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UBS Investment Research
Voltas Ltd
A long-term structural story
„ A long-term structural story; present in infra-focused markets
We initiate coverage of Voltas, an Indian MEP (mechanical, electrical, plumbing)
contractor and air conditioner/refrigerator manufacturer. Voltas is highly leveraged
to infrastructure projects in the Middle East (ex-Dubai; 24% of EBIT in FY12E)
and India (20% of EBIT in FY12E). While H1 FY12 order flow/billing may be
muted, we believe improvements in the Middle East and North Africa (MENA)
and India could cause a significant re-rating of the share price. We estimate Voltas’
non-MEP business at 54% of EBIT in FY12.
„ Significant experience, brand, Tata management and execution ability
Tata’s controlling stake in Voltas, five decades of experience in MEP and
execution of landmark international projects are positives. Voltas’ execution ability
on integrated projects, local JVs, its presence in the high-growth air conditioner
and commercial refrigeration segments, and an agency business highly geared to
economic growth should support earnings growth, in our view.
„ EPS CAGR of 22% in FY11-13E; high return business
We forecast an EPS (excluding exceptionals) CAGR of 22% in FY11-13 and a
high ROIC of 36% in FY12, even after the recent easing. We are positive about its
asset-light business model, low leverage and Rs47bn order book (34% in India, the
rest in MENA) that has 1.5 years’ visibility. Strong growth of the non-MEP
business should continue and its contribution will rise, in our view.
„ Valuation: negatives priced in; Buy rating and Rs225.00 price target
We derive our price target from a DCF-based methodology and explicitly forecast
long-term valuation drivers using UBS’s VCAM tool. We assume a WACC of
12.52%. Near-term share price performance could be muted because of tensions in
the Middle East.
Investment Thesis
We initiate coverage of Indian MEP (mechanical, electrical, plumbing)
contractor and air conditioner/refrigeration manufacturer, Voltas, with a Buy
rating and a price target of Rs225.00, 23.5% above the current share price. While
the share price has corrected significantly because of tensions in the Middle East
and order flow/execution may be muted for some time, we believe capex
improvements in infrastructure-focused markets like MENA and India will cause
a significant share price re-rating, based on the company’s high growth potential
and superior returns.
We believe Voltas’ positives are a strong balance sheet (low leverage), asset-light
business model, a Rs47bn order book (34% in India, the remainder overseas—
largely Qatar and Abu Dhabi, which have been less affected by recent tensions in
the Middle East and North Africa (MENA)), strong growth of its non-MEP
business (55.5% of FY12E EBIT; we estimate market volume to grow at 25-30%
over the next three to five years) and international JVs. We expect one to two
quarters of muted results in Segment A (EMP), and would likely view any nearterm weakness in the share price as an attractive buying opportunity.
Voltas is a MEP contractor in India, the Middle East (no existing order book in
Dubai and possibly negligible receivables from previous projects), Singapore
and Hong Kong. It offers engineering solutions in heating, ventilation and air
conditioning (HVAC) and commercial refrigeration, it manufactures ACs and is
engaged in the agency business, mostly machinery (textiles, material handling,
construction and mining).
We believe Voltas is a long-term structural play on infrastructure-focused
markets like India (we estimate the infrastructure market is worth US$500bn
over five years in India, of which MEP is a major segment) and the Middle East
(according to Zawya, projects worth US$2.6trn are planned). Excluding Abu
Dhabi cancellations, it has no Dubai exposure). It also has exposure to the fastgrowing AC and commercial refrigeration market in India (a 25-30% volume
CAGR over the next three to five years).
While headwinds like political uncertainty in MENA, slower order flow and
execution, and higher working capital requirements exist, we think any
improvement from H2 FY12 in the spending environment in MENA and India
could cause the share price to rerate significantly. Tata’s controlling stake, five
decades’ experience in MEP and execution of landmark international projects
like the Ferrari F1 race track in Abu Dhabi are positives, in our view. We
estimate an EPS (excluding exceptionals) CAGR of 22% in FY11-13, assuming
a pick-up in order execution from H2 FY12, and a high ROIC of 36% even after
recent easing. After the significant share price correction (44% in the past few
months), we believe most negatives are priced in. Voltas trades at 17.6x FY12E
and 14.6x FY15.0E PE, a discount to the peer capital goods’ median and close
to its historical median range.
Key catalysts
Over the near to medium term, share price performance may be weak given
political uncertainty in MENA (24% contribution to EBIT in FY12E), slightly
slower domestic order execution (the company’s Indian MEP segment at 20% of
EBIT in FY12E), potential muted results (subsidiary Rohini Electricals’ gradual
breakeven and slower billing; Voltas gained a majority share on 31 August
2010) for one to two quarters and potential consensus downgrades (consensus
estimates and YoY growth rates seem to be high).
However, Voltas’ non-MEP revenue and EBIT should grow strongly. These
business segments relate to the fast-growing AC (durables), commercial
refrigeration and engineering product segments (at an average 56% of EBIT
through FY11-13E). Voltas is also present in the highly attractive infrastructurefocused markets of India and the Middle East, where spending should resume.
Hence we focus more on long-term catalysts and would likely view any near- to
medium-term weakness in the share price would be an attractive buying
opportunity. Voltas has a favourable balance sheet, one to two years of order
book visibility, a high ROCE and we forecast a 56% contribution from nonMEP businesses in FY11-13.
Q Improvement in Middle East and India project execution/awards.
Barring two quarters of muted order flow/execution, we expect a significant
increase in new orders. We base this on the US$2.6trn worth of projects
planned in the MENA region. We believe spending will return, especially
now that crude prices are favourable and the fiscal situation appears benign.
Also, we expect domestic capital and infrastructure spending to resume over
the medium term. We believe the above will be the biggest catalysts for a
significant share price rerating after the sharp correction of the past few
months
Q Ongoing strong performance of the unitary cooling segment. Comprising
ACs and commercial refrigeration products, we forecast the segment is on a
fast-growth trajectory of 25-30% YoY volume growth over the next three to
five years. The growth in consumption, aspirations and the middle class as
well as rapid urbanisation coupled with agricultural growth should offer
support. Any progress and implementation of proposals contained in the
recent Budget to support cold chains will strengthen the segment, in our view.
Q Diversification of end markets—focus on the infrastructure and
industrial segments could facilitate order book growth at a time when
commercial activity is subdued over the near to medium term.
Q High returns due to asset-light business model and working capital
management. We believe Voltas’ corporate governance is perceived
favourably by investors (Tata management). Historically, Voltas has reported
extremely high ROCE. Even after cautiously assuming some decline over
our forecast period on a changed business environment, returns should still
be higher compared to most global capital goods/infrastructure companies.
We believe this will enhance investor sentiment and interest in the company.
Risks
Q Any significant political volatility in the Middle East and extended delays in
project execution in India. The EMP (electro-mechanical project) segment in
the Middle East and India is a significant revenue and earnings contributor.
We take comfort from the fact that all its Middle East order book is in Qatar
and UAE (nothing in Dubai), where the environment is relatively more stable.
Any severe geopolitical tensions in MENA and across the region will put the
order book and execution at risk. Also, any longer-than-expected delays in
infrastructure projects could impact our FY12 estimates.
Q Volatile currency and commodity prices could impact margins, as almost 30-
35% of the top line is denominated in foreign currency (US$, Dh, QIR) and
most international contracts are lump-sum. However, Voltas does book 90%
of raw material costs when a project is awarded.
Q Higher-than-expected working capital requirements and unattractive
payment terms for new projects could hamper returns and stretch the
company’s balance sheet. We understand that contracts in MENA have
incrementally moved from a cost-plus basis to fixed priced.
Q Higher competition and limited product differentiation; many MNCs are
planning to enter the MEP segment and competition is likely to be higher in
the Middle East after the collapse of the Dubai property market. However,
we expect Voltas’s brand and experience to partly benefit new order wins. In
the AC segment, most products are now “Energy Rated”, limiting product
differentiation.
Valuation and basis for our price target
We derive our price target from a DCF-based methodology and explicitly
forecast long-term valuation drivers using UBS’s VCAM tool. We believe DCF
captures Voltas’ long-term growth potential in infrastructure-focused markets
like India and the Middle East. However, to account for the geopolitical
environment in the Middle East, we assume a high WACC of 12.52%, higher
than that assumed for capital goods and construction companies under our
coverage.
Over the next few years, we forecast a sharper increase in working capital due to
possible slower payments and thereon growth in free cash flow to normalise.
Given that MEP is an asset-light business and typically has higher ROCE than
construction, we expect high ROCE over our forecast horizon. However, note
that we assume ROCE to have eased from the high levels of FY10.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
UBS Investment Research
Voltas Ltd
A long-term structural story
„ A long-term structural story; present in infra-focused markets
We initiate coverage of Voltas, an Indian MEP (mechanical, electrical, plumbing)
contractor and air conditioner/refrigerator manufacturer. Voltas is highly leveraged
to infrastructure projects in the Middle East (ex-Dubai; 24% of EBIT in FY12E)
and India (20% of EBIT in FY12E). While H1 FY12 order flow/billing may be
muted, we believe improvements in the Middle East and North Africa (MENA)
and India could cause a significant re-rating of the share price. We estimate Voltas’
non-MEP business at 54% of EBIT in FY12.
„ Significant experience, brand, Tata management and execution ability
Tata’s controlling stake in Voltas, five decades of experience in MEP and
execution of landmark international projects are positives. Voltas’ execution ability
on integrated projects, local JVs, its presence in the high-growth air conditioner
and commercial refrigeration segments, and an agency business highly geared to
economic growth should support earnings growth, in our view.
„ EPS CAGR of 22% in FY11-13E; high return business
We forecast an EPS (excluding exceptionals) CAGR of 22% in FY11-13 and a
high ROIC of 36% in FY12, even after the recent easing. We are positive about its
asset-light business model, low leverage and Rs47bn order book (34% in India, the
rest in MENA) that has 1.5 years’ visibility. Strong growth of the non-MEP
business should continue and its contribution will rise, in our view.
„ Valuation: negatives priced in; Buy rating and Rs225.00 price target
We derive our price target from a DCF-based methodology and explicitly forecast
long-term valuation drivers using UBS’s VCAM tool. We assume a WACC of
12.52%. Near-term share price performance could be muted because of tensions in
the Middle East.
Investment Thesis
We initiate coverage of Indian MEP (mechanical, electrical, plumbing)
contractor and air conditioner/refrigeration manufacturer, Voltas, with a Buy
rating and a price target of Rs225.00, 23.5% above the current share price. While
the share price has corrected significantly because of tensions in the Middle East
and order flow/execution may be muted for some time, we believe capex
improvements in infrastructure-focused markets like MENA and India will cause
a significant share price re-rating, based on the company’s high growth potential
and superior returns.
We believe Voltas’ positives are a strong balance sheet (low leverage), asset-light
business model, a Rs47bn order book (34% in India, the remainder overseas—
largely Qatar and Abu Dhabi, which have been less affected by recent tensions in
the Middle East and North Africa (MENA)), strong growth of its non-MEP
business (55.5% of FY12E EBIT; we estimate market volume to grow at 25-30%
over the next three to five years) and international JVs. We expect one to two
quarters of muted results in Segment A (EMP), and would likely view any nearterm weakness in the share price as an attractive buying opportunity.
Dubai and possibly negligible receivables from previous projects), Singapore
and Hong Kong. It offers engineering solutions in heating, ventilation and air
conditioning (HVAC) and commercial refrigeration, it manufactures ACs and is
engaged in the agency business, mostly machinery (textiles, material handling,
construction and mining).
We believe Voltas is a long-term structural play on infrastructure-focused
markets like India (we estimate the infrastructure market is worth US$500bn
over five years in India, of which MEP is a major segment) and the Middle East
(according to Zawya, projects worth US$2.6trn are planned). Excluding Abu
Dhabi cancellations, it has no Dubai exposure). It also has exposure to the fastgrowing AC and commercial refrigeration market in India (a 25-30% volume
CAGR over the next three to five years).
While headwinds like political uncertainty in MENA, slower order flow and
execution, and higher working capital requirements exist, we think any
improvement from H2 FY12 in the spending environment in MENA and India
could cause the share price to rerate significantly. Tata’s controlling stake, five
decades’ experience in MEP and execution of landmark international projects
like the Ferrari F1 race track in Abu Dhabi are positives, in our view. We
estimate an EPS (excluding exceptionals) CAGR of 22% in FY11-13, assuming
a pick-up in order execution from H2 FY12, and a high ROIC of 36% even after
recent easing. After the significant share price correction (44% in the past few
months), we believe most negatives are priced in. Voltas trades at 17.6x FY12E
and 14.6x FY15.0E PE, a discount to the peer capital goods’ median and close
to its historical median range.
Key catalysts
Over the near to medium term, share price performance may be weak given
political uncertainty in MENA (24% contribution to EBIT in FY12E), slightly
slower domestic order execution (the company’s Indian MEP segment at 20% of
EBIT in FY12E), potential muted results (subsidiary Rohini Electricals’ gradual
breakeven and slower billing; Voltas gained a majority share on 31 August
2010) for one to two quarters and potential consensus downgrades (consensus
estimates and YoY growth rates seem to be high).
However, Voltas’ non-MEP revenue and EBIT should grow strongly. These
business segments relate to the fast-growing AC (durables), commercial
refrigeration and engineering product segments (at an average 56% of EBIT
through FY11-13E). Voltas is also present in the highly attractive infrastructurefocused markets of India and the Middle East, where spending should resume.
Hence we focus more on long-term catalysts and would likely view any near- to
medium-term weakness in the share price would be an attractive buying
opportunity. Voltas has a favourable balance sheet, one to two years of order
book visibility, a high ROCE and we forecast a 56% contribution from nonMEP businesses in FY11-13.
Q Improvement in Middle East and India project execution/awards.
Barring two quarters of muted order flow/execution, we expect a significant
increase in new orders. We base this on the US$2.6trn worth of projects
planned in the MENA region. We believe spending will return, especially
now that crude prices are favourable and the fiscal situation appears benign.
Also, we expect domestic capital and infrastructure spending to resume over
the medium term. We believe the above will be the biggest catalysts for a
significant share price rerating after the sharp correction of the past few
months
Q Ongoing strong performance of the unitary cooling segment. Comprising
ACs and commercial refrigeration products, we forecast the segment is on a
fast-growth trajectory of 25-30% YoY volume growth over the next three to
five years. The growth in consumption, aspirations and the middle class as
well as rapid urbanisation coupled with agricultural growth should offer
support. Any progress and implementation of proposals contained in the
recent Budget to support cold chains will strengthen the segment, in our view.
Q Diversification of end markets—focus on the infrastructure and
industrial segments could facilitate order book growth at a time when
commercial activity is subdued over the near to medium term.
Q High returns due to asset-light business model and working capital
management. We believe Voltas’ corporate governance is perceived
favourably by investors (Tata management). Historically, Voltas has reported
extremely high ROCE. Even after cautiously assuming some decline over
our forecast period on a changed business environment, returns should still
be higher compared to most global capital goods/infrastructure companies.
We believe this will enhance investor sentiment and interest in the company.
Risks
Q Any significant political volatility in the Middle East and extended delays in
project execution in India. The EMP (electro-mechanical project) segment in
the Middle East and India is a significant revenue and earnings contributor.
We take comfort from the fact that all its Middle East order book is in Qatar
and UAE (nothing in Dubai), where the environment is relatively more stable.
Any severe geopolitical tensions in MENA and across the region will put the
order book and execution at risk. Also, any longer-than-expected delays in
infrastructure projects could impact our FY12 estimates.
Q Volatile currency and commodity prices could impact margins, as almost 30-
35% of the top line is denominated in foreign currency (US$, Dh, QIR) and
most international contracts are lump-sum. However, Voltas does book 90%
of raw material costs when a project is awarded.
Q Higher-than-expected working capital requirements and unattractive
payment terms for new projects could hamper returns and stretch the
company’s balance sheet. We understand that contracts in MENA have
incrementally moved from a cost-plus basis to fixed priced.
Q Higher competition and limited product differentiation; many MNCs are
planning to enter the MEP segment and competition is likely to be higher in
the Middle East after the collapse of the Dubai property market. However,
we expect Voltas’s brand and experience to partly benefit new order wins. In
the AC segment, most products are now “Energy Rated”, limiting product
differentiation.
Valuation and basis for our price target
We derive our price target from a DCF-based methodology and explicitly
forecast long-term valuation drivers using UBS’s VCAM tool. We believe DCF
captures Voltas’ long-term growth potential in infrastructure-focused markets
like India and the Middle East. However, to account for the geopolitical
environment in the Middle East, we assume a high WACC of 12.52%, higher
than that assumed for capital goods and construction companies under our
coverage.
Over the next few years, we forecast a sharper increase in working capital due to
possible slower payments and thereon growth in free cash flow to normalise.
Given that MEP is an asset-light business and typically has higher ROCE than
construction, we expect high ROCE over our forecast horizon. However, note
that we assume ROCE to have eased from the high levels of FY10.
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