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UBS Investment Research
Havells India
Wired for a brighter future
Initiate coverage with a Buy rating
Havells India (HVEL) is a leading Indian consumer electrical goods company. The
company has demonstrated an ability to gain market share and improve
profitability. We believe HVEL will continue its industry-leading growth in India’s
electrical consumer durables sector. We initiate coverage with a Buy rating and a
price target of Rs465.00.
Lighting (and fixtures), fans and new products to drive rapid growth
HVEL has a strong distribution network and its product strategy is aimed at
capturing a larger share of distribution channels. HVEL is launching water heaters
and its subsidiary Sylvania’s lighting products in India. We believe that lighting
and durables will continue to drive industry-leading growth. We forecast FY12-15
revenue CAGRs of 26% for lighting and 19% for durables.
Sylvania turnaround on track; Latin America growing nicely
HVEL has succeeded in turning Sylvania around by cutting fixed costs, exiting
unprofitable products and outsourcing manufacturing, resulting in €34m in annual
cost savings. Despite flat revenue, Sylvania’s EBITDA margin rose from 0% in
FY10 to 4.7% in H1 FY11, and Latin American revenue increased 16.7% YoY (in
US$ terms) in H1 FY11. Sylvania contributed 28% of consolidated EBITDA and
49% of consolidated revenue in H1 FY11.
Valuation: Rs465.00 price target
We derive our price target for the standalone business from a DCF-based
methodology and explicitly forecast long-term valuation drivers using UBS’s
VCAM tool. Our price target implies 17.6x FY12E PE after adjusting for our value
of Rs19 per share for Sylvania. We value the Sylvania business at 7.5x
EV/EBITDA.
Investment Thesis
HVEL is a leader in India’s electrical consumer durable products space. It
also has an international presence through its subsidiary Sylvania, which is
present in Europe, Latin America and Asia. We believe HVEL is well
positioned to grow its India business given its strong distribution network,
product strategy and consumption growth. After installing new Sylvania
management teams in Latin America and Asia, HVEL has been able to
grow revenue from these regions.
HVEL has demonstrated its ability to launch new products and gain market
share. In the fan segment, HVEL achieved a 13% market share in India
within six years of launch (launched in 2004) and is now the fourth largest
player in the segment. HVEL has grown its market share in switchgear from
15% in 2006 to a market leading 20% in 2010. As its market position
improves, HVEL has been able to gain pricing power and improve margin
contribution (gross margin) from these segments. As a case in point,
HVEL’s margin contribution from fans improved from 14% in FY07 to
26% in H1 FY11. This was driven by improving brand recognition and
subsequent higher pricing.
HVEL recently launched a water heater product line (an Rs8bn market in
India) and is advertising it. The company is aiming at growing its lighting
and fixture business by introducing Sylvania’s lighting products in India.
HVEL has also been able to grow its revenue in Latin America over the
previous three quarters. During H1 FY11, its US$ revenue from Latin
America rose 16.7% YoY.
Our price target implies 17.6x FY12E PE after adjusting for our value of
Rs19 per share for Sylvania, compared to 18x FY12E PE for its peers.
Key catalysts
Resumption of double digit growth in the switchgear business once an
OEM contract expires. Havells’ growth in the switchgear business was
muted in H1 FY11. It did not renew a contract manufacturing OEM account
with an international switchgear manufacturer. HVEL also launched its
switchgear product in European markets. After the contract runs off
completely, we expect switchgear revenue growth to return to a normalised
CAGR of 12-15% in FY12-15.
Successful turnaround in Sylvania Europe and continued growth in
Latin America and Asia. HVEL has demonstrated progress in turning
around Sylvania. It has cut fixed costs, exited from low margin commodity
lighting products, increased outsourcing to China and India, and
subsequently improved operating margins. Sylvania reported an EBITDA
margin of 4.7% in H1 FY11 as compared with 0% in FY10. Sylvania has
also shown impressive revenue growth in Latin America—during H1 FY11,
Latin American revenue rose 16.7% YoY (in US$ terms). We believe that
continued operational turnaround at Sylvania and growth in Latin America
will act as positive share price catalysts. We assume EBITDA margins of
5.7% in FY12 and 6.4% in FY13 for Sylvania in our model, while the
company thinks it can achieve an 8-9% EBITDA margin in FY13. The
market is currently ascribing no value to Sylvania.
Lighting and new products to drive rapid growth. We believe that new
luminaire and durable products will be critical in driving accelerated future
revenue growth. HVEL plans to launch Sylvania’s luminaire products in
India; we think this will provide the needed breadth to Havells’ luminaire
portfolio. We believe there is potential upside risk to our lighting and
luminaire sales estimates. Additionally, HVEL is launching a new water
heater line. We think acceleration in revenue growth driven by these product
categories could act as a significant revenue booster.
Risks
Volatility in raw material prices. Cable and wire contributed 41% of
revenue in FY10 and H1 FY11. Cable and wire margins are linked to
commodity prices (copper and aluminium).
Severe slowdown in Europe. There has been continued newsflow about
economic weakness in Europe. Europe contributes 60% of Sylvania’s
revenue. Any severe slowdown in residential and commercial construction in
Europe could hurt Sylvania’s revenue.
Any expensive acquisition/poor capital allocation. We think this is
unlikely.
Setbacks in institutional sales/withdrawal from the institutional channel.
While HVEL has a very strong position in consumer electrical products, it
has not done very well in the industrial and commercial market. Any setback
in this market would result in lower YoY growth.
Pricing/promotional tactics by any leading competitor.
HVEL does not have an internationally recognised auditor.
Valuation and basis for our price target
We value HVEL’s standalone business and the Sylvania business separately.
We believe this is a suitable approach since the standalone business is a market
leader with high profit margins and strong growth prospects; while Sylvania is
in turnaround mode, will have a lower EBITDA margin and is likely to grow at
a far lower rate.
Havells’ standalone valuation
We derive our value for HVEL’s standalone business from a DCF-based
methodology and explicitly forecast long term valuation drivers using UBS’s
VCAM tool. We initiate coverage with a Buy rating and a price target of
Rs465.00, which is 23.5% above the current level. Our price target implies
17.6x FY12E PE after adjusting for our value of Rs19 per share for Sylvania.
This is supported by our forecast 30%+ ROE and FY11-15 EPS CAGR of 22%
for the standalone business.
HVEL has historically traded in an EV/EBITDA range (1 standard deviation) of
5-12x, and a PE range of 8-18x. HVEL traded at low multiples when the market
was worried about continued losses at Sylvania and subsequent continued stress
on HVEL’s standalone balance sheet. Our price target implies 17.6x FY12E PE
(after adjusting for our value of Rs19 per share for Sylvania) and 11.5x FY12E
EV/EBITDA. While these are at the high end of the historical averages, HVEL
is a much larger company today with a longer history of market share gains, and
we therefore believe it deserves to trade at a premium to its historical average.
The stock is trading at 14.1x FY12E EPS.
Sylvania valuation
We value Sylvania at 7.5x EV/EBITDA, which is at the lower end of the
EV/EBITDA range for its global peer set. We think this is conservative since:
We ignore the tax shield that Sylvania enjoys (its European business will not
pay taxes for the foreseeable future).
We value the potentially higher growth Latin American business at par with
the mature European business. Latin America contributed 33% of revenue in
H1 FY11.
Comparable valuations
We believe there is no true comparable for Havells standalone business in India.
The paint industry has a significantly higher industry concentration. Projects
contribute a much larger share of revenue for Voltas and Blue Star. Crompton
Greaves’ value is primarily driven by electrical transmission products
(transformers). Bajaj Electricals also has a higher share of projects business, and
its projects business is growing faster than the products business. However, if
HVEL continues to demonstrate rapid growth and increase its market share in
the consumer electrical durables business, we think it could eventually trade in
line with the multiples the paint companies command
Sensitivity analysis
We conducted a sensitivity analysis of our valuation. Our sensitivity analysis of
the parameters indicated suggests that:
WACC: A 1ppt increase in WACC, from 13.19% to 14.19%, would result in an
8% decline in our valuation, while a 1% decrease would result in a 13% increase.
Sales growth: A 1% increase in our long-term sales growth assumption would
result in a 5.4% increase in our valuation, while a 1% decline would result in a
2.1% decrease.
EBIT margin: A 1ppt increase in our long-term EBIT margin assumption
would result in a 9% increase in our valuation, while a 1% decline would result
in a 6% decrease.
Capex to sales: A 1ppt increase in long-term capex, as a percentage of sales,
would result in a 3.5% decline in our valuation, while a 1ppt decrease would
result in a 6.5% increase.
Corporate governance
After the merger of Standard Electric into Havells, Havells’ management does
not have any other business interests. We think Standard Electric was merged
into Havells at a reasonable valuation, at 1.2x EV/Sales and 12x PE multiples.
Management holds a 60% stake in Havells, and we believe its interests are
aligned with those of minority shareholders.
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