17: Recent transactions in the electrical segment have been at punchy multiples

Acquirer-Target Number of distributors Year Deal value

(` mn) (%) Stake acquired

EV/ EBITDA (x)

PE (x)

Matsushita-Anchor 10,000 dealers and 300,000 retailers 2010 20,000 80 14 15

Legrand-Indo Asian Fusegear 250 distributors and 15,000 dealers and retailers 2010 6,000 100 20 -

Schneider Electric-Luminous 900 distributors and 25,000 retail outlets 2011 14,000 74 16 -

Schneider-Digi Link 3,000 retail stores 2011 5,030 100 - 23

Source: Ambit Capital research, Industry

Entry of MNCs not a major threat for incumbents: Despite the entry of several MNC players, we do not see significant threat to the listed LE incumbents. This is because the MNCs’ product portfolios have limited overlaps with LE companies (exhibit 18). MNC companies typically focus on products which find application in industries (i.e. industrial switchgears) as margins are higher in the industrial segment and competition from the unorganized segment is minimal.

Exhibit 18: Product mapping of LE companies with MNCs suggests limited overlap

LE companies MNCs

Havells V-Guard

Bajaj Electricals Anchor Polycab Legrand L&T Schneider Siemens/

Osram Philips

India Electrical Consumer Durables

Fans √ √ √ √

Water heater √ √ √

Irons √ √ √

Kitchen appliances

√ √

Lighting CFLs √ √ √ √ √

LEDs √ √ √

Indoor luminaries

√ √ √ √

Outdoor luminaries √ √ √

Switchgears Low voltage √ √ √ √ √ √ √

Medium voltage

√ √ √ √

High voltage √

Switches √ √ √ √ √

Motors √ √ √

Cables & Wires

Low voltage cables

√ √ √ √

High voltage cables

√

Residential wires

√ √ √ √

Source: Ambit Capital research, Industry

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We believe the MNCs will continue to focus on the industrial segment. We conclude this from the limited number of distributor and channel partners that they have, the lack of new product launches in the non-industrial category and the limited advertisement and promotional spend of the MNCs relative to their peers.

Exhibit 20: MNCs’ distribution network is weak compared to that of LEs

Companies Distributors Retailers Other formats

Locals

Havells 5,000 100,000 135 Havells Galaxy stores

V-Guard 280 12,000 retailers and 1,200 channel partners

Bajaj Electricals 1,000 400,000 retail outlets and 4,000 authorized dealers

20 Bajaj World stores

Finolex 20,000 dealers and 2500 channel partners

MNCs

ABB 23 marketing offices across India

Schneider 255 7 panel builders and 61 system integrators

Siemens 500 channel partners 19 sales offices


Exhibit 19: Lower ad-spends of MNCs (%) ABB 0.03 Siemens 0.18 L&T (consolidated) 0.23


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Industry competitive matrix Exhibit 21: Competitive analysis of the industry

Segment Market size

(`bn)

% share of overall market

opportunity

Type of margin

Ranking of players (from best to worst)

Feedback from primary data

Domestic switchgear

16 4 Medium Havells

Legrand - MDS

Schneider

Whilst Havells is very strong in this segment, it is facing strong competition from MNC players like Legrand and Schneider. With Panasonic acquiring Anchor we expect competition to further increase as Panasonic is very aggressively pushing switchgears (source: our discussions with dealers). This was not the case with Anchor earlier as it was known more for its switches.

Modular switches 14 4 Medium Anchor

Havells

Roma

Anchor has been a market leader for a very long time as the life of its switches is high and the range of choice it provides is very wide. Now with Panasonic coming on board, Anchor’s positioning has further strengthened.

Industrial switchgear

30 8 Highest L&T

Siemens

Schneider

Havells

MNC players dominate this segment given their wide product range, proven track record, and superior technology. LE companies have negligible presence in this segment.

Cable & wires 170 47 Low Polycab

Finolex

Havells

This is a commoditized market where there is huge competition from the unorganized market. Polycab is a trusted name as it has been around for 30 years and offers attractive pricing (~10% lower than Havells and V-Guard).

CFLs 20 6 Low Philips

Havells

Osram

This is increasingly becoming a commoditized market as many new players have entered this space. However, LED is increasingly catching up with the CFL market.

Luminaries 25 7 High Philips

Crompton

Bajaj

Havells

Wipro

This is a high-end segment with the main customers being hoteliers, malls and HNIs. In this market Havells' positioning is not the best as its products are more targeted to the average Indian rather than the affluent.

Fans 38 10 Medium Crompton

Usha

Havells

Orient

By far Crompton is the undisputed leader given its fast mover advantage and impressive supply chain network which helps it achieve economies of scale in this business. Lastly this is a cash cow for Crompton as the business operates on negative working capital

Small domestic appliances

50 14 Medium TTK, Hawkins

Bajaj, Racold

Havells

TTK and Hawkins are the leader in this segment given their strong brand, broad portfolio of products and strong distribution network.

Total 363 100

Source: Company, Industry feedback

Light Electricals


Exhibit 22: Havells emerges as a superior brand across LE companies

V-Guard Havells Finolex Bajaj

Electricals Remarks

1) Brand strength

FY11 revenues

7,263

28,817

20,358

27,408

Ranking

FY11 EBITDA margins

10.0% 9.9% 6.8% 8.6%

Ranking

% spend on adv.

3.81% 2.39% 0.38% 2.21%

Ranking

Overall rank

Whilst Havells emerges as the strongest player (given the highest revenues and superior EBITDA margins), V-Guard is competing aggressively with Havells by spending aggressively on branding. Note that V-Guard's non-southern (region dominated by Havells) share in total sales has increased from 5% in FY08 to 22% in FY11. Finolex, on the other hand, seems to be struggling with lower EBITDA margins and minimal ad spends. Bajaj Electricals continues to leverage on its flagship "Bajaj" brand given strong EBITDA margins despite the lowest share in inhouse manufacturing relative to peers.

2) Distribution network

Distributors 280 5,000 - 1,000

Retailers 12,000 retailers

and 1,200 channel partners

1,00,000

20,000 dealers and

2,500 channel partners

4,00,000 retail outlets

and 4,000 authorized

dealers

In-house 135 Havells Galaxy

Stores 20 Bajaj

World stores

Ranking

Bajaj Electricals gets the highest rank given its strong distribution network courtesy its existence for 72 years. Havells is catching up fast by focusing more on distributors and opening its own Galaxy stores. The reason for focusing on distributors is its successful channel financing scheme which acts as a win-win model for both distributors and Havells. V-Guard, although it scores the lowest, is adding channel partners at a fast pace given its strategy to crack open the non-Southern market. In the last three years V-Guard's distributors have nearly tripled from 108 in FY08 to 280 in FY12.

3) Range of products

Number of products

Fans, Stabilizers, LT Power Cable, PVC Cable, UPS,

Induction Cooker, Geyser

Fans, Domestic Appliances(18 types),

Cables, Wires, Switches, Geysers, Switchgears,

CFL, Luminaries

Wires and Cables,

CFLs, Copper

Rods

Domestic Appliances (23 types),

Fans, Lighting &

Luminaries

Ranking

Havells offers the widest range of products ranging from fans, switchgears, CFLs, luminaries, wires, cables, geysers and other domestic appliances. This is the most diverse product range offered amongst these four players. Whilst Bajaj Electricals and V-Guard (to some extent) are also present in the consumer durables segment, their product profile is not as diverse.

4) Exposure to the various sectors

Highly competitive

Moderately competitive

Least competitive

Average ranking

The most competitive segment consists of the wires and cables market since it is largely unorganized and the margins are also the lowest. The moderately competitive market consists of the consumer durables, lighting and luminaries segment whereas the least competitive market comprises the switchgears segment (since the margins are the highest and it has a limited number of players). Accordingly, Bajaj ranks the highest as it has no exposure to the highly competitive segment and the majority of its products fall in the moderately competitive segment. Finolex Cables, on the other hand, has the least attractive product mix.

Overall ranking On an overall basis, Havells scores the highest while Finolex scores the lowest.


Light Electricals


South India real estate market preferred over North India … The Southern India market has been growing

The Southern Indian real estate market has held up much better than the Northern or Western Indian markets over the last couple of years. The volumes for the South-India based players (Sobha, Purvankara and Prestige Estates) have improved in FY11 and FY12 compared to the North Indian players such as DLF and Unitech whose volumes have seen a dip.

Exhibit 23: South India players’ performance better (figures in mn sq ft sold) …

0

1

2

3

4

5

6

Sobha Puravankara Prestige Estates

FY10 FY11 FY12


Exhibit 24: … compared to its North Indian peers

02468

1012141618

Unitech DLF Parsvnath

FY10 FY11 FY12

Source: Ambit Capital research, Note data for Parsvnath is not available for FY12.

Southern region to become the downtown of India

LE companies are increasingly focusing on South India said a marketing manager of a large unlisted LE company. The reason for the same is the strong demand in South India from offices, commercial buildings and residential markets. This is corroborated by JLL’s (a leading real estate consultant) market research which concludes that:

(a) Nearly 45% of India’s office stock (top 7 cities) is represented by the Southern cities,

(b) Office vacancy rate in south India is likely to be 16% by end-2012 compared to the national average of 20%,

(c) Southern cities recorded nearly one-thirds the country’s new residential launches in the past five quarters compared to less than 25% three years ago in 2009,

(d) South India to constitute about 56% of the country’s mall supply between the years 2012 and 2016 thereby increasing its share compared to the pan-India stock from 20% in 2011 to 36% by 2016.

South India is a user driven market

Unlike North India, South India is a user driven market. We highlight this because the investor driven markets in India are likely to see a slowdown given falling investor risk appetite. This is corroborated by the falling volumes in the equity stock market and rising demand for fixed income securities. Note that real estate as an asset class is considered risky given the size of investment (big ticket), project delays, long gestation period and liquidity challenges (illiquid market).

Light Electricals


According to DTZ India (the real estate consultant), around 70% of the real estate market in NCR, Delhi and Mumbai is investor driven. Anecdotal evidence suggests the prevalence of black money as one of the main reasons for this. Consequently, these markets have seen a sharp appreciation in property prices in the past two years. In contrast, for developers down South, the proportion of end user sales is higher. For Sobha, the percentage of properties owned by businessman/entrepreneurs (i.e. the investor community) is only 9%. Consequently, the property prices have also been moderate.

Also South Indian residential markets have been a follower of the “affordability” mantra given that more than 80% of new launches are being priced under the `4,000 per square feet category. Consequently the residential markets in South India have remained resilient in the last two years (exhibit 23 and 24) relative to the decline recorded in the sales volume of North Indian players. Note that sales in NCR markets witnessed a YoY drop in sales of 58% and 57% respectively compared to Bangalore which witnessed a drop of only 18%.

Exhibit 25: South India based developers average realizations are lower compared to North India based developers (figures are in ` per sq feet)

3588

4303

5181

6193 6356

3000

4000

5000

6000

7000

Puravankara PrestigeEstates

Sobha DLF Unitech

Source: Ambit Capital research, Company, DLF and Unitech are North India based developers

Exhibit 26: Sobha hardly has any exposure to investors

End-user %

IT/ITeS professional 39

Medical/ pharmaceuticals 4

Business/ entrepreneurs 9

Other professionals 44

Others 4

Total 100


Exhibit 27: Hirco Chennai sales to bulk (investors) in FY10 was significantly lower ..

Bulk sales 27%

Retail sales 73%


Exhibit 28: … compared to its Navi Mumbai sales

Bulk sales 65%

Retail sales 35%


Light Electricals


…hence prefer V-Guard over Havells V-Guard’s share of South India (as a percentage of its revenues) is 3x that of Havells: 78% of V-Guard's revenues in FY12 came from South India compared to less than 30% for Havells, Bajaj Electricals and Finolex Cables. This augurs well for V-Guard given the opportunity highlighted in the previous section. Also our discussions with dealers suggest V-Guard is in the top 3 for LE across all the South Indian states compared to Havells being top 3 in just Kerala and Tamil Nadu.

Virtual monopoly player in stabilizers (the most profitable product): V-Guard is a market leader in the stabilizer market given the quality of its product and the scarcity value of the product as none of the other LE companies offer this product. In fact, the only organized players which compete with V-Guard are Blue Bird and Everest. With huge power deficits continuing to dog the country thanks to the acute shortage of coal, the demand for stabilizers is likely to stay high. Except for Gujarat, most other states are experiencing power shortages and power cuts which are leading to disruptions in power supply and wild voltage fluctuations. V-Guard’s recent success in North India (see details in the section below) is thanks to the acute power cuts in the National Capital Region, Uttar Pradesh and Punjab. V-Guard’s product has been a hit (due to its good quality and also its scarcity value given the limited number of organized players) as per our discussion with dealers. In fact, it has also to a good degree complemented cross selling of V-Guard’s other products.

The stabilizer is V-Guard’s star product given that it contributed 52% to FY12 EBIT and generated 43% return on capital employed (stabilizers constitute 64% of the electronics segment). The reason why it is so successful is because its role is to protect expensive white goods like TV, washing machine, fridge, air conditioners etc., against power fluctuations. Not only is it very affordable (costs less than 5% of the overall cost of the white goods), more importantly it increases the life of the asset by at least 50% thereby justifying its criticality. Other than stabilizers, V-Guard also sells UPS and inverters, which are used as power backups.

Exhibit 30: Stabilizer* is the star product for V-Guard

(%) Sales break up

EBIT break up RoCE Capital

employed

Electronics (includes stabilizer) 32 52 43 21

Electronic / Electro-mechanical 65 40 10 72

Others 3 8 22 7

Source: Company, Ambit Capital research. Data pertains to FY11; Note:’ Electronics’ consist of Stabilizers, UPS and Inverters,’ Elecronic/Electro-Mechanical’ consist of PVC Cables, LT Power Cable, Fans, Pumps whilst other products fall in the’ others’ category *64% of electronic sales are stabilizers.

V-Guard catching up with Havells on working capital efficiency: Havells is a pioneer as far as managing working capital efficiency is concerned. (Havells (domestic business) cash conversion in FY12 was 2 days) . Having said so, whilst there is limited scope of improvement from Havells, there is an opportunity for others to catch up. V-Guard has taken up this opportunity by starting vendor financing whereby the target is to increase the creditor days by 60 days to 90 days. The advantage of vendor financing over channel financing is lower interest costs (given that the vendors are predominantly small scale units for which the interest rates are lower) coupled with lower delinquency risk for bankers as payment is to be made by V-Guard as opposed to by dealers in channel financing.

Aside from this, V-Guard is also working at bringing down its debtor days given its strong traction in North India. As an entry strategy, V-Guard had given higher credit to dealers in North India. Now with the product finding good acceptance (see below for more details) it is looking at normalizing the debtor days (which increased to 54 days in FY12 from 44 days in FY07, which is expected to reduce

Exhibit 29: Power deficit in V-Guard’s strong markets is higher than India’s average

Surplus/

Deficit (%)

India -8.1

Andhra Pradesh -12.4

Karnataka -11.6

Kerala -3.7

Tamil Nadu -17.0

NCR -0.4

Punjab -4.7

Uttar Pradesh -13.4

Light Electricals


from FY13 onwards). Consequently, we expect V-Guard to catch up with Havells' cash conversion cycle in a span of two years. Currently, V-Guard's cash conversion cycle is at 67 days compared to 2 days for Havells (standalone).

Growing presence in North India: Whilst Havells’ revenues from North India has remained constant at ~30% in the last three years (the North is the biggest electrical market), V-Guard’s share has been increasing at a rapid pace from 5% of revenues in FY08 to ~22% in FY11). In a span of five years the company has managed to break even, a phenomenal achievement said a marketing manager of an unlisted large LE company. This is because the northern and western regions are traditionally the most difficult markets to break. Havells which is a strong brand in North India (given its base in Delhi) has struggled to build market share in the West. Havells’ market share in the West has not been able to gain significant market share in the last three years which increased from 11% of revenues in FY10 to 15% of revenues in FY12. Whilst V-Guard had to offer a higher credit period as an incentive to attract dealerships in the initial three years (which meant its CFO turned negative in FY10 and FY11). In FY12, its CFO has returned to positive territory as cash conversion in FY12 improved to 67 days from 96 days in FY11.

Light Electricals


Valuation In the last one year, the share prices of Havells and V-Guard have outperformed the Sensex by ~53% and 35% respectively on the back of strong results and stock re-ratings. PAT in FY12 increased 22% for Havells and 28% for V-Guard on the back of growth in revenues and improvement in EBITDA margin. Whilst we are bullish on LE companies from a long term perspective (given rising urbanization as the disposable household income of the Indian middle class grows), we prefer V-Guard over Havells as explained in the earlier section. Whilst V-Guard is trading at a discount of 17% on FY13 P/E compared to Havells (domestic business), we believe this is unjustified given the higher earnings CAGR (22% versus 17% for Havells (domestic business) over FY12-FY14), improving cash conversion from 67 days to 59 days over FY12-14 (compared to deteriorating for Havells (domestic business) from 2 days to 6 days over FY12-14) and higher RoEs of 26.4% in FY14 (compared to 26.6% in FY12) compared to Havells’ domestic business RoEs of 20% in FY14.

When compared with global electrical companies V-Guard and Havells are trading at a premium of 39% and 76% on FY13 earnings and EV/EBITDA which seems justified given higher RoEs and higher earnings growth. Havells and V-Guard are expected to report earnings growth of 22% and 17% over FY12-14 and average RoEs of 26% and 20% over FY12-14 compared to global companies’ earnings growth and average RoE of 17% and 16% over FY12-14 respectively.

Exhibit 31: Relative valuation

PE (x) EV/EBITDA (x) P/B (x) EPS CAGR RoE (%)

Company name CMP (LC)

Mcap (USD)

FY13E FY14E FY13E FY14E FY13E FY14E (FY12-14E) FY13E FY14E Country

Havells India Ltd (domestic business)

537 1,203 18.3 15.4 12.0* 10.3* 3.4 2.9 17% 20.1 20.5 INDIA

V-Guard Industries Ltd 301 161 15.3 12.0 9.2 7.5 3.5 2.9 22% 25.2 26.4 INDIA

Bajaj Electricals Ltd 177 318 11.4 9.1 6.4 5.2 2.1 1.8 28% 20.0 21.4 INDIA

Finolex Cables Ltd 40 110 5.4 4.2 3.9 3.2 0.6 0.5 22% 13.3 16.1 INDIA

Median 13.3 10.5 7.8 6.3 2.7 2.3 22% 20.0 20.9

Fagerhult AB 193 364 11.6 10.3 7.8 7.3 2.4 2.1 7% 21.9 20.6 SWEDEN

General Cable Corp 28 1,372 10.3 7.9 5.6 4.8 0.8 0.7 46% 12.2 15.7 USA

Zumtobel AG 9 462 16.1 9.1 5.4 4.3 0.9 0.9 60% 6.2 10.7 AUSTRIA

Nexans SA 36 1,256 11.8 8.8 4.5 3.9 0.5 0.5 NA 6.4 6.1 FRANCE

NVC Lighting Holdings 1 574 6.0 5.8 3.7 3.1 0.8 0.7 6% 15.4 16.1 CHINA

Breville Group Ltd 5 654 14.6 13.0 8.7 8.0 3.6 3.2 22% 26.3 26.3 AUSTRALIA

Beldin Inc 34 1,534 12.2 10.0 6.3 5.5 1.9 1.6 17% 18.5 20.2 USA

Legrand SA 26 8,440 13.2 12.4 7.9 7.6 2.1 1.9 7% 16.6 16.7 FRANCE

Median 12.0 9.5 5.9 5.1 1.4 1.2 17% 16.0 16.4

Source: Ambit Capital research, Bloomberg, *to calculate the standalone EV of Havells, we reduce the target EV of Sylvania from the consolidated EV (at CMP) of Havells.

Light Electricals


Exhibit 32: Havells (consolidated) is trading at its highest 1-year forward EV/EBITDA multiple ...

0

100

200

300

400

500

600

700

Apr

-08

Aug

-08

Dec

-08

Apr

-09

Aug

-09

Dec

-09

Apr

-10

Aug

-10

Dec

-10

May

-11

Sep-

11

Jan-

12

May

-12

9x8x7x6x

10x11x

Source: Ambit Capital research, Bloomberg

Exhibit 33: … and highest 1-year forward PE multiple

0

100

200

300

400

500

600

700

Apr

-08

Aug

-08

Dec

-08

Apr

-09

Aug

-09

Dec

-09

Apr

-10

Aug

-10

Dec

-10

May

-11

Sep-

11

Jan-

12

May

-12

18x16x

14x12x10x8x

Source: Ambit Capital research, Bloomberg

Light Electricals


Company specific summaries Havells India: The end of the ‘dream run’? (BUY, CMP `537, 12% upside)

Havells is India’s leading electrical company with a strong distribution network in Europe through Sylvania. In the last five years whilst the domestic business has seen a golden run with stellar earnings CAGR of 24%, Sylvania has seen a strong turnaround from an EBITDA loss in FY10 to 7.3% margin in FY12.

However we believe that company will face a long and tough road ahead given that: (a) our interaction with dealers highlights slowdown in sales in FY13; (b) the re-rating on account of Sylvania’s turnaround seems to have played out; and (c) entry into the domestic appliances business will be margin dilutive. We arrive at a fair value of `602 based on our DCF model implying FY13 P/E of 17.7x.

V-Guard Industries: Guarding for a long innings (BUY, CMP `301, 24% upside)

V-Guard is a dominant player in southern India in the light electrical industry. Now, after five years of hard work it has established its name and has broken even in Northern India. This is a considerable achievement given Havells’ dominant presence in the North and the challenges faced by entrants in developing distribution networks anywhere in India.

We believe that the earnings momentum for the company will continue on the back of (a) dominant position in the stabilizer market – its flagship product (b) outlook for the South Indian real estate market appears better compared to the North Indian market and (c) improving cash conversion cycle for the company on account of vendor financing. We arrive at a fair value of `373 on the basis of our DCF model implying FY13 P/E of 18.9x

Light Electricals 01 August, 2012

Havells India Bloomberg: HAVL IN EQUITY Reuters: HVEL.NS

Accounting: AMBER Predictability: GREEN Earnings Momentum: AMBER

Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit Capital may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decision.

Please refer to the Disclaimers at the end of this Report.

BUY

Exhibit 1: Key financials

Year to March (` mn) FY10 FY11 FY12 FY13E FY14E

Operating income 51,625 56,126 65,182 72,796 81,420 EBITDA 3,222 5,570 6,573 7,563 8,495 EBITDA (%) 6.2% 9.9% 10.1% 10.4% 10.4% EPS (`) 11.6 24.9 29.6 34.1 39.9 RoE (%) 13.8% 59.0% 46.0% 37.8% 33.4% RoCE (%) 6.2% 23.1% 25.5% 25.1% 24.8% P/E (x) 46.4 21.6 18.1 15.8 13.5


Analyst contacts

Bhargav Buddhadev Tel: +9122 3043 3252 [email protected]

Harshit Vaid Tel: +9122 3043 3259 [email protected]

Recommendation

CMP: `537


Previous TP: NA

Upside (%) 12

EPS (FY13E): `34.1



Stock Information

Mkt cap: `67bn/US$1.2bn

52-wk H/L: `616/313


Beta: 0.9

BSE Sensex: 17,236

Nifty: 5,229

Stock Performance (%)

1M 3M 12M YTD

Absolute (8) (3) 48 39

Rel. to Sensex (7) (3) 53 28

Performance (%)

10,00012,00014,00016,00018,00020,000

Aug-11 Dec-11 May-12

250

350

450

550

650

Sensex Havells

1-year forward P/E band chart

0100200300400500600700

Apr

-08

Aug

-08

Dec

-08

Apr

-09

Aug

-09

Dec

-09

Apr

-10

Aug

-10

Dec

-10

May

-11

Sep-

11

Jan-

12

May

-12

7x

`

11x

17x

15x


The end of the ‘dream run’? Havells’ share price has outperformed the Sensex by 53% over the last 12 months on the back of the turnaround at Sylvania and strong domestic performance. However, our extensive discussions with dealers suggest difficult times ahead for Havells’ domestic business. In Sylvania, we believe the margin expansion story has played out; therefore earnings growth will now follow revenue growth, which we expect will likely be around 4% in FY13. Whilst we initiate with a BUY given the recent correction in the stock price, our upside is modest at 12%.

Competitive position: STRONG Change to this position: NEGATIVE

Havells is India’s leading electrical company with a strong distribution network in Europe through its acquired subsidiary, Sylvania. In the last five years whilst the domestic business has seen a golden run with PAT CAGR of 24%, Sylvania has seen a strong turnaround from EBITDA losses in FY10 to a 7.3% operating margin in FY12. However, the road ahead for Havells appears to be a rocky one: Discussions with dealers across India point to problems ahead for

Havells India: We met with Havells’ dealers in Mumbai and spoke to their dealers in the North, East, West and South of India. The feedback we got was declining sales in West and North India and flat to marginal growth in the East and South. Given that the North and West account for 44% of Havells’ sales, we expect 17% revenue growth over FY12-FY14 compared to consensus’ 22%.

Rerating on account of Sylvania seems to have played out: Sylvania’s margins have improved significantly to 7.3% in FY12 from 2.3% in FY09 thanks to two restructuring programmes. However, for margins to improve from this point on is a challenge given that the benefits from the two restructuring programmes have already played out. Going forward we expect EBITDA growth for Sylvania to mirror revenue growth. Given historical revenue CAGR of 0% over FY08 to FY12 and given the worsening macro economic situation in Europe (which accounts for 62% of Sylvania’s revenues), we expect only 4% revenue growth for Sylvania in FY13.

Entry into the small domestic appliances market could lower margins: Havells has aggressive plans to scale up domestic appliance revenues to 6% by FY15 from 2% of FY12 sales. This will likely be margin dilutive as Havells taps the modern retail distribution network for growing this business. Note that modern retail chain offers lower margins to manufacturers relative to other formats of distributors given their premium positioning. Consequently, we model EBITDA margin to decline to 12% in FY17 from 12.6% in FY12.

Valuation: Havells’ is currently trading at 15.8x FY13 earnings. Our SOTP based target price uses 13.6% WACC for Havells standalone (perpetuity growth of 5% from FY24), 14% WACC for Sylvania (perpetuity growth of 2% from FY24) and gives a fair value of `602/share implying FY13 P/E of 17.7x (compared to its 5-year average of 14.5x and Bajaj Electricals’ forward P/E of 11.8x).

Havells India


Company Financial Snapshot

Profit and Loss (consolidated) FY12 FY13E FY14E Net sales 65,182 72,796 81,420 Optg. Exp(Adj for OI.) 58,609 65,233 72,924 EBIDTA 6,573 7,563 8,495 Depreciation 949 979 1,043 Interest Expense 1,281 1,063 1,014 PBT 4,757 5,644 6,586 Tax 1,058 1,392 1,613 Adj. PAT 3,699 4,252 4,973 Profit and Loss Ratios EBIDTA Margin % 10.1% 10.4% 10.4% Adj Net Margin % 5.7% 5.8% 6.1% P/E (X) 18.1 15.8 13.5 EV/EBIDTA (X) 11.2 9.7 8.6

Company Background

Founded in 1958, Havells India, a leading Indian electrical consumer durables company markets products such as switchgears, lightings and luminaries, fans, domestic appliances and cables and wires. In FY08, the company acquired Sylvania, a Europeancompany with distribution across Europe and Latin America and successfully managed to turn it around into a profitable operation. Havells is run from the outskirts of Delhi by its promoter (Qimat Rai Gupta, Chairman and MD) and his son, Anil Gupta (Joint MD). In FY12, Havells posted consolidated revenues of `65bn (+16% YoY) and profit after tax of `3.7bn (+22% YoY). The standalone domestic business accounted for 55% of these revenues and 82% ofthe profits.

Balance Sheet (consolidated)

FY12 FY13E FY14E Total Assets 41,754 46,532 51,628 Net Fixed Assets 13,908 14,430 14,887 Current Assets 27,183 32,103 36,741 Other Assets 663 - - Total Liabilities 41,753 46,531 51,627 Networth 9,556 12,933 16,868 Debt 8,685 8,355 7,240 Current Liabilities 22,956 24,687 26,963 Deferred Tax 556 556 556 Balance Sheet Ratios ROE % 46.0% 37.8% 33.4% ROCE % 25.5% 25.1% 24.8% Net Dept/Equity 0.91 0.65 0.43 Equity/Total Assets 0.23 0.28 0.33 P/BV (X) 7.0 5.2 4.0

Cash Flow (consolidated) FY12 FY13E FY14E PBT 4,757 5,644 6,586 Depreciation 949 979 1,043 Tax (1,097) (1,392) (1,613) Change in Wkg Cap (1,204) (603) (181) CF from Operations 4,617 5,690 6,849 Capex (1,511) (838) (1,500) Investments 441 - - CF from Investing (1,053) (838) (1,500) Change in Equity - 0.1 - Debt (924) (330) (1,115) Dividends (1,644) (1,938) (2,052) CF from Financing (2,568) (2,268) (3,167) Change in Cash 996 2,585 2,182

Havells is the market leader amongst the electrical companies (Revenues in Rs mn)…

..given its pan-India presence

-

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

FY11 FY12

V-Guard Finolex Bajaj Electricals Havells

North 29%

South 25%

East 24%

West 15%

Central 7%

Source: Company, Ambit Capital research Source: Ambit Capital research, figs represent % of FY12 revenues across India

Havells India


Exhibit 1: SWOT analysis for Havells

Strengths Weaknesses

Havells is India’s largest electrical company with a strong pan-India presence. Its distribution network in India includes 100,00 retailers, 5,000 distributors and 135 Havells Galaxy stores.

Best working capital turnover in the Indian industry thanks to its unique channel financing scheme.

Over the last four years, Havells has strengthened its brand in the Indian market through sustained high profile advertising.

The turnaround at Sylvania suggests that the firm’s managerial depth and expertise might be better than what appeared to be the case four years ago (when Havells had acquired Sylvania at the top-of-the-cycle valuations of 7.5x EV/EBITDA and found itself encumbered with debt:equity of 1.9x post the acquisition).

Havells’ relatively high churn compared to its marketing staff has, to an extent, damaged its reputation as a good employer.

In spite of trying for the last 7-8 years, the company seems to have failed to crack open the West India market (where Polycab, Anchor and Finolex Cables are the leaders).

Opportunities Threats

Havells has the lowest market share in West India given the dominance of Finolex Cables, Anchor and Polycab. Given that Mumbai is India’s largest residential market by value, Mumbai and its adjacent areas are a big opportunity for Havells.

Through Sylvania, it can start cross selling Havells’ products in European countries given Sylvania’s strong distribution channel.

Entry of MNC players (such as Schneider Electric and Legrand) in the light electricals industry can be a threat for incumbents such as Havells and Bajaj Electricals.

Slowdown in the real estate market in North India can adversely impact Havells’ sales as it is the market leader in that area.

Since Latin America and Europe are Sylvania’s end markets, a slow down in these geographies will pull Sylvania’s sales down.


Exhibit 2: Explanation for our flags on the cover page

Segment Score Comments

Accounting AMBER

Our accounting analysis highlights a mixed bag of favorable and unfavorable practices for Havells. Whilst the company has a sensible revenue recognition policy (CFO/EBITDA in FY12 was 87%), negligible investment income (less than 1%), related party transactions (payment of rent and usage charges to its associate companies – QRG Enterprises and Guptajee & Co.) and the Audit Committee composition (presence of non-independent directors on the Committee) raises concerns.

Predictability GREEN Management’s guidance on revenues and EBITDA margin were met in FY12. Historically as well the company has not surprised negatively on its earnings except in FY09 post the acquisition of Sylvania when it reported dismal results.

Earnings Momentum AMBER There have been no material upgrades in the earnings estimates for Havells post its FY12 results.


Havells India


Havells: The leader in India

In our competitive matrix discussed on page 12 of the thematic, Havells emerges as a superior brand across LE companies. Havells today is the largest selling brand in India on the back of its strong distribution network, broad product portfolio and aggressive advertisement spend (see chart below).

Exhibit 4: Havells is the largest domestic electrical company (sales in ` mn)…

-5,000

10,00015,00020,00025,00030,00035,00040,000

FY09 FY10 FY11 FY12

V-Guard Finolex Bajaj Electricals Havells

Source: Company, Ambit Capital research, Note: Figs. for Havells represent their domestic sales

Exhibit 5: …aided by aggressive brand building due to high advertising spends (figs represent ad spends in ` mn)

-

200

400

600

800

1,000

FY07 FY08 FY09 FY10 FY111.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

Havells Bajaj Electricals V-GuardFinolex Ad spend as % of sales


90% of Havells’ sales take place through dealers (a majority of whom are not exclusive dealers). In our discussions with dealers what stands out is the extent to which Havells takes care of its dealers. For instance, post the demise of Lehman Brothers the prices of cables and wires crashed, led by a sharp correction in copper prices which crashed by 67% in the space of six months. Consequently, dealers came under severe stress as they had piled up inventory in September to cash in on the festive season. To share the losses of the dealers, the company announced a special trade discount of 1%. This went down very well with the dealers as none of the other competitors matched this gesture.

On cash generation also, Havells on a standalone basis scores very well compared with its peers. This is because of its unique channel financing scheme (CFS), which ensures that Havells has the lowest debtor days. Although channel financing is also offered by its competitors, Havells still has the lowest number of debtor days because the top dealers of Havells are mandatorily required to opt for this scheme (which is not the case with its competitors where the option remains with the dealer to choose the scheme or not). We explain this channel financing scheme in greater detail on the next page.

Exhibit 3: Havells’ has a strong distribution network and broad product portfolio

Distribution network

Distributors 5,000

Retailers 1,00,000

Havells Galaxy Stores 135

Product portfolio Cables & Wires, Switchgears, Fans, Motors, Switches, Domestic Appliances, CFLs and Lightings.

Source: Company, Ambit Capital research.

Havells India


Exhibit 6: Havells’ cash conversion is the best thanks to its lower debtor days

Company/Metric Pre-tax CFO as a % of

EBITDA Average debtor days Average creditor days Average inventory days

FY09 FY10 FY11 FY09 FY10 FY11 FY09 FY10 FY11 FY09 FY10 FY11

Havells India (standalone)

146% 80% 116% 13 13 12 52 45 46 53 41 51

Indian peers

V-Guard 99% -13% -22% 50 50 50 29 32 27 46 54 61

Bajaj Electricals 112% 42% 78% 103 108 122 64 72 87 35 32 34

Finolex Cables (2608%)* 115% 48% 23 15 18 19 13 9 52 41 45

Peer group median (ex Havells)

99% 42% 48% 50 50 50 29 32 27 46 41 45

Divergence from peer group median

47% 38% 68% (37) (37) (38) 24 12 19 7 0 6

Havells (consolidated) 90% 116% 61% 50 54 57 46 45 48 61 57 62

Source: Ambit Capital research based on company filings. * The company incurred a major loss on forex transactions.

The way channel financing works is that the bank provides finance directly to the approved dealer under credit risk cover from an insurance company with partial or no recourse on the company. The company realizes its sales proceeds immediately and the operating funds so unlocked, can be deployed to fuel business growth. Under the channel financing scheme, a dealer can avail the credit facility every time he purchases goods from the principal (i.e. Havells in this instance). The bank is further paid directly by the dealer within the time limits set under the facility. The dealer gains not only in terms of obtaining hassle-free credit but also by way of a cash discount from the company for paying upfront. This discount can help offset the cost of credit sought from the bank.

The Sylvania turnaround is commendable Post the acquisition of Sylvania in FY08, Havells was derated as Sylvania started incurring losses and concerns were raised on Sylvania’s debt repayment.

Exhibit 8: Forward P/E for Havells fell post acquisition of Sylvania in FY08

0

100

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700

Apr

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-08

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18x16x14x12x10x8x

Source: Bloomberg, Ambit Capital research

To bring Sylvania back on track Havells launched two restructuring programmes:

(a) Phoenix – a plan to rationalize the high fixed-cost structure at Sylvania by reducing manpower and closing plants in high-cost countries such as Europe and Latin America. This plan was implemented between January 2009 and September 2009 with a one-time cost of Euro12mn. It resulted in cost savings of Euro17.5mn (equal to ~15% of Sylvania’s pre-acquisition cost base).

Exhibit 7: Net debt:equity post acquisition of Sylvania

FY07 0.1x

FY08 1.6x

FY09 1.6x

FY10 2.3x

FY11 1.2x

FY12 0.7x


Havells India


(b) Parakram – a plan implemented between September 2009 and December

2010 (cost: Euro20mn) with a focus to reduce personnel costs in Europe by outsourcing the production of non-core components to low-cost manufacturing locations like China and India. This programme resulted in the personnel costs at Sylvania falling by Euro16mn (equivalent to 13% of its FY09 personnel cost).

Consequently, Sylvania’s EBITDA margin increased to 7.3% in FY12 from 2.3% in FY09 as the company saved on fixed costs, exited the low margin commodity lighting product business and increased outsourcing from China and India.

Exhibit 10: Post-acquisition, Sylvania started making losses which turned around in FY11 (figures represent PAT in ` mn)

176

(3,054)

(1,705)

430 668

(4,000)

(3,000)

(2,000)

(1,000)

-

1,000

FY08 FY09 FY10 FY11 FY12

PAT


The long, tough road to redemption

Discussions with dealers across geographies highlight the tough times ahead for Havells India

We met Havells’ dealers in Mumbai and spoke to Havells’ dealers across the geographies - North, East, West and South. The feedback we gathered was declining sales in the West and North India and flat to marginal growth in East and South India. This is further corroborated by the fall in real estate registrations across these geographies.

Mumbai (the largest residential market in the country by value), Delhi and Gurgaon (the largest residential markets in the country by volume) saw residential sales decline by more than 50% YoY in 1Q of CY12. As per the real estate consultants (Knight Frank and PropEquity), this is likely to deteriorate further as the current sales environment is weaker compared to 1QCY12 due to a combination of high property prices and execution delays.

Bangalore, Chennai and Kolkata, on the other hand, saw sales declining by only 5%-20% on a YoY basis in 1QCY12 given affordable prices and end-user driven demand rather than investor driven-demand. Note that Mumbai, Delhi and NCR, the demand for residential housing is driven more by investors (more than 50% of the demand is from investors) compared to South and East India. More importantly according to JLL’s report, South India is likely to see strong momentum in residential sales in the foreseeable future. The reasons are highlighted in our thematic section (Southern region to become the downtown of India).

This shift in demand to the South does not augur well for Havells growth in FY13 as ~44% of Havells’ sales arise from the North and West compared to 22% for V-Guard. Therefore, we are modeling revenue growth of 16% in FY13 for Havells which is at the lower end of the management guidance range of 15%-20%.

Exhibit 9: Sylvania’s EBITDA margin recovery

-2.0%

0.0%

2.0%

4.0%

6.0%

8.0%

FY08 FY09 FY10 FY11 FY12

EBITDA (%) Source: Company, Ambit Capital research

Exhibit 11: 44% of Havells sales come from north and west

North 29%

South 25%

East 24%

West 15%

Central 7%

Source: Ambit Capital research.

Havells India


Our dealer checks also highlighted that there are payment delays across the board coupled with an inventory build up at the dealer level. Furthermore, if the sales during the festival season are slow, then margins could fall as companies will have to offer higher trade discounts to push sales. Consequently, on the working capital front we model Havells’ domestic cash conversion to decline from 2 days in FY12 to 6 days in FY13.

Exhibit 12: We are below consensus* on Havells standalone revenues and EBITDA

Consensus Ambit % change

Sales (` mn)

FY13E 46,955 42,067 -7%

FY14E 54,992 49,769 -7%

EBITDA (` mn)

FY13E 5,733 5,258 -8%

FY14E 7,028 6,122 -13%

Source: Bloomberg, Ambit Capital research *as on 31st July’2012.

Re-rating on account of Sylvania appears to have played out

Sylvania’s EBITDA margin has improved significantly to 7.3% in FY12 from 2.3% in FY09 thanks to the two restructuring programmes mentioned previously. In fact, the current margins are, historically, the highest for Sylvania. However, for margins to improve from hereon is challenging given that the benefits from the two restructuring programmes have played out. These benefits included reducing employee expenses and cutting fixed costs (through closure of factories) by outsourcing production to India and China. This point on, Sylvania’s performance will be driven by revenue growth, an area where Sylvania has struggled historically. Revenue CAGR since the time of Sylvania’s acquisition in April 2007 has been disappointing (revenue CAGR of 0% over FY08-FY11). Further, with the macro economic situation in Europe worsening, it seems unlikely that Sylvania’s revenues will materially grow from hereon. Whilst management has guided for a revenue growth of 4%-5% in FY13, so far in FY13, sales have moderated in Latin America and declined in Europe. Furthermore the Euro has depreciated 20% against the Chinese currency over the past one year and 65% of Sylvania’s production is outsourced (predominantly from China). Consequently we model a 40bps reduction in gross margins to 54.4% in FY13 from 54.8% in FY12.

However, whilst bears might argue that Sylvania’s exports will benefit from the Euro’s appreciation against the dollar (and thereby offset the loss on account of depreciation of the Euro versus Chinese currency), we note that there is no natural hedge given that dollar exports account for only 33% of Sylvania’s revenues compared to 65% of the production, which comes predominantly from China.

Entry into the small domestic appliances market to impact margins

During FY12, Havells India entered into the small domestic appliances market which includes mixer, grinders, juicers, toasters, electric kettles, blenders, irons and geysers. The reason for entering into this business segment seems to be:

(a) Impressive industry growth of ~17% over the last five years and

(b) Minimal investment in fixed assets given that a majority of these appliances are imported from China, Taiwan, Korea and Malaysia.

Havells India


Havells has aggressive plans to scale up domestic appliance revenues to 6% by FY15 from 2% of FY12 sales. This will likely be margin dilutive as Havells taps the modern retail distribution network for growing this business. Note that modern retail chain offers lower margins to manufacturers relative to other formats of distributors given their premium positioning. Consequently, we model EBITDA margin to decline to 12% in FY17 from 12.6% in FY12. Note that Bajaj Electricals, which is a very big player in trading of small domestic appliances (32% of FY12 revenues) with product offerings and price points similar to Havells, makes margins of ~12% on domestic appliances sold under the brand name of Morphy Richards. TTK Prestige also makes a margin of 12% from trading in kitchen appliances, despite its strong brand.

Also, this is likely to be working capital intensive given that Havells will have to invest in a new distribution channel (we have modelled its cash conversion cycle to deteriorate to 6 days in FY13 from 2 days in FY12. This is because a majority of Havells’ channel partners sell electrical products (i.e. cables and wires, switches, switchgear) only and domestic appliances are NOT sold through them. This was also confirmed by a Havells’ dealer. Havells will thus have to invest in distribution channels which either sell utensils or white goods like Vijay Sales. Whilst dealers selling utensils sell domestic appliances up to a ticket size of `1,500-`2,000 per unit, white goods electrical stores like Croma, Vijay Sales sell domestic appliances of bigger ticket sizes.

Havells India


Key assumptions and estimates – Havells standalone Over FY12-FY14, we expect Havells standalone to report revenue CAGR of 17% (FY10-FY12 CAGR of 23%) and PAT CAGR of 17% (FY10-FY12 CAGR of 16%) driven by the assumptions shown in the table below.

Exhibit 13: Key assumptions and estimates for Havells standalone (all figures in ` mn unless otherwise mentioned)

FY11 FY12 FY13E FY14E Comments

Key assumptions (% YoY growth in revenues)

Switchgears (25% of FY12 revenues)

12% 23% 10% 15%

We have modeled growth rates of 10% and 15% for FY13 and FY14 respectively on the basis of our discussions with dealers which suggest that FY13 will be a tough year for the industry. Management has also guided to similar growth rates.

Cables (45% of FY12 revenues) 28% 29% 15% 15% We assume the growth rates in FY13 and FY14 to moderate to 15% against the historic levels of ~30% on the back of a larger base effect and slowing demand in the real estate and power sectors.

Lightings and Fixtures (15% of FY12 revenues)

28% 27% 20% 25%

We assume a marginal decline in the growth rate for FY13 (given that it is likely to be a tough year) compared to its historical growth. For FY14, we assume the growth rate to increase to 25% (average growth rate over FY11-FY13).

Electrical Consumer Durables (15% of FY12 revenues)

40% 23% 23% 26% We model the highest growth rates in the electrical consumer durables segment, as we believe that newer product launches within the small domestic appliances category will drive revenues.

Key estimates

Sales 28,817 36,156 42,067 49,769 Based on our assumptions above, we believe that the company will record a CAGR of 17% over FY12-FY14 compared to 23% over FY10-FY12.

Sales (YoY growth) (%) 21.5% 25.5% 16.3% 18.3%

EBITDA 3,406 4,557 5,258 6,122

EBITDA margin (%) 11.8% 12.6% 12.5% 12.3%

We model the EBITDA margin to decline by 10bps and 20bps YoY respectively in FY13 and FY14 on the back of higher direct costs and the rising share of brown goods. We believe that the company will record a CAGR of 16% over FY12-FY14 compared to 21% over FY10-FY12.

EBITDA (YoY growth) (%) 10% 34% 15% 16%

Interest expense 191 444 342 340 With improving cash flows, the company will be able to repay its existing debt and accordingly the interest payments will reduce in FY13.

PBT 3,103 3,738 4,487 5,323 Lower interest payments will help enhance the profit before tax. We believe that the company will record a CAGR of 19% over FY12-FY14 compared to 14% over FY10-FY12.

Tax rate (%) 22.0% 18.3% 22.0% 22.0%

Adj. PAT 2,421 3,054 3,500 4,152 FY12-FY14 adjusted PAT CAGR at 17% v/s 16% CAGR during FY10-FY12

PAT (YoY growth) (%) 6% 26% 15% 18%

Cash flow from operations (CFO) 3,416 3,572 3,801 4,910

We expect the company to continue to generate positive cash flows from operations in FY13 and FY14. However the pace is likely to reduce to a CAGR of 19% in FY12-FY14 compared to 32% during the period FY10-FY12

Capex (1,617) (1,358) (1,000) (1,000) We model maintenance capex

Free cash flow 28 1,624 2,801 3,910


Havells India


Key assumptions and estimates – Sylvania Over FY12-FY14, we expect Sylvania to report revenue and PAT CAGR of 3% and 11% respectively driven by the assumptions shown in the table below.

Exhibit 14: Key assumptions and estimates for Sylvania (all figures in ` mn unless otherwise mentioned)

FY11 FY12 FY13E FY14E Comments Key estimates

Sales 27,077 29,547 30,729 31,651

We expect the growth rates in FY13 and FY14 to be moderate at 4% and 3% respectively given the challenging macro economic conditions in Europe. Note that 65% of Sylvania’s revenues come from Europe.

Sales (YoY growth) (%) -2% 9% 4% 3%

EBITDA 1945 2165 2305 2374

EBITDA margin (%) 7.2% 7.3% 7.5% 7.5%

We model 20bps improvement in margins in FY13 on the back of operating leverage. However from FY14 onwards we do not see any improvement as we believe operating leverage has already played out and EBITDA will grow in-line with revenue. (EBITDA in FY09: `749mn, FY10 `-66mn.)

EBITDA (YoY growth) (%) NA 11% 6% 3%

Interest expense 698 786 721 674 Partial repayment in FY13 and FY14 is likely to result in saving interest expense.

PBT 778 1,044 1,157 1,263 PBT will grow at a CAGR of 10% over the period FY12-FY14.

Tax rate (%) 44.8% 36.0% 35.0% 35.0%

Adj. PAT 430 668 752 821 Adjusted PAT to grow at a CAGR of 11% over FY12-FY14. (Adjusted PAT in FY09: `-3bn, FY10 `-1.7bn.)

PAT (YoY growth) (%) NA 55% 13% 9%

Cash flow from operations (CFO) 313 1,541 1,888 1,939

Capex (152) (1984) (500) (500) We model only maintenance capex

Free cash flow 162 (444) 1,388 1,439


Exhibit 15: Estimates for Havells (consolidated) (all figures in ` mn unless otherwise mentioned)

FY11 FY12 FY13E FY14E Comments Key estimates

Sales 56,126

65,182

72,796

81,420

Given that Sylvania accounts for 42% and 39% of FY13 and FY14 sales wherein the growth is only 3%-4%, the overall revenue growth rate for Havells declines to ~11%.

Sales (YoY growth) (%) 8.7% 16.1% 11.7% 11.8%

EBITDA

5,570

6,573

7,563

8,495 EBITDA margin (%) 9.9% 10.1% 10.4% 10.4%

We expect the margins to improve on the back of 20bps improvement in Sylvania’s margins.

EBITDA (YoY growth) (%) 73% 18% 15% 12%

Adj. PAT

3,005

3,699

4,252

4,973 Adjusted PAT to grow at a CAGR of 16% over FY12-FY14.

PAT (YoY growth) (%) 332% 23% 15% 17%

Cash flow from operations (CFO)

2,530

4,617

5,690

6,985 Operating cash flow CAGR of 23% compared to 26% CAGR over FY10-FY12

Capex -1584 -1511 (838) (1500) We model only maintenance capex

Free cash flow 768 3563 4853 5485


Havells India


Absolute valuation

We have valued Havells using a free cash flow (FCFF) model for the standalone domestic business and Sylvania separately.

Havells standalone:

Our FCFF metric is ’cash profit – increase in working capital – capex’. Our FCFF model has three distinct phases:

FY13-FY17: We model each year in detail and assume that: (i) revenues will grow at a CAGR of 18% (FY08-FY12 revenue CAGR has been 15%); and (ii) operating margins would gradually fall to 12% by FY17 (from 12.6% in FY12) given the high direct cost and rising share of brown goods.

From FY18-FY24: We have modeled a 2% drop in the growth rate of sales for the company each year until FY24. Furthermore, we have also reduced the EBITDA margin gradually by 10bps every year to 11.3%.

From FY25: We have assumed a terminal growth rate of 5% and EBITDA margin of 11.3% from FY25 onwards.

We expect Havells’ RoCE to remain constant at around 22% over FY12-FY17 and reduce thereon to 15% in FY2024 on the back of our assumption of a gradual fall in operating margins. Based on these assumptions and assuming a WACC of 13.6%, our FCFF model values the domestic business of Havells at `578 per share (implying FY13 P/E of 20.6x)

Exhibit 17: Our free cashflow (FCF) valuation for Havells standalone is `578/share

Period ` mn

Net PV of free cash flows for Havells 37,992

Terminal value 35,711

Total 73,703

Less: Net debt 1,562

Value of Havells 72,141

Total no. of shares (in mn) 124.8

Value per share (`/share) 578


Sylvania:

Our FCFF metric is ’cash profit – increase in working capital – capex’. Our FCFF model has three distinct phases:

FY13-FY17: We model each year in detail and assume that: (i) revenues will grow at a CAGR of 3%; and (ii) operating margins would remain flat at 7.5% until FY17.

From FY18-FY24: We have modeled a 3% growth in sales for the company each year until FY24. However, we assume EBITDA margin to gradually drop by 10bps every year to 6.8%.


Based on these assumptions and assuming a WACC of 14%, our FCFF model values Sylvania at `24 per share (implying FY13 EV/EBITDA of 4x).

Exhibit 16: Assumptions on WACC

Cost of equity 14%

Cost of debt 11%

Debt/Equity 5.7%

Corporate Tax Rate 30%

WACC 13.6%

Source: Ambit Capital research.

Havells India


Exhibit 18: Our free cashflow (FCF) valuation for Sylvania is `24/share

Period ` mn

Net PV of free cash flows for Sylvania 7,921


Total 9,697


Value of Sylvania 2,957




Accordingly, our total fair value for Havells is `602/share

Exhibit 19: Total value/share for Havells

Period `

Value per share for Havells Standalone 578

Value per share for Sylvania 24

Total value per share for Havells 602


Havells India


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Havells India


Balance sheet (consolidated) Year to March (` mn) FY10 FY11 FY12 FY13E FY14E

Shareholders' equity 312 624 624 624 624 Reserves & surpluses 3,690 5,914 8,932 12,309 16,244 Total net worth 4,002 6,537 9,556 12,933 16,868 Minority Interest 2 6 1 1 1 Preference share capital - - - - -Debt 10,664 9,569 8,685 8,355 7,240 Deferred tax liability 434 559 556 556 556 Total liabilities 15,102 16,671 18,798 21,845 24,665 Gross block 26,963 28,454 27,577 29,077 30,577 Net block 8,874 9,955 10,284 10,805 11,262 Goodwill 3,212 3,354 3,625 3,625 3,625 CWIP 336 249 663 - -Investments - - - - -Cash & equivalents 1,480 1,779 2,336 4,921 7,240 Debtors 6,982 7,721 8,905 9,560 10,147 Inventory 8,246 10,860 13,678 15,198 16,700 Loans & advances 1,745 1,595 2,144 2,308 2,518 Other current assets 103 123 120 115 136 Total current assets 18,556 22,077 27,183 32,102 36,741 Current liabilities 15,555 15,061 17,860 19,230 21,113 Provisions 321 3,904 5,096 5,457 5,850 Total current liabilities 15,876 18,965 22,956 24,687 26,963 Net current assets 2,680 3,113 4,227 7,415 9,778 Miscellaneous - - - - -Total assets 15,102 16,671 18,798 21,845 24,665 Source: Company, Ambit Capital research

Income statement (consolidated) Year to March (` mn) FY10 FY11 FY12 FY13E FY14E

Operating income 51,625 56,126 65,182 72,796 81,420 % growth -6% 9% 16% 12% 12% Operating expenditure 48,404 50,556 58,609 65,233 72,924 EBITDA 3,222 5,570 6,573 7,563 8,495 % growth 12% 73% 18% 15% 12% Depreciation 837 804 949 979 1,043 EBIT 2,385 4,766 5,625 6,584 7,453 Interest expenditure 979 902 1,281 1,063 1,014 Non-operating income 222 238 414 122 148 Adjusted PBT 1,628 4,102 4,757 5,644 6,586 Tax 932 1,031 1,058 1,392 1,613 Adjusted PAT/Net profit 696 3,005 3,699 4,252 4,973 % growth 81% 332% 23% 15% 17% Extraordinaries - 31 - - - Reported PAT/Net profit 696 3,036 3,699 4,252 4,973 Minority interest 0 4 - - - Share of associates - - - - - Adjusted consolidated net profit 696 3,005 3,699 4,252 4,973 Reported consolidated net profit 696 3,036 3,699 4,252 4,973 Source: Company, Ambit Capital research

Havells India


Cash flow statement (consolidated) Year to March (` mn) FY10 FY11 FY12 FY13E FY14E

PBT 1,628 4,070 4,757 5,644 6,586

Depreciation 837 804 949 979 1,043

Interest 871 902 1,281 1,063 1,014

Tax (699) (850) (1,097) (1,392) (1,613)

(Incr) / decr in net working capital 2,543 (1,998) (1,204) (603) (181)

Others (2,267) (398) (69) 0 -

Cash flow from operating activities 2,913 2,530 4,617 5,690 6,849

(Incr) / decr in capital expenditure (1,444) (1,584) (1,511) (838) (1,500)

(Incr) / decr in investments - (186) 441 - -

Others 383 8 17 - -

Cash flow from investing activities (1,061) (1,762) (1,053) (838) (1,500)

Issuance of equity - - - 0 -

Incr / (decr) in borrowings (1,761) 454 (924) (330) (1,115)

Others (1,097) (1,108) (1,644) (1,938) (2,052)

Cash flow from financing activities (2,858) (654) (2,568) (2,268) (3,167)

Net change in cash (1,006) 114 996 2,585 2,182Source: Company, Ambit Capital research

Ratio analysis (consolidated) Year to March (%) FY10 FY11 FY12 FY13E FY14E

EBITDA margin (%) 6.2% 9.9% 10.1% 10.4% 10.4% EBIT margin (%) 4.6% 8.5% 8.6% 9.0% 9.2% Net profit margin (%) 1.3% 5.4% 5.7% 5.8% 6.1% Dividend payout ratio (%) 39% 12% 25% 21% 21% Net debt: equity (x) 2.29 1.19 0.66 0.27 0.00 Working capital turnover (x) 43.03 42.07 34.47 29.19 32.08 Gross block turnover (x) 1.91 1.97 2.36 2.50 2.66 RoCE (%) 6.2% 23.1% 25.5% 25.1% 24.8% RoE (%) 13.8% 59.0% 46.0% 37.8% 33.4% Source: Company, Ambit Capital research

Valuation parameters (consolidated) Year to March (` mn) FY10 FY11 FY12 FY13E FY14E

EPS (`) 11.6 24.9 29.6 34.1 39.9 Diluted EPS (`) 11.6 24.9 29.7 34.1 39.9 Book value per share (`) 66.5 52.4 76.6 103.7 135.2 Dividend per share (`) 3.8 2.5 6.5 7.0 8.3 P/E (x) 46.4 21.6 18.1 15.8 13.5 P/BV (x) 8.1 10.2 7.0 5.2 4.0 EV/EBITDA (x) 22.8 13.2 11.2 9.7 8.6 EV/EBIT (x) 30.8 15.4 13.0 11.1 9.8 Source: Company, Ambit Capital research

Havells India



Light Electricals 01 August, 2012

V-Guard Industries Bloomberg: VGRD IN EQUITY Reuters: VGUA.NS

Accounting: GREEN Predictability: GREEN Earnings Momentum: GREEN

Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit Capital may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decision.

Please refer to the Disclaimers at the end of this Report.

BUY

Exhibit 1: Key financials

Year to March FY10 FY11 FY12 FY13E FY14E

Operating income 4,547 7,266 9,936 12,585 15,783 EBITDA 509 730 935 1,082 1,342 EBITDA (%) 11.2% 10.1% 9.4% 8.6% 8.5% EPS (`) 8.5 14.3 17.0 19.7 25.2 RoE (%) 19.0% 27.2% 26.6% 25.2% 26.4% RoCE (%) 15.1% 17.7% 19.7% 19.9% 21.0% P/E (x) 35.3 21.1 17.7 15.3 12.0


INITIATING COVERAGE

Bhargav Buddhadev Tel: +91 22 3043 3252 [email protected]

Harshit Vaid Tel: +91 22 3043 3259 [email protected]

Recommendation

CMP: `301


Previous TP: NA

Upside (%) 24

EPS (FY13E): `19.7



Stock Information

Mkt cap: `9bn/US$162mn

52-wk H/L: `329/141


Beta: 0.9

BSE Sensex: 17,236

Nifty: 5,229

Stock Performance (%)

1M 3M 12M YTD

Absolute 29 58 30 94

Rel. to Sensex 30 58 35 83

Performance (%)

15,000

16,200

17,400

18,600

19,800

Jul-11 Dec-11 May-12

120

180

240

300

360

Sensex V-Guard

1-year forward P/E band chart

050

100150200250300350

Mar

-08

Jun-

08

Oct

-08

Jan-

09

Apr

-09

Jul-

09

Nov

-09

Feb-

10

May

-10

Sep-

10D

ec-1

0M

ar-1

1Ju

n-1

1O

ct-1

1Ja

n-1

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pr-1

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15x13x11x

9x7x

5x


Taking guard for a long innings V-Guard has outperformed its rival, Havells (domestic business) with CAGR in sales of 37% v/s 15% over FY08-FY12. Our extensive discussions with unlisted companies and dealers suggest that this momentum is likely to continue due to its strong competitive positioning in the southern Indian housing market (which likely appears to remain robust), dominant market share in voltage stabilizers (its flagship product) and its improving cash flow profile (due to a vendor financing arrangement with Yes Bank). We initiate with a BUY.

Competitive position: MODERATE Change to this position: IMPROVING

V-Guard is a dominant player in Southern India in the light electrical industry. Now, after five years of hard work it has established its name and has broken even in Northern India. This is a considerable achievement given Havells’ dominant presence in the North and the challenges faced by entrants in developing distribution networks anywhere in India. We prefer V-Guard over Havells due to:

V-Guard’s dominant position in voltage stabilizers: V-Guard is a market leader in this segment (25% share in the organized market). Its unique outsourcing model (for stabilizers) differentiates it from larger players like Havells, Bajaj and Finolex who do not have this product. In the last five years revenues from stabilizers have grown at a CAGR of 16%. In FY12, they were 20% of total revenues and 34% of EBITDA. Rising demand for white goods (forward 5-year CAGR likely to be 17% compared with 15% in the last five years) and increasing power outages augur well for stabilizers.

South Indian housing market likely to do better than the North: 78% of V-Guard's revenues in FY12 came from Southern India compared with less than 30% for Havells, Bajaj Electricals and Finolex Cables. We expect the South Indian housing market to do better compared to the North Indian market because: (a) It is an end-user driven market, (b) It is more affordable (80% of new launches are priced below `4,000 per sq ft); and (c) The region is likely to be the next downtown of India as per Jones Lang LaSalle.

Improving cash profile: We expect V-Guard’s cash conversion to improve to 55 days by FY15 from 67 days in FY12 as it launches vendor financing. Unlike Havells which has successfully launched channel financing, we believe V-Guard is better off choosing vendor financing. This is because its vendors are small scale industrial units which come under priority sector lending for bankers and hence get lower interest rates. Also, delinquency risk is lower given that the payment is to be made by V-Guard compared to the dealer in the case of channel financing.

Valuation: Our DCF model uses a WACC of 13.5% and generates a fair value of `373 per share (implying an FY13 P/E 18.9x). At CMP (`301), the share is trading at 15.3x FY13 P/E compared to Havells domestic business which is trading at 18.3x on FY13 P/E. We believe this is unjustified given higher earnings CAGR of 22% over FY12-FY14 and RoEs of 26% compared to earnings CAGR of 17% over FY12-FY14 and RoEs of 20% for Havells (domestic business).

V-Guard Industries


Company Financial Snapshot

Profit and Loss FY12 FY13E FY14E Net sales 9,936 12,585 15,783 Optg. Expenses 9,001 11,502 14,442 EBIDTA 935 1,082 1,342 Depreciation 97 120 143 Interest Expense 170 161 161 PBT 692 827 1,072 Tax 184 240 321 Adj. PAT 508 587 750 Profit and Loss Ratios EBIDTA Margin % 9.4% 8.6% 8.5% Adj Net Margin % 5.1% 4.7% 4.8% P/E (X) 17.7 15.3 12.0 EV/EBIDTA (X) 11.0 9.2 7.5

Company Background

Established in 1977, V-Guard Industries is a dominant player in south India in the light electrical industry. Beginning with itsflagship product, voltage stabilizers (in which it is the marketleader), the company has, over the years, expanded itsproduct profile to include PVC insulated cables, LT power cables, Fans, Geysers, Pumps, UPS and Inverters. The company, which went public in 2008, currently has fourmanufacturing facilities apart from tie-ups with various vendors from whom the company sources around 60% of itsproduct portfolio.

Balance Sheet

FY12 FY13E FY14E Total Assets 4,707 5,729 6,895 Net Fixed Assets 1,230 1,360 1,468 Current Assets 3,366 4,258 5,316 Other Assets 111 111 111 Total Liabilities 4,707 5,729 6,894 Networth 2,106 2,557 3,133 Debt 1,049 1,150 1,150 Current Liabilities 1,508 1,979 2,569 Deferred Tax 43 43 43 Balance Sheet Ratios RoE % 26.6% 25.2% 26.4% RoCE % 19.7% 19.9% 21.0% Net Debt/Equity 0.50 0.45 0.37 Equity/Total Assets 0.45 0.45 0.45 P/BV (X) 4.3 3.5 2.9

Cash Flow FY12 FY13E FY14E PBT 692 827 1,072 Depreciation 97 120 143 Tax (157) (240) (321) Change in Wkg Cap 30 (348) (379) CF from Operations 830 520 675 Capex (293) (250) (250) Investments 7 - - CF from Investing (277) (250) (250) Change in Equity - - - Debt (303) 101 - Dividends (287) (297) (335) CF from Financing (590) (197) (335) Change in Cash (37) 73 89

Snapshot of V-Guard’s business segments

% of revenues

(FY12) % of EBIT

(FY12) Key products Competitors

Electronics 32 52 Stabilizers, UPS and digital inverter Bluebird, Luminous and Su-Kam

Electricals/Electro Mechanical

65 40 PVC Cables, LT Power Cables, Fans, Pumps, Water Heaters

Havells, Polycab, Crompton Greaves, Racold and Finolex Cables

Others 3 8 Solar Water Heater Tata-BP Solar

Total % 100 100


V-Guard Industries


Company overview Promoted by Mr. Kochouseph Chittilappilly in 1977, the company is a dominant player in the South Indian electrical market. The company deals in various products ranging from stabilizers, UPS, digital inverters to PVC and LT power cables to fans, pumps and water heaters and the more recently launched induction cooktops and domestic switchgears. The company follows a very light asset model (asset turnover in FY12 was 6.2x) and outsources ~60% of its products from a range of vendors. Post the IPO in 2008, the company has set up a manufacturing unit for cables in Kashipur, Uttarakhand and is in the process of doubling capacity for the same by FY14. The company has been focusing on turning into a pan-India player and has taken appropriate steps to increase its presence in other regions of India apart from South India, where it is already in the top 3 across key states such as Kerala, Karnataka, Tamil Nadu and Andhra Pradesh.

Exhibit 1: V-Guard’s revenues have grown at a CAGR of 35% over the last 5 years …

-

2,000

4,000

6,000

8,000

10,000

12,000


Revenues (Rs mn)

35 % CAGR


Exhibit 2: … whilst PAT has grown at a CAGR of 28% over the same period

-

100

200

300

400

500

600


Adjusted PAT (Rs mn)

28% CAGR


Exhibit 3: SWOT analysis of V-Guard

Strengths Weaknesses

Strong brand presence in the south Indian electrical market (Top 3 player in the southern states – Kerala, Karnataka, Tamil Nadu and Andhra Pradesh).

Successful entry into North India. Achieved breakeven in 5 years as share of revenue from North India increased from 5% in FY08 to 21% in FY12.

Competitive positioning in its flagship product stabilizer is very strong given its unique outsourcing model

Very weak in Western India as highlighted by our dealer checks.

Lacks bargaining power with vendors manufacturing stabilizers as it cannot afford to delay payments given their 100% dependence on the company. Hence, the creditor days for V-Guard are the lowest amongst its peers (refer exhibit 7).

Not able to successfully implement the outsourcing model in north India. This can become a hindrance in the years to come as the existing vendors get maxed out on utilization.

Opportunities Threats

Rest of India opportunity for V-Guard is available to be tapped given that 78% of its revenues are concentrated currently in South India

Plenty of opportunity to grow revenues by increasing sales of new product categories i.e. kitchen appliances and switchgear. Per annum industry size for kitchen appliances and domestic switchgear is at `50bn and `15bn respectively compared to `21bn for stabilizers, its flagship product.

Improvement in supply of power will reduce the requirement for voltage stabilizers. In FY12, whilst stabilizers constituted only 20% of its revenues, the EBITDA share was around 34%.

A slowdown in real estate in Southern India is a major threat, given that 78% of revenues arise from South India. According to dealer checks new housing is the biggest demand driver for electrical products as replacement demand is meagre.


V-Guard Industries


Why do we like V-Guard?

Dominant player in stabilizers (flagship product) V-Guard is a dominant player in the voltage stabilizer market (the firm has been selling this for the last three decades) with a market share of ~25% in the organized market. Revenues for stabilizers in the last five years have grown at an CAGR of 16% driven by volume CAGR of 15% in white goods (refrigerators, TVs, air conditioners and washing machines), V-Guard’s market share gain in Southern India and its entry into the non-southern India market (primarily North) in FY08. Furthermore, the return on capital employed for stabilizers is also stellar at 43%+ (stabilizers are a part of V-Guard’s ‘electrical’ segment, which in FY12 reported a RoCE of 43%). Also, within the electrical segment, the RoCE for stabilizers is the highest given minimal investment in gross block (V-Guard’s investment for stabilizers is only in moulds) as V-Guard outsources the production of its stabilizers. The only additional investment in capital employed is working capital which as per the management is ~50 days.

Exhibit 4: V-Guard’s stabilizer revenues have outperformed (grown at 16% CAGR over the last five years) …

24% 23%

-1%3%

26%

37%

20%

-

500

1,000

1,500

2,000

2,500

FY06 FY07 FY08 FY09 FY10 FY11 FY12

-10%

0%

10%

20%

30%

40%

Revenues (Rs mn) (LHS) Growth Rate (RHS)


Exhibit 5: … industry growth rates for white goods (which grew at 15% CAGR in the last five years) (Figs represent revenues in ` bn)

020406080

100120140160

Television Refrigerators Air Conditioner's Washing Machine

FY07 FY12

+7% CAGR

+19% CAGR

+17% CAGR

+18% CAGR

Source: CRISIL, Ambit Capital research

V-Guard Industries


Growth momentum to continue for stabilizers

Stabilizers are primarily used in white goods to safeguard them from power fluctuations. We expect the growth in stabilizers (market size for stabilizers is ~`21bn) to increase at a faster pace over the next five years compared to the last five years given: (a) CRISIL’s forecast of a 17% growth in white goods (see exhibit 6) over the next five years compared to 15% growth in the last five years, and (b) The rising power deficit in India (which has increased from 10.3% in FY11 to 11.1% in FY12) as average PLFs have started to decline given challenges around coal availability coupled with the deteriorating financial condition of state electricity boards. In the stabilizer segment, we also expect market share of organized players to increase from the current share of ~25% given that the product is affordable (cost of a stabilizer ranges from `1,000-`2,500 per unit in comparison with the cost of white goods that range from `20,000-`100,000).

Exhibit 6: Outlook for the future in white goods remains bright (Figs represent revenues in ` bn)

0

50

100

150

200

250

300

Television Refrigerators RAC's Washing Machine

FY12 FY17E

+14% CAGR

+16% CAGR

+20% CAGR+16% CAGR

Source: CRISIL, Ambit Capital research

Scalability of stabilizers not a challenge for V-Guard

V-Guard follows a unique outsourcing strategy wherein it has tied up with around 70 charitable organizations / women’s self help groups (all based in south India) who exclusively manufacture this product for the company. The advantage of using these types of vendors is the excise benefit. Note that charitable organizations / women’s self help groups are not subject to excise duty. The function of the vendor is to manufacture the products as per the specifications of V-Guard. The company assists these vendors in the procurement of raw material and also maintains their quality and testing standards by ensuring the presence of their own quality inspectors at these units. With V-Guard now looking at expanding into Northern India, sceptics are quick to point that with the charitable organizations-centric outsourcing model being primarily concentrated in South India, V-Guard might struggle in the North. We do not think this could be a big concern since the cost of freight is marginal at 1%-2% of revenues compared to gross margins of 35% (as per the management). Also, the scalability of the south-based vendors will not be a constraint as their installed manufacturing capacity can be expanded by as much as 50% from the current level (currently operating at 70% capacity) by introduction of semi-automated machines at a minimal additional capex of `0.5mn-`0.6mn/facility which will be incurred by the vendor and not by V-Guard.

V-Guard Industries


Trump card for penetrating Northern India

V-Guard’s trump card in the penetration of the Northern Indian market has been stabilizers. This is because this product is unique to V-Guard, as the other electrical companies such as Havells, Bajaj Electricals, Crompton Greaves and Finolex Cables do not sell stabilizers.

Our discussions with dealers on this subject suggest that there are strong challenges in finding vendors for stabilizers in North India. This seems to be true given that V-Guard, which had started manufacturing stabilizers in North India through vendors around three to four years back, has not been able to scale up. Whilst bears might say “Why can’t other organized players start manufacturing stabilizers by themselves?” our discussion with companies highlights labour as a bottleneck. Relative to other products manufactured by electrical companies, stabilizers is the most labour intensive. Hence if organized players want to be competitive against the unorganized players, the only way out is to outsource production as this would reduce labour cost by at least 50%. The reason why this is not easy is because it requires significant time and effort to build and maintain a large vendor network. For instance, V-Guard manages more than 70 vendors to generate a topline of `2bn, implying a turnover of `30mn per vendor.

Secondly, relative to the other organized players (Blue Bird and Everest) V-Guard’s brand is far stronger given its pan-India presence and brand recall post its successful advertising campaign in the Indian Premier League. Furthermore, our discussions with unlisted electrical companies suggests that V-Guard has limited competition from Everest in the North given that Everest is more of a regional player (based in Chennai) with limited presence in the North. The only competition is from Blue Bird (based in Delhi). However, Blue Bird is more focused on the industrial side, say our primary data experts. The firm is known for its industrial stabilizers (like Servo and constant voltage stabilizers) which are used in IT parks, call centers, X-ray machines, ECG machines, CT scans etc. Southern Indian real estate market likely to fare better than the rest of India

Despite 30% revenue CAGR over FY08-FY12 from the non-South markets, V-Guard continues to be a dominant Southern Indian player with 78% of revenues coming from this region. Given the dominance of the South Indian market for V-Guard and given that the South Indian real estate market is likely to do well compared to the rest of India we believe the prospects augur well for V-Guard. Please see the section titled South India real estate market preferred over North India for more details. Also our discussions with dealers suggest that V-Guard is in the top 3 in the light electricals segment across all the South Indian states compared to Havells being top 3 in just Kerala and Tamil Nadu.

V-Guard catching up with Havells on working capital efficiency

One of our concerns is V-Guard’s rising working capital debt (up 5x to `852mn in FY12 from `179mn in FY09). To arrest this increase, management has introduced vendor financing whereby the target is to increase creditor days to 90 (from the current 28 days) over a period of time and thereby bring down the cash conversion cycle to match the industry leader’s (Havells) cycle of around 2-4 days.

Creditor days for V-Guard are lower at 28 days (v/s Havells’ 49) because V-Guard’s vendors are 100% dependent on V-Guard. If the company does not pay them on a monthly basis the vendors might have financial constraints. Through vendor financing, V-Guard is looking at increasing its creditor days from 30 to 90 days. The way this scheme works is that instead of V-Guard paying the vendors in 30 days, the bank pays the vendors post 30 days and then V-Guard will pay the

V-Guard Industries


vendor post 60 days from the date of payment to the vendor by the bank. The outcome of this is lower interest cost as V-Guard’s working capital turnover improves and its dependence on debt comes down. Whilst bears might argue that this is moving interest cost to raw material cost given that now V-Guard’s raw material cost will be higher (small-scale industrial units will now load interest and sell) given the higher credit period, we believe there will still be a savings in the interest cost for V-Guard as cost of debt for the small scale industrial units is at least 100bps lower compared to V-Guard. In other words, instead of V-Guard borrowing it will be the small-scale industrial units who will be borrowing.

Exhibit 7: V-Guard’s creditor days are the lowest in the sector ...

FY10 FY11 FY12

V-Guard 32 27 28

Havells 45 46 49

Bajaj Electricals 76 86 94


Exhibit 8: ... hence V-Guard’s CFO/EBITDA has historically been low

-30%

0%

30%

60%

90%

120%

150%

FY10 FY11 FY12

V-Guard Havells Bajaj Electricals


We believe vendor financing has an edge over channel financing as it attracts lower interest cost given that the vendors are predominantly small-scale industrial units and hence eligible for low cost priority sector lending from banks. The way it works is that the money which the banks use to pay the vendors after 30 days is shown in the vendor’s books as loans. This loan is then repaid after 60 days by vendors from the amount received from V-Guard. Also, delinquency risk is lower given that the payment is to be made by V-Guard compared to by the dealer as in the case of channel financing.

On the debtor front, the company has already reduced the credit period offered to the new distributors in north India given the positive response to the company products. The company has managed to achieve breakeven in most of its branches in these states given strong brand recall thanks to advertising. This is corroborated by the fact that despite cutting introductory commissions (they were as high as 7%-8% of sales) the growth trajectory in the north continues to remain robust (share of revenues from the non-south zone has increased from 5% in FY08 to 22% in FY11).

V-Guard Industries


Key assumptions and estimates Over FY12-FY14, we expect V-Guard to report revenue CAGR of 26% (FY08-FY12 CAGR of 37%) and PAT CAGR of 22% (FY08-FY12 CAGR of 32%) driven by the assumptions shown in the table below.

Exhibit 9: Key assumptions and estimates for V-Guard (all figures in ` mn unless otherwise mentioned)

FY11 FY12 FY13E FY14E Comments

Key assumptions (% YoY growth in revenues)

Electronics segment (32% of FY12 revenues)

45 44 32 28

Stabilizers, UPS and Inverters are the products categorized under this segment. Historically, sales for this segment have grown at a CAGR of 24% over the past five years compared to growth of 11% for white goods (which is the primary driver). We have assumed a growth rate of 32% and 28% for FY13 and FY14 for this segment on the back of the expected growth rate of 17% in white goods over FY12-FY17 and rising power outages. (The power deficit in India has increased from 10.3% in FY11 to 11.1% in FY12.)

Electro-mechanical segment (65% of FY12 revenues)

70 31 23 24

This segment comprises PVC Cables, LT Power Cables, Pumps, Water Heaters and Fans. The high growth witnessed in cables during FY11 was on the back of the commissioning of V-Guard’s plant in North India where it manufactures cables. However, dealers say that the competition in the cables market is very high and hence we have modelled a growth rate of only about 25% in this category over FY12-FY14. Within Pumps, we believe that the company will not be able to sustain the growth it has seen in the past (at a CAGR of 31%). We infer this from the muted outlook highlighted by the management in its FY12 annual report and the estimated industry growth rate at 18% as projected by Frost & Sullivan. We further estimate growth in the water heater segment and fans at 40% and 25% respectively.

Others (3% of FY12 revenues)

25 22 48 33

The contribution of sales from this segment is the least (at around 3%). This segment comprises solar water heaters. Our assumptions for higher growth rates in this segment is largely on the back of the commissioning of its new plant in Perundarai and the benefits the company will gain from the subsidy under the MNRE scheme which will make it more affordable. Secondly, sales from the new product launches by the company i.e. switchgears, induction cook tops and mixer grinders will also enhance the sales for this segment.

Key estimates

Sales 7,266 9,936 12,585 15,783 Based on our assumptions highlighted above, we believe the company will grow at a CAGR of 26% over FY12-FY14 compared to 48% for the period FY10-FY12.

Sales (YoY growth) (%) 60 37 27 25 EBITDA 730 935 1,082 1,342

EBITDA margin (%) 10.1 9.4 8.6 8.5

We model a decline of ~80 bps in margins in FY13 on the back of increase in the cost of goods sold as the company resorts to vendor financing and higher employee expenses on account of new branches and expansions.

EBITDA (YoY growth) (%) 43 28 16 24 FY12-14 EBITDA CAGR of 20% vs FY10-12 CAGR of 36%

Interest expense 113 170 161 161

Whilst historically the increasing working capital limit remained an overhang for the company, the increase in the creditor days vide vendor financing will significantly reduce the working capital requirements over the next couple of years. Consequently, interest expenditure is likely to remain flat in FY13 and FY14 and then will reduce at a faster rate from FY14 onwards.

PBT 591 692 827 1,072

Whilst the PBT did not grow as fast as EBITDA due to higher interest costs, we expect this trend to reverse in FY13 and FY14 as the debt:equity reduces. We model FY12-14 PBT CAGR at 24% which is higher compared to the EBITDA CAGR of 20%.

Tax rate (%) 28 27 29 30 Based on management guidance, we have assumed tax rates of 29% and 30% respectively in FY13 and FY14.

Adj. PAT 401 508 587 750 FY12-FY14 adjusted PAT CAGR of 22% v/s FY10-FY12 CAGR of 41%. PAT (YoY growth) (%) 57 27 16 28

Cash flow from operations (CFO)

(323) 830 520 675 Whilst we expect V-Guard to continue to generate positive cash flows in FY13 and FY14 as well, we expect a decline in FY13 largely on account of revenue growth.

Capex (86) (293) (250) (250) We have assumed capital expenditure of `250mn in FY13 and FY14 as company doubles the capacity at its cables factory.

Free cash flow (369) 553 270 425


V-Guard Industries


In our estimates for FY2013, we are broadly in line with consensus at the topline level. However, at the EPS level, we are below consensus by 10% given our expectation that V-Guard’s operating margins will fall (due to higher raw material cost given the launch of vendor financing).

Exhibit 10: Ambit v/s consensus estimates for V-Guard

Consensus Ambit % change

Sales (` mn)

FY13E 12,454 12,585 1%

FY14E 15,333 15,783 3%

EPS (`)

FY13E 21.9 19.7 -10%

FY14E 28.2 25.2 -11%


Absolute valuation We have valued V-Guard using a free cash flow (FCFF) model. Our FCFF metric is ’cash profit – increase in working capital – capex’. Our FCFF model has three distinct phases:

FY13-FY17: We model each year in detail and assume that: (i) revenues will grow at a CAGR of 20% (FY08-FY12 revenue CAGR has been 37%); and (ii) operating margins would gradually fall to ~8.4% by FY17 (from 9.4% in FY12) given the increase in the cost of raw materials.

From FY18-FY24: We have modelled a 1% drop in the growth rate of sales for the company each year until FY24. Furthermore, we have also reduced the EBITDA margin gradually by 10bps every year to 7.7%.


We expect V-Guard’s RoCE to improve from 21% in FY12 to gradually reach a peak of 24% by FY15 and reduce thereon to 16% in FY24 on the back of our assumption of a gradual fall in operating margins. Based on these assumptions and assuming a WACC of 13.5%, our FCFF model values V-Guard at `373 per share (implying FY13 P/E of 18.9x) and 24% upside.

Exhibit 11: Our free cashflow (FCF) valuation for V-Guard is `373/share

Period ` mn

Net PV of free cash flows for V-Guard 6,080


Total 12,135


Value of V-Guard 11,120




V-Guard Industries


Exhibit 12: FCFF profile for V-Guard

0100200300400500

600700

1 2 3 4 5 6 7 8 9 10 11 12

0%

5%

10%

15%

20%

25%

PV of FCF (LHS) RoCE (RHS) WACC (RHS)


Exhibit 13: Explanation for our flags on the cover page

Segment Score Comments

Accounting GREEN

Whilst the company’s cash conversion (CFO/EBITDA) has historically been negative, the ratio in FY12 not only turned positive but exceeded EBITDA (ratio was 106%). Further in FY12, the company performed well related to its peer group on the following: (a) number of transactions with related parties was low, (b) the ratio of contingent liabilities remained low (at around 5% of networth) and (c) loans and advances as a percentage to net worth (at 13%) is also one of the lowest amongst its peers.

Predictability GREEN FY12 results were broadly in line with consensus and were also as per the guidance given by the management. Further, there have been no major announcements which have surprised negatively.

Earnings Momentum GREEN There have been upgrades of ~10% to V-Guard’s earnings over the past three-six months.


V-Guard Industries



V-Guard Industries


Balance sheet Year to March (` mn) FY10 FY11 FY12 FY13E FY14E

Shareholders' equity 298 298 298 298 298 Reserves & surpluses 1,116 1,421 1,808 2,259 2,834 Total net worth 1,415 1,720 2,106 2,557 3,133 Minority Interest - - - - -Preference share capital - - - - -Debt 805 1,376 1,049 1,150 1,150 Deferred tax liability 57 61 43 43 43 Total liabilities 2,277 3,157 3,198 3,750 4,326 Gross block 1,379 1,462 1,625 1,875 2,125 Net block 1,123 1,138 1,230 1,360 1,468 CWIP 29 14 111 111 111 Investments 46 - - - -Cash & equivalents 74 71 34 107 196 Debtors 756 1,231 1,478 1,838 2,262 Inventory 985 1,424 1,574 1,959 2,414 Loans & advances 89 157 279 353 443 Other current assets - 14 0 0 0 Total current assets 1,904 2,898 3,366 4,258 5,316 Current liabilities 690 731 1,264 1,669 2,180 Provisions 134 162 245 310 389 Total current liabilities 824 893 1,508 1,979 2,569 Net current assets 1,080 2,005 1,857 2,278 2,747 Miscellaneous - - - - -Total assets 2,277 3,157 3,199 3,750 4,326 Source: Company, Ambit Capital research

Income statement Year to March (` mn) FY10 FY11 FY12 FY13E FY14E

Operating income 4,547 7,266 9,936 12,585 15,783 % growth 43.2 59.8 36.7 26.7 25.4 Operating expenditure 4,037 6,536 9,001 11,502 14,442 EBITDA 509 730 935 1,082 1,342 % growth 58.7 43.4 28.1 15.7 24.0 Depreciation 71 79 97 120 143 EBIT 438 651 838 962 1,199 Interest expenditure 51 113 170 161 161 Non-operating income 9 53 24 26 33 Adjusted PBT 395 591 692 827 1,072 Tax 140 165 184 240 321 Adjusted PAT/Net profit 255 401 508 587 750 % growth 57% 57% 27% 16% 28% Extraordinaries - 25 - - - Reported PAT/Net profit 255 426 508 587 750 Minority interest - - - - - Share of associates - - - - - Adjusted consolidated net profit 255 401 508 587 750 Reported consolidated net profit 255 426 508 587 750 Source: Company, Ambit Capital research

V-Guard Industries


Cash flow statement Year to March (` mn) FY10 FY11 FY12 FY13E FY14E

PBT 395 591 692 827 1,072

Depreciation 71 79 97 120 143

Interest 51 113 170 161 161

Tax (125) (181) (157) (240) (321)

(Incr)/decr in net working capital (585) (949) 30 (348) (379)

Others 2 23 (1) - -

Cash flow from operations (191) (323) 830 520 675

Capex (253) (86) (293) (250) (250)

(Incr) / decr in investments 68 34 7 - -

Other income (expenditure) 4 7 8 - -

Cash flow from investments (181) (46) (277) (250) (250)

Issuance of equity - - - - -

Incr / (decr) in borrowings 542 592 (303) 101 -

Others (137) (217) (287) (297) (335)

Cash flow from financing 405 374 (590) (197) (335)

Net change in cash 33 5 (37) 73 89 Source: Company, Ambit Capital research

Ratio analysis Year to March (%) FY10 FY11 FY12 FY13E FY14E

EBITDA margin (%) 11.2% 10.1% 9.4% 8.6% 8.5%EBIT margin (%) 9.6% 9.0% 8.4% 7.6% 7.6%Net profit margin (%) 5.6% 5.5% 5.1% 4.7% 4.8%Dividend payout ratio (%) 28% 24% 20% 20% 25%Net debt: equity (x) 0.52 0.76 0.48 0.41 0.30 Working capital turnover (x) 4.52 3.76 5.45 5.80 6.19 Gross block turnover (x) 3.30 4.97 6.11 6.71 7.43 RoCE (%) 15.1% 17.7% 19.7% 19.9% 21.0%RoE (%) 19.0% 27.2% 26.6% 25.2% 26.4%Source: Company, Ambit Capital research

Valuation parameters Year to March (` mn) FY10 FY11 FY12 FY13E FY14E

EPS (`) 8.5 14.3 17.0 19.7 25.2 Diluted EPS (`) 8.5 14.3 17.0 19.7 25.2 Book value per share (`) 47.4 57.6 70.6 85.8 105.1 Dividend per share (`) 3.5 3.5 3.5 3.9 4.9 P/E (x) 35.3 21.1 17.7 15.3 12.0 P/BV (x) 6.3 5.2 4.3 3.5 2.9 EV/EBITDA (x) 20.2 14.1 11.0 9.2 7.5 EV/EBIT (x) 23.5 15.8 12.3 10.4 8.3 Source: Company, Ambit Capital research

V-Guard Industries


Notes:

V-Guard Industries


Institutional Equities Team

Saurabh Mukherjea, CFA Head of Equities (022) 30433174 [email protected]

Research

Analysts Industry Sectors Desk-Phone E-mail

Aadesh Mehta Banking / NBFCs (022) 30433239 [email protected]

Anand Mour FMCG (022) 30433169 [email protected]

Ankur Rudra, CFA Technology / Telecom / Education (022) 30433211 [email protected]

Ashvin Shetty Automobile (022) 30433285 [email protected]

Bhargav Buddhadev Power / Capital Goods (022) 30433252 [email protected]

Chhavi Agarwal Construction / Infrastructure (022) 30433203 [email protected]

Dayanand Mittal Oil & Gas (022) 30433202 [email protected]

Gaurav Mehta Derivatives Research (022) 30433255 [email protected]

Harshit Vaid Power / Capital Goods (022) 30433259 [email protected]

Jatin Kotian Metals & Mining / Healthcare (022) 30433261 [email protected]

Krishnan ASV Banking (022) 30433205 [email protected]

Nitin Bhasin Construction / Infrastructure / Cement (022) 30433241 [email protected]

Pankaj Agarwal, CFA NBFCs (022) 30433206 [email protected]

Parita Ashar Metals & Mining / Media / Telecom (022) 30433223 [email protected]

Rakshit Ranjan, CFA Mid-Cap (022) 30433201 [email protected]

Ritika Mankar Mukherjee Economy (022) 30433175 [email protected]

Ritu Modi Cement / Infrastructure / Healthcare (022) 30433292 [email protected]

Shariq Merchant Consumer (022) 30433246 [email protected]

Sales

Name Regions Desk-Phone E-mail

Deepak Sawhney India / Asia (022) 30433295 [email protected]

Dharmen Shah India / Asia (022) 30433289 [email protected]

Dipti Mehta India / Europe (022) 30433053 [email protected]

Pramod Gubbi, CFA India / Asia (022) 30433228 [email protected]

Sarojini Ramachandran UK +44 (0) 20 7614 8374 [email protected]

Production

Sajid Merchant Production (022) 30433247 [email protected]

Kausalya Vijapurkar Editor (022) 30433284 [email protected]

V-Guard Industries


Explanation of Investment Rating

Investment Rating Expected return

(over 12-month period from date of initial rating)

Buy >5%

Sell <5%

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