Crompton Greaves : 1x1 with Mr. Demortier, MD & CEO, CG ::JPMorgan

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Crompton Greaves Limited Underweight
CROM.BO, CRG IN
1x1 with Mr. Demortier, MD & CEO, CG


 We met Mr. Laurent Demortier who assumed office as MD & CEO of
CG in Jun-11. He stated that the sharp cut in margin outlook for FY12 was
a function of change in market dynamics – (1) pressure on pricing and cost
in the domestic market and (2) pressure on volumes overseas. Orders
booked over the past 3Qs in an intensely competitive and volatile
commodity price environment were low margin. As per management, the
downward pressure on profitability is a structural shift and is likely to
continue, implying that margins may not recover to historical levels.
We maintain our estimates, factoring in EBITDA margin dip of ~450bps
in FY12, followed by a recovery of only ~110bps in FY13.
 More color on segment performance. Management was confident of
meeting topline guidance of 8-10% growth in FY12, based on the ~Rs71bn
order backlog. A few significant comments - (1) Overseas subs: Sales to a
few countries like Libya, Algeria, Morocco and Tunisia were suspended in
Jun-q, which led to build up of inventory. The unsold products are now
being sold in the spot market at weak margins. Overall view on overseas
business was that pricing is likely to remain stable though volume growth
may be weak to allow only ~5% YoY growth in Euro terms in FY12. (2)
Domestic power segment: Severe pricing pressure owing to competition
heightened by Chinese/Korean players. According to management CG has
26% market share on substation products with PGCIL and they intend to
step up presence as a turnkey substation player. Mr. Demortier stated that
the real opportunity lies in using India as a low-cost manufacturing hub to
supply overseas. However this will require CG’s domestic factories to be
certified in developed markets and the process could take around one year;
(3) Consumer segment: Amid rising interest and RM cost, CG had
attempted to pass-on increase in costs to dealers in Mar-11. As Jun-q results
show (2% YoY topline growth) this had a heavily negative impact and CG is
now re-negotiating its supply agreements, as per management; (4) Industry
segment: Topline growth has been strong in the Jun-q (~18%), however
interest cost pressures could impact on industrial capex.
 Vision 2015 scaled down? Management stated that CG’s current vision is to
become a US$4.5bn revenue company by 2015, implying revenue CAGR of
~15% thru FY16 (vs. our est. of 12%). This is a scale down of earlier vision
to grow revenues to US$8bn, maintained since 2005. Our reading from the
interaction is that management intends to make a fresh start on the base
of realigned expectations in tune with the current market situation.
 We maintain UW recommendation on the stock. Post results, we
downgraded the stock (see note Transition pain or transitory pain?) and the
street cut FY12 EPS to ~Rs10.2 (down ~36%, as per Bloomberg). The stock
is trading between 17.3-19.6x FY12 earnings based on consensus and J.P.
Morgan estimates. We expect the sharp deterioration in profitability to lead
the P/E-derating. Over the past three years (pre estimate cuts) the stock has
traded at 14.5x avg. 1-yr forward P/E.