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Voltas
Rs209.55 - BUY
Strong growth from FY12 onwards
FY11 is likely to be a mixed bag for earnings, with sharp growth in engineering
products and unitary cooling businesses offsetting disappointing performance in
electro-mechanical products division. However, we expect 43% growth in new
orders which sets the tone for coming years. Voltas will benefit from a surge in
infrastructure spending in India and Middle East and its JV with Olayan allows it to
participate in Saudi Arabia market, the largest spender in the GCC. In India, Voltas
is already seeing strong traction in new water and power businesses. We forecast
26% Cagr in orders and a 21% in profits over FY11-14; maintain BUY.
Muted FY11. Voltas sees profit growth to be subdued in the electro-mechanical projects
(EMP) business in FY11. This is on account of slow execution on two projects in Qatar in 1H,
intensifying competition in Abu Dhabi, and drop in profitability of Rohini Industrial Electricals
(100% subsidiary). Equipment supply and room AC businesses continue to grow strongly.
Strong growth from FY12 onwards. Order inflows in the domestic business have been
growing well. Water treatment and purification business, in particular, has been expanding
sharply, albeit from a small base. In the international business, management expects that
FIFA 2022 award to Qatar and plans of establishing a trans-GCC metro system will create
significant MEP opportunities. It comments: “Looking at the positives in the International
Market and the improved fundamentals and sentiments in the Domestic market, there is
reason to believe that starting FY12 we should be in for a sustained growth phase for this
business extending 5-7 years, barring unforeseen circumstances.”
India and Middle East have massive infra spending plans. Metro trains, other infra
projects and industrial orders are emerging as new growth avenues for domestic business.
In the GCC region, though overall construction spending has stayed flat in CY10, it is mainly
on account of a fall in real estate investment; government infra spending has increased.
Moreover, while over US$500bn worth of projects were put on hold or cancelled in 2008-09,
most of the contracts due to be awarded in 2010 are active, suggesting that these should
get awarded over next few quarters. Our management conversations suggest that enquiry
levels have gone up; some large projects should get awarded over the next few quarters.
Saudi Arabia is an attractive market. Saudi Arabia has emerged as the largest
construction market in the GCC, with projects worth US$43bn awarded in 2010, compared
to US$26bn for Abu Dhabi. Under the stimulus package, US$385bn is targeted to be
invested in infrastructure by 2014. Voltas’ JV with Olayan Group gives it an opportunity to
penetrate the market, which has lower competition, thanks to high entry barriers.
Maintain BUY. Voltas’ stock price has historically shown a high correlation to orderflow
momentum. We forecast the company to post a 26% Cagr in order inflows and a 21% in
profits over FY11-14. As orders improve earnings visibility, we see a room for re-rating; BUY.
Mixed FY11, strong growth from FY12
• Strong order inflows. Order inflows in the domestic business have
grown strongly in 9mFY11. In the international business, management
expects that award of FIFA 2022 to Qatar will start resulting in new orders
from FY12-end onwards. Moreover, significant investment is planned for
trans-GCC metro system and should result in new MEP opportunities.
We have forecast Rs33bn (+43% YoY) worth of orders for FY11 and
Rs46bn (+39% YoY) for FY12. Given that the company has already orders
of Rs16bn in 1HFY11 and another “reasonably-sized” project at the
beginning of 3Q, it is on track to meet our order inflow numbers for FY11.
Our conversations with management suggest that while Voltas so far had
to collaborate with other MEP contractors to bid for large Middle East
projects (for example, it bid in collaboration with ETA and Hitachi for Burj
Khalifa project), it could now undertake a number of these alone, which
significantly increases its addressable market.
• Execution is picking up in domestic orders. Management commented
that execution has started picking up on the domestic projects that were
moving slow (due to design changes from customers’ side). Nevertheless,
we expect 3Q revenues to remain subdued, and a pick up in revenues to
be visible only in 4QFY11/FY12 revenues.
Our conversations with management suggest that while execution on
domestic orders has picked up, it continues to lag for two large Qatar
projects (worth Rs10-15bn). This is mainly on account of design changes
from the main contractor’s side. Given that these are government funded
projects, we see little risk of cancellation of these projects, though
revenue recognition could get deferred to FY12.
• EMP business margins could decline in 2H. EMP margins could decline
in the short term on account of a) intensifying margin pressure in the
Middle East; b) rising commodity costs; and c) drop in profitability of its
subsidiary, Rohini Electricals.
We have forecast pre-exceptional Ebit margins in the EMP business to
decline from 10% in 1H to c.8% in 2H. We note that commodity costs for
Voltas’ international projects are hedged through back-to-back forward
contracts; therefore, the company is exposed only to commodity price
movements in its shorter execution-cycle domestic projects.
Management, in the outlook statement, stated that profitability of its
100% subsidiary Rohini Industrials has fallen. We note that Voltas had
recorded Rs190m loss on account of accounting adjustments to one of the
subsidiary’s accounts. There is a possibility that the losses referred to by
the management could be on account of further accounting adjustments,
rather than weakness in operational performance.
• Update on Saudi Arabia JV. Management expects Voltas’ JV with
Olayan Group to become operational by April 2012. Management is
confident of gaining traction in the market, and comments: “While large
number of new projects is being launched, there is a paucity of good and
reputed MEP contractors compared to the amount of work available,
thereby, offering good opportunity for a Company like ours.”
Saudi Arabia is now the largest construction market in the GCC, having
awarded US$43bn worth of projects in 2010, compared to US$26bn by
Abu Dhabi. Under the economic stimulus package, US$385bn is
earmarked to be invested in infrastructure development by 2014.
Moreover, given that barriers to entry are high, especially for foreign
contractors, competition is limited and therefore margins are likely to be
better. We discuss this in more detail later.
• Robust performance by engineering equipment and room AC
businesses. Demand for textile machinery and material handling
equipment is strong, while mining and construction equipment sales are
going slow (export ban on iron ore, delays in Coal India orders). Room AC
sales are also growing at 30%+.
We believe that the impact of execution delays at the EMP business will be
offset, to a large extent, by strong growth in unitary cooling and
engineering products business. Unitary cooling business is benefitting
from low penetration of room ACs (2% compared to 53% for China) and
rising per-capita disposable income in India. We forecast the segment to
post 18.3% Cagr in revenues over FY11-14.
Engineering products and services business is a play on industrial capex.
While there have been mixed signals about corporate capex pick up so far,
Voltas has seen a strong revival in textile and material handling
equipment. Given that 25-35% of its revenues relate to commission
income, margins expand sharply as incremental commissions are earned.
We forecast 19.9% Cagr in revenues and 29.6% in Ebit in this segment
over FY11-14.
• Bullish on FY12. In the outlook statement, management commented:
“Looking at the positives listed under the International Market and the
improved fundamentals and sentiments in the Domestic market, there is
reason to believe that starting FY12 we should be in for a sustained
growth phase for this business extending 5-7 years, barring unforeseen
circumstances.”
While FY11 results could be a tad disappointing due to delays in execution
in certain projects, these revenues will flow through in FY12. This, coupled
with strong order inflow growth in FY11, should help the EMP segment
record 18.6% Cagr in revenues and 22% in Ebit over FY11-14. Overall,
we anticipate the company to record 21% Cagr in its EPS over this period.
Outlook for various sectors that are likely to contribute to MEP orderflow
Sector Near-term
outlook
Comments
Airport Neutral/
Positive
Investment in Indian airports about Rs200bn over next five years per media articles.
In FY11, Rs26bn planned to be spent on the four major airports under modernisation (Mumbai, Delhi, Hyderabad,
Bengaluru) and Rs13bn on modernisation of other metro airports (Chennai, Kolkata). MEP work already awarded.
Plans of modernising 35 non-metro airports, of this 16 completed. Some MEP work should flow.
12 greenfield airports planned to be awarded over next few years. Delays experienced, but significant MEP potential.
Progress has been slow in new project awards, especially the greenfield ones. In the near term, we expect MEP
project awards for Goa and Port Blair only.
As and when execution on new airports picks up, it will emerge as a significant MEP opportunity.
Metro trains Positive Metro under way/planned in Delhi, Mumbai, Bengaluru, Hyderabad, Mumbai, Chennai, Pune, Lucknow, Kanpur,
Ahmedabad, Ludhiana, Kochi, Indore and Chandigarh - total investment of US$40bn over the next 10-15 years.
In the near term, MEP awards are likely to come from Delhi, Mumbai, Bangalore, Chennai and Kolkata metros.
In particular, Bangalore, Chennai and Kolkata metro train stations should present a strong MEP potential of around
Rs12bn over the next 18 months. This is because these metros involve construction of underground stations.
In FY12/13, MEP work on III stage of Delhi metro should also commence.
Hospitality Positive All major hotel chains (such as Starwoods, Marriott, Indian Hotels) are planning to add to their hotel portfolio.
Healthcare Positive A study conducted by FICCI and Ernst & Young suggests that by the end of 2025, India will need 1.75m additional
beds; public sector expected to contribute only 15–20% of the US$86bn investment.
At present, India has only 860 hospital beds per million population against the world average of 2,600.
A significant proportion of construction cost of hospitals is spent on MEP work since hospitals require different airconditioning
types for operation theatres, patient rooms, diagnostic centres.
Education Positive Currently education sector accounts for 7% of India’s private consumption.
We estimate the Kindergarten to grade 12 segment to be a US$20bn market and private professional colleges to be
US$1.7bn market. We anticipate these markets to enjoy 13-14% and 16-17% Cagrs respectively over FY10-12.
Power
sector
Positive 26GW capacity has been added in the XI plan (FY07-12) so far, with a further 20GW under construction. Target for
XII plan (FY12-17) is likely to be about 100GW.
-1-3% of total project cost in a power plant relates to electrification and plumbing work.
Middle East EMP: boost from government funded projects
Construction project awards in the GCC have remained flat over the last four
years. Given that real estate construction has fallen, especially in Dubai, this
implies that spending on infrastructure projects has been going up.
We also note that whilst over US$500bn worth of projects were put on hold or
cancelled in 2008-09, most of the projects that were planned to be awarded
in 2010 are still active, though there have been some delays in awarding
them (Source: MEED). This suggests that though 2010 has not shown any
noticeable pick up in award momentum, projects that have experienced
delays are likely to get contracted over the next few quarters.
Moreover, trans-GCC railway project is planned to be built over the next few
years. It should involve an investment of about US$25bn and is slated to be
completed by 2017. According to MEED, preliminary engineering works have
been awarded for the first phase of the UAE’s section and tenders have been
put out for material supply and rolling stock. Voltas’ management believes
that this railway project presents a significant MEP opportunity, though it is
difficult to estimate the value of MEP work at this stage. We believe that with
oil prices recovering and macro environment in the Middle East economies
improving, large MEP projects will again start to flow through.
Saudi Arabia is an extremely attractive market
Saudi Arabia awarded the highest value of contracts (US$46bn) in the GCC
region in 2010. Of the ten largest projects awarded in the GCC, four were in
this Kingdom. Moreover, the government has declared a US$385bn stimulus
package for investment in infrastructure over the next four years.
Despite this being such a large market, competition is limited, on account of
high entry barriers. It is not easy for foreign companies to penetrate this
market, evident from the fact that over 80% of the construction projects
currently under execution have been won by local contractors. We note that
Voltas had has historically had a presence in this country through its
subsidiary, Saudi Ensas, which focused on smaller MEP projects. However, this
entity had been making losses and Voltas had provided it financial assistance
of more than Rs240m. The subsidiary is closed down.
With Voltas now forming a JV with Olayan Group, it intends to undertake large
projects, where competition is relatively less intense and margins are thus
better. Moreover, its association with Olayan Group, which is a large Saudi
Arabia-based conglomerate, will help it in understanding the market better
and in managing local issues, like arranging for visa, required approvals etc.
Qatar will be active in project awards over next few years
Qatar is likely to issue construction tenders for the first phase of its metro
network by the middle of 2011. Moreover, with FIFA 2022 World Cup awarded
to Doha, significant infrastructure management is planned in the region over
the next decade. Voltas’ management believes that project awards for FIFA
2022 could start from 2011-end itself.
Project awards in Abu Dhabi slower than expected
While Abu Dhabi awarded some large contracts in 2010 (like US$1.3bn
Cleveland Clinic and US$490m Presidential Palace), overall project award
activity has been slower-than-anticipated. For example, in 2009, Abu Dhabi
had awarded projects worth US$45bn (excluding US$20bn for nuclear
project), while in 2010 it managed to award projects of US$26bn only
(Source: MEED). According to Voltas management, on account of a slowdown
in project award activity and the collapse of the Dubai residential market,
competition for projects has intensified over the last few quarters.
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