Havells India - Upgrade to ADD—driven by Sylvania.: Kotak Sec

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Havells India (HAVL)
Others
Upgrade to ADD—driven by Sylvania. The turnaround at Sylvania has been faster
than our expectations. We have increased our operating margin assumptions for Sylvania
led by: (1) Higher-than-expected sales growth and (2) appreciating home market currencies
(w.r.t. USD) which is driving down the material costs. We would have upgraded the stock
to BUY if the improved operating performance would have been driven by higher-thanestimated
sales vs part contribution on account of currency. We are upgrading the stock
to ADD with a DCF-based target price of Rs425.




Sylvania—driving our upgrade
We believe the factors which are driving the improving performance at Sylvania are:
Higher-than-expected sales growth led by emerging markets. The Latam and the Asian
geographies have grown at 36% yoy for the 1HFY11 which has compensated the weak
performance in the European region (sales down 4.2% yoy for 1HFY11). With growth momentum
set to continue in the future, emerging market revenues should move from 30% of the total
revenues in FY2010 to 45% in the next two years, in our view.
Incremental sales driving operating leverage. We have highlighted the expense structure of
Sylvania for 1HFY11 in Exhibit 1. As per our estimates, direct manufacturing costs form ~70% of
the sales for the half year. So, €100 of incremental sales would add €30 to EBITDA, as the company
derives operating leverage from employee expenses and admin costs, which would remain
constant. We note that operating leverage at Sylvania is partly driving higher margins trajectory.

Home market currencies appreciating w.r.t. USD. We believe that appreciation of home
market currencies (Euro, Real etc) w.r.t. USD is also partly driving the management’s guidance on
higher margin trajectory going forward. As bulk (~50%) of manufacturing is outsourced out of
China (currency pegged to USD), appreciation of home market currencies w.r.t. to USD would
have reduced material costs leading to higher margins. We believe that part of the benefit would
have been captured by Sylvania as it runs a branded business.

Adjust our estimates upwards for Sylvania; upgrade to ADD
We are adjusting our estimates on account of: (1) Higher margins in Sylvania. We have
moved our EBITDA margin assumptions from 4.8% and 6% to 6.5% and 8% for FY2011E
and FY2012E, respectively. Our margin assumptions are at the lower end of the
management guidance, and

(2) we have reduced the effective tax rate in Sylvania to account for tax savings in Europe
on account of carried forward losses. We maintain our estimates for the domestic business
and upgrade the stock to ADD with a DCF-based target price of Rs425 (Rs390 previously).