"One CG. Fast CG. Lean CG."
FY12 Annual Report suggests several operational initiatives
FY12 performance impacted by various cyclical and structural factors
CG Global Overseas: Low cost locations witness revenue decline; Belgium / Canada /
Hungary report sharp profitability decline
Key Growth Drivers: Renewables / turnkey projects, industry segment - integration
motors with drives and increased internationalization, expanding automation footprints.
Valuation and view: We arrive at price target of INR154 (up 19% YoY), based on 12x
FY14 PER (standalone) and 8x EV/EBITDA FY14 (overseas). Maintain Neutral.
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"One CG. Fast CG. Lean CG."
FY12 saw focused organizational attention on the creation of:
One CG to leverage the right resources and skills to produce the best possible
product or solution for selling anywhere. This will ensure that the DNA of
selling must be one where customers come first, not where the factory is.
Fast CG i.e. restructuring of the operations into six geographic areas and also
business verticals - resulting in quick reaction to business opportunities.
Lean CG i.e. global best practices in sourcing, manufacturing, etc.
Over the years, CG has transformed from being largely an India oriented player
to Indian corporation with an international business. The attempt now is to make
a full transformation to a global corporation (also see Chairman's letter, page 9).
FY12 performance impacted by various cyclical and structural factors
Management summarized that FY12 performance was impacted by (1) intensified
global competition, (2) increased RM costs, (3) customers postponing deliveries,
and (4) internal issues. Many of these factors are cyclical, and may start turning
around from 2HFY13; continued global uncertainties and liquidity issues, coupled
with permanent price erosion in several segments remain overhangs.
Consumer business (19% of consolidated revenues) was impacted by poor market
growth in pumps (down 8%) and fans (down 2%), while Appliances are yet to
make a significant mark (6% contribution). Industrial business (16%) caters to
end-use segments like railway, cement, power, water and irrigation, many of
who face headwinds (order book down 11% YoY in FY12).
For CG Global, FY12 consolidated revenue was up 12% YoY given strong growth in
North America (up 46% YoY, driven by renewables) while Asia (ex India) was
most impacted (revenues down 27% YoY) because of slower offtake by customers.
CG Global Overseas: Low cost locations see revenue decline; Belgium,
Canada, Hungary report sharp profitability decline
Analysis of the 'Information in respect of subsidiary companies' indicate that
FY12 revenues in Belgium were stagnant, while PBT declined from INR1.5b in
FY11 to loss of INR420m. Canada, France and Hungary witnessed revenue decline
of 26%, 34% and 20% respectively, with sharp contraction in profitability.
The manufacturing footprint also got distorted - the factories in Belgium (high cost)
had large order books, whereas those in Hungary (low cost) witnessed slowdown.
FY12 US revenue grew 64%, increasing its share of revenue to 24%
v/s 17% in FY11 and 12% in FY10. Indonesia was the key exception which reported a
26% revenue growth crossing USD100m in sales for the first time; and order intake
stood at USD133m. Sharp contraction in FY12 profitability in Hungary is a surprise.
We calculate that for the overseas business, ~75% of the manufacturing footprint is
in high cost locations. Setting up of manufacturing plant at Brazil, and plans to
expand capacities in India and Hungary coupled with deeper customer interface
through "One CG. Fast CG" are attempts to correct the existing structure.
Key growth drivers: Increased traction in renewables / turnkey projects,
industry segment
Renewable segment contributed ~37% of CG Global overseas revenues in FY12.
Market share in offshore wind transformers stood at 51% (up from 42% YoY) and
4.2% in systems (up from nearly zero 3 years back). During FY12, CG Power entered
solar market and now has a 5.9% market share in USA. Contribution of turnkey
projects also increased, with contract revenues now contributing 16% of the
consolidated revenues (up from 7.5% YoY).
Railways and Oil & gas are important growth drivers, and the management stated
that a tentative order pipeline of USD150m has been developed in Oil & gas (new
segment). While these initiatives have led to increased order intake, we believe
profitability in system / turnkey projects (~23% of overseas revenues and 18% of
standalone intake) is lower than in products, and will impact the pace of margin
expansion going forward. We await further understanding on the same. Other key
growth drivers include: integration of motors with variable speed drives and
expanding footprint in automation.
Valuation and view
We expect CRG to report consolidated EPS of INR8.7/sh in FY13 (up 51% YoY) and
INR11.9/sh in FY14 (up 36% YoY. Correcting the manufacturing footprint and
internationalization of industrial business are important drivers, in our opinion.
We arrive at price target of INR154 (upside of 19% YoY), based on 12x FY14E PER
(standalone) and 8x EV/EBITDA FY14 (overseas). Maintain Neutral.
FY12 impacted by various cyclical and structural factors
Management summarized various reasons that impacted FY12 performance
#1 Intensified Global Competition
In the last 18 months, power equipment prices came under severe pressure with many
Chinese and South Korean manufacturers offering rock-bottom quotes.
The good news is that such intense competition may have passed. Buyers have understood
which players can deliver quality, and those who cannot.
Equally, it is important to note that no power equipment manufacturer or solutions provider
will enjoy the kind of prices and margins that were the norm for half a decade leading up to
FY10.
#2 Increased raw material costs
Raw material cost increased at rates much higher than finished goods prices, especially for
copper and steel.
It looks as if the growth in Material to Sales ratio has played out, and there are beginnings
of a moderate decline in the ratio.
#3 Customers postponing delivery given uncertainties and cash problems
Many power T&D customers were not taking delivery of their transformers or sub-stations,
usually on account of uncertainties and also cash problems.
This was particularly true in Europe and North America; blocked scarce factory space, did
not allow for revenue recognition, and extended the working capital cycle.
#4 Internal Issues
Internal issues regarding work flow at some facilities, including sudden spike in the
percentage of test bay problems as well as major re-work of power transformers, especially
in Belgium and Canada, leading to higher costs.
From 4QFY11 and through the first three quarters of FY12, these led to blocking of lines and
higher costs, which affected EBIDTA.
The problems have been identified and should be also under control by the middle of FY13.
Positives for FY13
The positive for FY13 are moderation in competitive intensity, decline in raw material
costs and possible addressing of internal issues in Belgium / Canada. Given the lead
time, we believe that the benefits from several of these positives will be more felt in
2HFY13, possibly leading to a gradual improvement in business.
However, continued global uncertainties and liquidity issues, coupled with permanent
price erosion in several products continue to remain an overhang for a sharp rebound
in business dynamics.
CG Power Overseas witnessed sharp margin contraction in FY12
During FY12, overseas business witnessed a sharp margin contraction largely given
delivery delays by customers, write-down of inventory, losses on projects in US, and
liquidity issues in Europe.
Key growth drivers: Traction in renewable/turnkey projects
Driver #1: Renewables - gaining traction
CRG is the global market leader in offshore wind transformer applications. Its market
share has increased from 42% in FY10/11 to 51% in FY12. CRG has also successfully
forayed into turnkey solutions for the renewable segment in Western Europe, post
completion of its maiden project of designing and building the transmission grid
connection offshore windpark 'Belwind' (165MW) into the coastal waters of Belgium
in September 2010. Over the last 10 months, it has received 4 new projects (1,000MW+),
leading to strong traction in order intake for CG Global. From a zero base 3 years ago,
CRG now accounts for 4.2% of the global offshore wind market in systems, and the
management expects this share to increase in future.
In USA, CRG is already a market leader having inter-connected 23% of the wind capacity
to the grid. During FY12, CG Power also entered the solar renewables market. Two key
orders received are from First Solar USA worth EUR19.5m and SMA worth EUR5m.
These orders have provided CG a 5.9% market share in overall US solar market, and
23.5% of the US solar utility market.
The renewable segment contributed EUR270m of revenues in FY12 (~37% of CG Global
overseas revenues); at end FY12, a renewable project pipeline of EUR214m was in
place which includes wind (EUR148m) and solar (EUR66m). For CG Global Overseas,
renewables contribute ~37% of revenues in Europe and ~45-50% of revenues in USA.
Wind Power: Turnkey projects drive order intake, strong traction witnessed
In July 2012, CRG received a 216MW offshore wind installation contract; and is the
fifth contract for CRG, following the earlier Belwind Phase 1, EON Amrumbank West,
WPD Butendiek and EON Humber Gateway contracts.
Extract from Chairman's letter
Where do we go from here?
More needs to be done. Motors need to be integrated with
variable speed drives. We must rapidly expand our footprint
in automation. We must leverage R&D more than ever before.
All this requires us to completely eschew notions of
geographic and plant-centric silos.
Your Company has to be 'One CG' - which leverages the
right resources and the right skills to produce the best
possible product or solution for selling anywhere. The
DNA of selling must be one where the customers come
first; not where the factory is.
Your Company has to be a 'Fast CG'. Businesses come
from geographic regions. Therefore, your Company has
been restructured according to six areas: South East Asia,
India, Middle East and Africa, Europe and Russia, North
America and Latin America. Businesses come from
different sectors. Consequently, CG is also being
organized along clearly defined business verticals such
as renewables, oil and gas and mining, both within and
across the SBUs. 'Fast CG' requires your Company to
react very quickly to the business opportunities - be these
geographic or sector-specific - and allocate the task of
execution to the team or plant that can best do it, and as
quickly as it can.
'Lean CG' requires global best practices in sourcing;
outstanding shop-floor capabilities and processes;
significant increases in manufacturing efficiency and
throughput; plus substantial improvements in key
capacities, whether these be through new greenfield
facilities or via acquisitions.
Have we got there yet?
The answer is 'No'. But I am convinced, along with your
Board of Directors and your Company's senior management
team that no effort will be spared to create a well-oiled
customer delighting CG - one that supplies solutions, systems
and products in a seamlessly unified manner across the
globe. The change has already begun. It will take some time
but we will get there.
Why am I so hopeful?
Because I have closely seen the sea changes that have
occurred within your Company even in the last decade -
when it transformed from being a largely India-oriented
player to an Indian corporation with an international
business.
We now need to make the full transition to being a global
corporation that is respected by its customers and peers. I
have witnessed what your Company's employees are capable
of delivering. I have seen how they can collaborate and
innovate to produce successes. And I have seen their pride
and hunger for winning. So, I have little doubt that we will
be able to successfully execute 'One CG. Fast CG. Lean CG'.
While FY2012 was a difficult year, the remodeling has begun.
Bear with CG, because the platform for creating a global
enterprise has commenced. One that will make all of us
prouder than ever before.
Driver #3: Integrated solutions (railways) and new business (Oil & gas)
1. Railways: CG has a product portfolio that is widely used by Railways. Power Systems
supplies trackside and loco transformers and switchgears, which are critical in
regulating the voltage level of motors used in electric locomotives & railway
electrification networks. Industrial Systems supplies traction motors, alternators,
control electrics/electronics, point machines, signaling relays and coach products
which are used in locomotives, driver consoles, signaling and track switching
operations. The recent entrant to the CG Group, CG Automation US (formerly QEI)
is an experienced supplier of SCADA systems, used by transportation utilities for
maintaining traction power and managing rail traffic. Aggregated, CG supplies a
gamut of products which can start, control and stop a train.
2. Oil & gas: The business started in 2HFY12 for CRG, and has had an encouraging
beginning. In the course of four months, a tentative order pipeline of EUR150m
has been developed. The requisite sales infrastructure is being set up in various
locations, such as at Houston, the Middle East and Asia. The company is working
medium- and low-voltage transformer space to:
(i) offer a larger suite of products to oil & gas majors and international EPC players,
and
(ii) access major oil and gas markets in the USA, Russia, the Caspian and the Middle
East.
CRG products from India and Indonesia are in the process of being prequalified
for oil & gas end-users and global EPC contractors. The management expects to
see good results from this vertical in the years to come.
Medium-term guidance: 450bp profitability improvement in 3 years
In May 2012, management stated that a three-year strategy to improve profitability is in
place. This includes four focus areas, which should result in EBITDA margin expanding 450bp
over the next three years (possible expansion in EBITDA margin from 7.1% in FY12 to ~11.5%
by FY15).
1. Improved offerings, largely towards high technology/high voltage products including
EHV segment and building up service business portfolio, penetration into new geographies
like Middle East, Brazil, etc. should have a 150bp impact on EBITDA margin.
2. Rationalization of raw material sourcing and focus on low cost countries including
China will lead to 150bp improvement in EBITDA margin.
3. Change in manufacturing footprint, with rationalization of capacity utilization in
European factories and capacity expansion from 85,000MVA to 140,000MVA (+50,000MVA
incremental capacity in India) over the next three years will result in 100bp expansion in
EBITDA margin.
4. Improvement in manufacturing processes by way of implementation of Six Sigma and
sustainability programs across factories will result in 50bp improvement in EBITDA
margin.
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