Crompton Greaves - Downgrade to N: Profit warning too big too late::HSBC Research,

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Crompton Greaves (CRG IN)
Downgrade to N: Profit warning too big too late
 Little clarity on the abruptness of margin decline; visibility
on recovery, if any, remains opaque
 Guidance lowered too late; investors’ confidence shaken
 We lower our FY12/13e EPS by c43%/c32%, reduce TP to
INR205 (from INR 330) and downgrade the stock to N from OW
Crompton Greaves reported a very weak set of numbers on 19 July, missing Q1 sales
estimates by c7%, EBITDA by c45% and EPS by c64%. The EBITDA margins
disappointed significantly and came in at c7.5% vs. consensus expectations of c12.5%. In
addition, at INR110m, the interest expense also came in ahead of expectations and an
increase in tax rate to c37.9% added further pressure on the bottom line. Consequently, the
EPS of INR1.2 declined by c58% y-o-y.
Decline in margins a key concern; visibility remains opaque. While decline in margins
was broad-based, it was acute in Power Systems (c800bps decline y-o-y). Mgmt attributed
this to 1) lower volumes, 2) disruption in Middle East, and 3) pricing pressure in
domestic. While these factors somewhat explain the pressure on margins, they do little to
justify the abruptness and the scale of margin decline, particularly as some of these drivers
are not new. In addition, these factors are persistent in nature and cannot be seen as one
off. Hence, in the absence of a credible guidance, it remains difficult to gauge whether
margins will at all return to the levels of c13-14%.
Guidance lowered sharply; market confidence seems shaken. Mgmt has lowered their
FY12 guidance of sales growth to c10-12% from c13-14% and EBITDA mgn to c8-10% from
c13-14%. Given that new growth guidance is only marginally lower, the abruptness of the
steep revision in margin guidance is difficult to understand, particularly as equipment
manufacturers typically have some visibility on profitability levels embedded in their order
book. In addition, we believe that due to the lack of any apparent one-off reason for
deterioration in Q1 earnings, market is likely to be sceptical about the new guidance.
We lower our FY12/13e EPS by c43%/c32%. Crompton has guided for continued EPS
growth in FY12, which we believe is unlikely given their bearish guidance on order intake,
sales growth and EBITDA margins. For FY12, we have lowered our estimate for sales growth
to c10.8%, EBITDA margin to c8.9% and EPS to cINR9.2 from c15.1%, c13.8% and
cINR16.2 previously. We expect growth to resume in FY13 and forecast an EPS of INR12.7.
Stock tumbles c27% post results, doesn’t look inexpensive; d/g to Neutral. On our new
est., the stock is currently trading at c19.3x FY12e PE and c13.9x FY13e PE. The 12 month
fwd PE is c17.9x vs. historical average of c18.3x. Given that growth will resume only in FY13,
where visibility remains opaque, we believe the market will likely give a much lower multiple
to this expected growth. Hence, we would expect the stock to de-rate further. Consequently,
we lower our TP on CRG to INR205 (INR330 earlier) and downgrade the stock to Neutral
from OW. Our TP implies a 12m fwd target multiple of c15.2x vs. c16.9x earlier.