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VOLTAS LTD
PRICE: RS.220
RECOMMENDATION: BUY
TARGET PRICE: RS.245
FY11E P/EX: 19.9
Outlook on Middle East MEP is improving and the company's recent JV with
Olayan should enable Voltas to effectively enter the Saudi market (largest in
GCC countries).
In view of the 15% price correction from recent high in Voltas stock, we
upgrade the stock to BUY with a target price of Rs.245.
Voltas announced the formation of JV with Olayan Financing Company, Riyadh for
execution of electromechanical projects in the Kingdom of Saudi Arabia (KSA). The
share holding pattern will be in equal proportion of 50% each and the JV is expected to be operational by April 2011. The Olayan Group is a private multinational
enterprise comprising 50 companies and affiliated businesses engaged in distribution, manufacturing, services and investment. The JV will take up MEP projects and
subcontract the entire project to Voltas for design, supply of equipment as well as
project execution. Thus, bulk of the profits for projects undertaken in KSA will flow
to Voltas directly as well as through JV.
The Voltas management has not been present in the KSA as the management was
not comfortable with the terms of doing business in the country. However, the KSA
market for MEP is huge and almost the entire size of the GCC market. The KSA
also continues to invest heavily into infrastructure development and announced a
expansionary budget in 2010. Some of the important projects are listed below.
Management bullish on the demand outlook for Middle East MEP
The voltas management is quite optimistic about the rebound of the MEP market in
the Middle East and expects the recovery to gain momentum from 2012 onwards.
Frost and Sullivan predicts that regional MEP market which stood at USD 13.5 bn in
2008 should expand to USD 22 bn by 2013. As per the research firm, the market
expansion will be driven KSA, Qatar and Abu Dhabi. From a MEP contractor standpoint, for gaining a competitive edge, availability of skilled (for project design and
service support) and semi-skilled manpower is a must.
Earnings Outlook
n Electromechanical Projects and Services is the core business of the Company and
comprises 65% of the annual turnover. About 70-75% of the segment turnover
comes from International Operations mainly the Middle East. Revenues were
down for the quarter due to delay in execution of two large projects in Qatar
(approx Rs 10.5 bn) as well as India. The management indicated that the momentum in project execution should improve from H2 FY11. The company's order book of Rs 50 bn provides a visibility of 19 months of projects revenues,
which is adequate.
n The management appeared positive on the order pipeline and indicated that
opportunities are substantial. Voltas has won a large international order in October, which will get reflected in the 3Q order book as the company does not announce individual order wins
n Margins shrunk 140bps in Q2 FY11 to 10.1% mainly as due to the Electromechanical Projects segment which reported a margin loss of 350 bps as some of its
overseas subsidiaries engaged in the projects segment had to incur one-time
charges. Even adjusting for non-recurring items of expenditure, margins are likely
to remain under pressure as revenues are flowing from contracts taken at very
competitive margins during poor market conditions.
Capital engagement has increased significantly in Electromechanical projects and Unitary Cooling segment
On account of the substantial client advances, Voltas's electromechanical projects
business has been working on a very lean working capital. However, capital employed has increased substantially in the Electromechanical projects business despite
no increase in volume of work. This may be due to execution sluggishness in some
large projects.
Future Prospects
The company sees a healthy project pipeline from the Middle East market and volume of new enquiries has increased and so has been the fresh orders that have
been booked in the first quarter.
We believe that the Electromechanical segment would continue to post sedate
growth in the current fiscal but momentum in growth should accelerate in the Engineering services business. The Unitary cooling segment should grow at a healthy clip
in the current year. Thus, we have built in a 15% rise in revenue in FY11.
Valuation
The Voltas stock has corrected 15% from its 52 week high of Rs 258 due to general
weakness in markets. There were also some misleading reports on the company's
involvement in recent telecom scam (which the company has already clarified on
the exchange). In our previous update, we had recommended "Reduce" citing stagnant order backlog, increasing capital engagement and fair valuations. In view of
the recent correction in stock price and the optimistic outlook on the Middle East
MEP market, we upgrade stock to BUY with an enhanced price target of Rs.245 (Rs
231 earlier)
Voltas is currently trading at 19.9x and 16.7x FY11 and FY12 earnings respectively.
On a FY12 EV/EBITDA basis, the stock is trading at 10.9x.
Based on WACC of 13.4% and terminal growth rate of 4%, we arrive at a DCF
value of Rs 245 (Rs 231 earlier).
Upgrade to BUY on ...
Improving order intake and order pipeline in the Middle East coupled with recent
stock price correction.
Risk to Recommendation
n Delay in order accretion.
n Downside to margins due to unforeseen project costs
n Slowdown in GDP affecting purchasing power of households translating into
lower offtake of ACs and subdued real estate demand.
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