Havells : Philips Faces Weak Demand in European Lighting Business  Citi Research

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Havells India (HVEL.BO)
Alert:  Philips Faces Weak Demand in European Lighting
Business
 Weak demand in lighting business in Europe — Philips Electronics, one of the
leading players in the Europe lighting business, has issued a profit warning that weak
demand, especially in Western Europe, will affect results at its lighting and consumer
lifestyle arms. Phillips' lighting business is facing weak consumer demand and low
construction activity.
 Phillips guides to low single-digit growth in lighting business in 2QCY11 — It has
announced new management for lighting business. Additionally, Phillips will announce
further decisive actions shortly, including a company-wide cost reduction program as
part of the already launched ‘Accelerate’ performance improvement program.
 European lighting market remains slow — According to Citi European engineering
team, end-market recovery in lighting business remains slow. Please see
https://www.citigroupgeo.com/pdf/SEU40208.pdf
 Havells focusing on cash flows and profitability and not growth — European
business contributes ~30% of consolidated revenues and ~16%-19% of consolidated
EBITDA of Havells India.  Havells’ management has been focusing on improving cash
flow and profitability in European business and not driving growth. European operations
have undergone restructuring over the past 2-3 years, which has reduced fixed costs in
the business to help the business stay profitable despite a slowdown. Management
believes the Philips’ profit warning is more of an internal issue with Phillips and
does not impact Havells’ business plans in Europe.
 Well positioned to benefit from construction and consumer spending in India —
Havells enjoys healthy RoEs, a diversified business model, and a wide distribution
reach through 4,300 dealers and ~35,000 retail points across India.  A larger product
basket has enabled Havells to capture more of the dealer revenue pie, raising dealers’
dependence on Havells and creating entry barriers. The company’s financial strength
has enabled it to invest in brand building.
 Remain cautious, awaiting more clarity on European situation — Our target price
of Rs425 (India business valued at Rs384 at 15x Sep12EPS and Sylvania at Rs41 at
5.5xEV/E) captures these positives.  We remain cautious on the stock given macro
uncertainties and await further clarity on demand situation in Europe to become more
constructive on stock.
Havells India
Valuation
Our target price of Rs425 is based on a sum-of-the-parts approach. We value the India
business at Rs384 and Sylvania at Rs41. The parent business is valued at 15x Sep12E
P/E, at a slight premium to its historical average of 14x to reflect its brighter EPS and
ROE outlooks. The 15x P/E is supported by a ~20% EPS CAGR over FY11-14E and
~20% average RoE. P/E is generally used to value branded consumer and capital
goods companies, segments in which Havells operates. We value Sylvania on 5.5x
March 12E (low visibility beyond March 12) EV/EBITDA. Despite recovery in operations
and profitability, PAT is expected to remain depressed due to high depreciation and
interest costs and thus we prefer to use EV/EBITDA . We conservatively use 5.5x,
derived from a comps analysis and taking the European risks into consideration.
Risks
Our quantitative risk-rating system, which tracks 260-day historical share price volatility,
assigns a Low Risk rating to Havells. Upside risks to our target price include better
performance from Sylvania, lower commodity prices, successful new- product
launches, and a decline in competitive intensity