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Industrials
India
Sharp price run-up takes away valuation argument; business remains weak. We
had recently upgraded industrial stocks (Thermax, Voltas and Crompton on Dec 22,
2011) on valuation argument. The recent run-up has largely taken away the valuation
argument with business conditions still being weak. We correspondingly downgrade
Thermax and Voltas to REDUCE (from ADD) and Crompton to ADD (from BUY).
Business conditions remain weak and pick-up, if any, would be gradual, exposing stocks
to risks of disappointment. Reiterate REDUCE on L&T with an unchanged TP of Rs1,175.
Sharp price run-up (of 15-30%) prompts re-evaluation of opportunities and risks
We note a sharp price rally across industrials stocks (Thermax, Voltas and Crompton) to the tune of
15-30% in the past few weeks. The stocks have also significantly outperformed relative to the
market (Sensex). This is in the face of persistent weaknesses in the business environment related to
industrials capex cycle, high competitive intensity etc.
Business commentary remains weak; sequential pick-up may be very gradual
Recent interactions with several companies reflect weak business environment with (1) sharp decline
in ordering activity to the tune of 30-50% and (2) rising competitive intensity squeezing margins.
This feedback pertains to recent past; it is still a medium-term indicator, as sequential pick-up may be
slow. Structural (clearances, land acquisition, fuel) and cyclical issues would alleviate gradually only.
Thermax (TP: Rs440): Downgrade on strong outperformance and weak peer commentary
Downgrade Thermax to REDUCE (from ADD) on (1) strong recent stock performance (trades at
15X FY2013E EPS, 3.1X P/B with an RoE of 22%), (2) potential disappointment in order booking
traction; we build 10% decline in inflows versus commentary of 30-50% decline from peers
(Cethar)/ecosystem companies (Triveni turbines), (3) continued margin pressures and (4) strong
operating performance so far; creates possibility for significant underperformance against high
expectations.
Voltas: REDUCE as cost escalations continue to hurt with other segments also under pressure
Downgrade Voltas to REDUCE (TP: Rs90) from ADD on recent sharp outperformance (trades at
11X FY2013E EPS, 1.6X P/B with an RoE of 16%) while business environment remains challenging
for (1) cost escalation issues in ME projects adversely impacting near-term margins, (2) likely lower
margins in consumer business, especially with high inventory, higher prices by Chinese suppliers,
depreciating Rupee and weak demand milieu and (3) lack of visibility on agency business as well.
Downgrade Crompton to ADD (from BUY) with a revised target price of Rs155/share
Downgrade CRG to ADD (from BUY) with a revised TP of Rs155 (from Rs135) based on 15X
FY2013E EPS (from 13X). The stock is currently trading at 13.2X FY2013E EPS and P/B of 2X with
an RoE of 16.5%. Key risks relate to (1) weakness in consumers segment on demand slowdown,
margin pressures on Rupee depreciation, (2) potential slowdown in industrials segment and (3)
lack of expected stability in domestic power and improvement in overseas power business.
Reiterate REDUCE on L&T with an unchanged target price of Rs1,175/share
Reiterate REDUCE on (1) weak capex cycle impacting quality and quantity of inflows, (2) potential
earnings disappointment led by execution and margins, (3) rising competition across sectors, (4)
L&T size (Rs800 bn inflows in FY2011) implies that several sectors have to be in momentum for
business to grow and (5) investments in BOT assets potentially at lower returns. L&T currently
trades at 14.7X FY2013E EPS (12.7X standalone P/E adjusted for subs), 2X P/B with RoE of 16.4%.
Sharp price run-up (of 15-30%) prompts re-evaluation of opportunities and risks
We note sharp price rally across industrials stocks (Thermax, Voltas, Crompton) to the tune
of 15-30% in the past few weeks. Crompton stock price has run up by about 25% since
Dec 21, 2011, Thermax by 20% and Voltas has risen by about 8% during the same period.
Apart from the absolute price run-up, the stocks have also significantly outperformed
relative to the market (Sensex).
This is in the face of persistent weakness in the business environment related to industrials
capex cycle, high competitive intensity etc. We re-evaluate our stance on these companies
given the potential opportunities and risks.
Broadly negative feedback from interactions with various companies
Our recent interactions with several companies broadly reflected weak business environment
related to investment activity, slowdown in order inflows, competitive intensity etc. Key
takeaways include:
Areva T&D. Areva T&D management cited weak demand from private industrial and
private utility segments as well as from SEBs. While strong ordering activity from PGCIL
was a saving grace, this may also weaken going forward as (1) increased ordering activity
in FY2012 being the final year of the plan period and (2) weak generation sector capex
activity to eventually affect T&D sector capex as well.
Cethar Vessels. The company management highlighted sharp decline in order booking
(likely to book only Rs4-5 bn of order inflows in FY2012E versus initial expectations of
Rs15 bn). The company also cited increased competition from smaller players including
players that have JV with Chinese players. Such players have been winning larger
proportion of deals versus earlier.
Triveni Turbines. In its 3QFY12 results conference call, Triveni Turbines’ management
cited a contraction in ordering activity by 30% in the sub-30 MW steam turbines segment
and a 50% decline for 30-100 MW steam turbines. The company is actively looking
towards international markets for growth opportunities/ to offset slowdown in the
domestic market.
Prasha Technologies. One of the genset OEMs (For Ashok Leyland, Mahindra Navistar
and Perkins) based in Northern India suggested that his business may be down about 40-
50% on a yoy basis on back of weak demand conditions. Spurt in demand witnessed in
the past few years, particularly led by telecom players, has corrected over the past few
quarters on the back of (1) slower rollout of incremental telecom towers and (2) lower
power consumption.
Powerica. Genset OEM for Cummins highlighted weak demand, thus missing its target
for FY2012E. However, the company highlighted some sequential pick-up in the month
of December versus a very weak period between July and November 2011.
Thermax: Downgrade on strong outperformance, fear of prolonged slowdown
We downgrade our rating on Thermax to REDUCE (from ADD) based on (1) strong stock
performance over the past few weeks, leaving limited upside to our target price (trades at
15X FY2013E EPS, 3.1X P/B with an RoE of 22%), (2) potential disappointment in order
booking traction; we build 10% decline in inflows versus commentary of 30-50% decline
from peers (Cethar)/ecosystem companies (Triveni turbines), (3) continued margin pressures
and (4) strong operating performance so far; creates possibility for significant
underperformance against high expectations.
We retain our estimates of Rs32.8 and Rs31.4 for FY2012E and FY2013E, respectively and
our target price of Rs440/share based on 14X FY2013E EPS.
Weak commentary from peers (Cethar Vessels) related to order inflow traction and
competitive intensity
Our recent call with the management of Cethar Vessels indicated weak takeaways for
Thermax with respect to potential slowdown in order inflows and a stiff competitive
environment. Key takeaways from the call included:
Sharp slowdown even in base orders as IPP orders remains absent; increased
competition further reducing share. Cethar Vessels expected about Rs15 bn of base
order inflows in FY2012E (Rs12 bn in FY2011) and is likely to close the year with only Rs4-
5 bn worth of base order inflows. The company also cited increased competition from
smaller players, including players that have JV with Chinese players.
Lower execution and order inflows to affect revenue growth; expect flat yoy sales in
FY2012E now versus 20%+ growth expected earlier.
Weak takeaways for Thermax as 2HFY12E may be much weaker than 1HFY12
performance so far, in terms of order inflows. Sharp decline in incremental order
booking for Cethar as well as commentary about competition provide us weak takeaways
for Thermax as well and highlight a possibility of disappointment in 2HFY12E versus a
strong performance so far in 1HFY12 in terms of order inflows.
Increasing competitive intensity in a weak demand environment would also adversely impact
future margins of the company.
Potential for disappointment over high expectation on strong operations in FY2012E
so far
Thermax recorded a strong revenue growth of 25% in 1HFY12. We believe that this strong
growth momentum is unlikely to continue and growth would moderate in 2H. Hence, we
highlight potential for sharp disappointment over likely high expectation based on the
strong performance recorded in 1H.
3QFY12E: Likely to lose growth momentum versus 1H; PAT may decline yoy on lower
margins
We expect Thermax to lose revenue growth momentum, slowing down to about 9% in
3QFY12E versus a strong yoy growth of 25% recorded in 1HFY12 likely led by slowdown in
order inflows and execution of exiting orders. EBITDA margin is also expected to decline by
about 130 bps yoy to 10.5% in 3QFY12E (relatively flat on a sequential basis). The decline in
EBITDA margin is likely to lead to a net PAT decline—we expect net PAT of Rs944 mn in
3QFY12E, down 5.8% yoy from Rs1 bn in 3QFY11.
Voltas: Downgrade to REDUCE on outperformance while business environment
remains weak
We downgrade our rating on Voltas to REDUCE from ADD on recent sharp outperformance
(trades at 11X FY2013E EPS, 1.6X P/B with an RoE of 16%) while the business environment
remain challenging as (1) cost escalation issues in Middle East projects may remain, leading
to lower near-term margins, (2) likely lower margins in consumer business (UCP segment),
especially with high inventory, higher prices by Chinese suppliers, depreciating Rupee and
weak demand environment and (3) lack of visibility on agency business as well.
We retain our estimates of Rs6.4 and Rs7.6 for FY2012E and FY2013E, respectively and our
target price of Rs90/share based on 12X FY2013E EPS.
Cost escalation issues in Middle East projects may remain, marring near-term
margins
We believe that the cost overrun issues in the Qatar projects (Sidra Medical & Research
Centre – Rs8-9 bn order and Barwa – Rs5 bn order) would continue in 3QFY12E as well
which may mar near-term margins of the company. Note that Voltas reported very low EMP
segment EBIT margin of 70 bps in 2QFY12, negligible compared to 8.2% last year. Voltas
was expected to conduct a techno-commercial audit of the projects by end of 3QFY12
which may lead to additional provisions etc. during the quarter. While the management
believes that eventually cost escalations would be settled with the client, the near-term
margins of the segment are likely to remain under pressure
Consumer business may also face margin headwinds, especially in a depreciating
Rupee environment
We believe that the consumer business of Voltas (Unitary Cooling Products segment) may
also face margin pressure, especially with high inventory, higher prices by Chinese suppliers
and a weak Rupee environment as a significant proportion of sourcing for this segment may
be US$ denominated. We believe that in a weak demand environment (on unfavorable
weather and the general economic downturn), the company may not be able to pass on the
increased costs to its customers.
Lack of clarity on engineering products business
The company is still awaiting clarity on CAT’s plans for product distribution in India (also
expects some product-line expansion).
In the mining & construction equipment business, some of the international principals
represented by Voltas sold their businesses to Caterpillar Inc (CAT). CAT already has two
agents in India (GMMCO and TIPL).
3QFY12E: Expect flat revenues and sharp margin decline to lead 28% lower net PAT
We expect Voltas to report revenues of Rs10.6 bn in 3QFY12E, relatively flat over 3QFY11
revenues of Rs10.4 bn. We expect a sharp margin decline of 230 bps yoy to 5% in 3QFY12E
on cost escalations in Middle East projects and weak UCP segment margins; this is, however,
versus almost negligible EBITDA margin (of 0.7%) in 2QFY12. Flat yoy revenues and sharp
margin decline is likely to lead to a 28% decline in net PAT to Rs406 mn in 3QFY12E.
Downgrade Crompton to ADD (from BUY) with a revised TP of Rs155/share
We downgrade our rating on Crompton to ADD (from BUY earlier) with unchanged
estimates of Rs9.2 and Rs10.3 for FY2012E and FY2013E, respectively. We revise our target
price on Crompton to Rs155/share (from Rs135/share earlier) based on 15X FY2013E EPS
(from 13X earlier). The stock is currently trading at 13.2X FY2013E EPS and P/B of 2X with
an RoE of 16.5%.
Key risks to the business relate to (1) weaknesses in the consumers segment on demand
slowdown and margin pressures on recent Rupee depreciation, (2) potential slowdown in
industrials segment and (3) lack of expected stability in domestic power and improvement in
overseas power business
Risks relate to weakness in consumers and industrials segments
We believe that the consumers segment of Crompton may face margin pressures, especially
in a depreciating Rupee environment as the segment sourcing is primarily in US$ terms while
revenues are in INR. The pricing levels may not have changed materially in the light of
slowing demand environment and hence, Crompton may not have been able to pass the
entire cost increase to customers.
We also note that the consumer segment witnessed a slowdown in business with some lag
(slowdown only reflected since 1QFY12 versus strong growth in preceding six quarters) and
hence, recovery may also happen with some delay.
However, Rupee depreciation would benefit Crompton on overseas business and
exports
We highlight that Crompton’s overseas subsidiaries business accounts for about 40% of
sales and about 33% of EBIT. These subsidiaries do the majority of business in Euros and
US$ and would therefore benefit from the recent depreciation of the Rupee. Unlike ABB and
Siemens, Crompton is a net exporter (exports of Rs10 bn and imports of Rs6 bn in FY2011)
and would also be benefitted from translation gains.
We note that on an average Rupee depreciated by about 13.7% versus the Dollar and about
6% versus the Euro in 3QFY12 against the similar period last year.
Domestic power business may stabilize; however, incremental demand may continue
to remain weak
We believe that the domestic power business of Crompton may stabilize related to price
corrections/margin contractions and intensifying competition. However, demand
environment may continue to remain challenging; while PGCIL activity has been good in the
past few months, incremental demand may be weak. Moreover, slowdown witnessed in
power generation capacity addition is likely to eventually affect transmission-related capex as
well.
3QFY12E: Expect moderate revenue growth; however, net PAT may decline on yoy
margin contraction
We expect Crompton to record a moderate revenue growth of about 12.6% yoy to Rs27 bn
in 3QFY12E from Rs24 bn in 3QFY11. The revenue growth is expected to be driven almost
entirely by overseas business based on a reasonably strong order book, strong execution in
2QFY12 and currency translation benefit. Standalone revenues are expected to remain
relatively flat yoy as domestic consumer (sedate demand conditions, Rupee depreciation and
higher souring costs) and industrial (sedate demand) businesses may come under more
pressure versus reported so far. We expect Crompton to report consolidated EBITDA margin
of 9.2% in 3QFY12E (versus 14.2% in 3QFY11), a sequential improvement of about 80 bps
on higher overseas business margins. The sharp yoy decline in margins is likely to lead to a
net PAT decline of 40% yoy to Rs1.4 bn in 3QFY12E
Reiterate REDUCE on L&T with an unchanged target price of Rs1,175
Reiterate REDUCE on L&T based on (1) a weak capex cycle impacting quality and quantity of
order inflows, (2) potential disappointment in near-term earnings performance versus
expectations potentially led by execution and margins, (3) increasing competition across
sectors along with clients breaking orders in small parts, reducing L&T’s size advantage, (4)
L&T size (Rs800 bn inflows in FY2011) implies that several sectors have to be in momentum
for business to grow and (5) incremental investments in BOT assets potentially at lower
returns. L&T is currently trading at 14.7X FY2013E EPS (12.7X standalone P/E adjusted for
subs), 2X P/B with RoE of 16.4%.
Retain estimates and SOTP-based target price of Rs1,175/share
We retain our estimates and our SOTP-based target price of Rs1,175/share comprised of (1)
Rs800/share from the standalone EPC business (on 12X FY2013E EPS), (2) Rs177/share from
the service subsidiaries (Finance, Infra Finance and Infotech), (3) Rs42/share from the
manufacturing subsidiaries and associate companies, (4) Rs107/share from 1.2X book value
(1.5X earlier) of infrastructure SPVs and (5) Rs34/share from other subsidiaries and
investments of the company.
3QFY12E: Revenue momentum may continue but margins would be key to watch for
We expect L&T to record a 21% yoy revenue growth in 3QFY12E in line with 1HFY12
performance (though note that this is below management guidance of 25%). Margins
would be the key to watch for, considering recent sharp downgrade of margin guidance in
the 2QFY12 results conference call. We expect the company to report EBITDA margin of
10.2%, about 60 bps lower on a yoy basis leading to a net PAT of Rs8.9 bn, a growth of
11% over 3QFY11 net PAT of Rs8.05 bn.
L&T has announced orders worth Rs95 bn in 3QFY12. This is in addition to reported order
inflow of Rs323 bn in 1HFY12. We are expecting order inflows of Rs720 bn for the full year
FY2012E.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Industrials
India
Sharp price run-up takes away valuation argument; business remains weak. We
had recently upgraded industrial stocks (Thermax, Voltas and Crompton on Dec 22,
2011) on valuation argument. The recent run-up has largely taken away the valuation
argument with business conditions still being weak. We correspondingly downgrade
Thermax and Voltas to REDUCE (from ADD) and Crompton to ADD (from BUY).
Business conditions remain weak and pick-up, if any, would be gradual, exposing stocks
to risks of disappointment. Reiterate REDUCE on L&T with an unchanged TP of Rs1,175.
Sharp price run-up (of 15-30%) prompts re-evaluation of opportunities and risks
We note a sharp price rally across industrials stocks (Thermax, Voltas and Crompton) to the tune of
15-30% in the past few weeks. The stocks have also significantly outperformed relative to the
market (Sensex). This is in the face of persistent weaknesses in the business environment related to
industrials capex cycle, high competitive intensity etc.
Business commentary remains weak; sequential pick-up may be very gradual
Recent interactions with several companies reflect weak business environment with (1) sharp decline
in ordering activity to the tune of 30-50% and (2) rising competitive intensity squeezing margins.
This feedback pertains to recent past; it is still a medium-term indicator, as sequential pick-up may be
slow. Structural (clearances, land acquisition, fuel) and cyclical issues would alleviate gradually only.
Thermax (TP: Rs440): Downgrade on strong outperformance and weak peer commentary
Downgrade Thermax to REDUCE (from ADD) on (1) strong recent stock performance (trades at
15X FY2013E EPS, 3.1X P/B with an RoE of 22%), (2) potential disappointment in order booking
traction; we build 10% decline in inflows versus commentary of 30-50% decline from peers
(Cethar)/ecosystem companies (Triveni turbines), (3) continued margin pressures and (4) strong
operating performance so far; creates possibility for significant underperformance against high
expectations.
Voltas: REDUCE as cost escalations continue to hurt with other segments also under pressure
Downgrade Voltas to REDUCE (TP: Rs90) from ADD on recent sharp outperformance (trades at
11X FY2013E EPS, 1.6X P/B with an RoE of 16%) while business environment remains challenging
for (1) cost escalation issues in ME projects adversely impacting near-term margins, (2) likely lower
margins in consumer business, especially with high inventory, higher prices by Chinese suppliers,
depreciating Rupee and weak demand milieu and (3) lack of visibility on agency business as well.
Downgrade Crompton to ADD (from BUY) with a revised target price of Rs155/share
Downgrade CRG to ADD (from BUY) with a revised TP of Rs155 (from Rs135) based on 15X
FY2013E EPS (from 13X). The stock is currently trading at 13.2X FY2013E EPS and P/B of 2X with
an RoE of 16.5%. Key risks relate to (1) weakness in consumers segment on demand slowdown,
margin pressures on Rupee depreciation, (2) potential slowdown in industrials segment and (3)
lack of expected stability in domestic power and improvement in overseas power business.
Reiterate REDUCE on L&T with an unchanged target price of Rs1,175/share
Reiterate REDUCE on (1) weak capex cycle impacting quality and quantity of inflows, (2) potential
earnings disappointment led by execution and margins, (3) rising competition across sectors, (4)
L&T size (Rs800 bn inflows in FY2011) implies that several sectors have to be in momentum for
business to grow and (5) investments in BOT assets potentially at lower returns. L&T currently
trades at 14.7X FY2013E EPS (12.7X standalone P/E adjusted for subs), 2X P/B with RoE of 16.4%.
Sharp price run-up (of 15-30%) prompts re-evaluation of opportunities and risks
We note sharp price rally across industrials stocks (Thermax, Voltas, Crompton) to the tune
of 15-30% in the past few weeks. Crompton stock price has run up by about 25% since
Dec 21, 2011, Thermax by 20% and Voltas has risen by about 8% during the same period.
Apart from the absolute price run-up, the stocks have also significantly outperformed
relative to the market (Sensex).
This is in the face of persistent weakness in the business environment related to industrials
capex cycle, high competitive intensity etc. We re-evaluate our stance on these companies
given the potential opportunities and risks.
Broadly negative feedback from interactions with various companies
Our recent interactions with several companies broadly reflected weak business environment
related to investment activity, slowdown in order inflows, competitive intensity etc. Key
takeaways include:
Areva T&D. Areva T&D management cited weak demand from private industrial and
private utility segments as well as from SEBs. While strong ordering activity from PGCIL
was a saving grace, this may also weaken going forward as (1) increased ordering activity
in FY2012 being the final year of the plan period and (2) weak generation sector capex
activity to eventually affect T&D sector capex as well.
Cethar Vessels. The company management highlighted sharp decline in order booking
(likely to book only Rs4-5 bn of order inflows in FY2012E versus initial expectations of
Rs15 bn). The company also cited increased competition from smaller players including
players that have JV with Chinese players. Such players have been winning larger
proportion of deals versus earlier.
Triveni Turbines. In its 3QFY12 results conference call, Triveni Turbines’ management
cited a contraction in ordering activity by 30% in the sub-30 MW steam turbines segment
and a 50% decline for 30-100 MW steam turbines. The company is actively looking
towards international markets for growth opportunities/ to offset slowdown in the
domestic market.
Prasha Technologies. One of the genset OEMs (For Ashok Leyland, Mahindra Navistar
and Perkins) based in Northern India suggested that his business may be down about 40-
50% on a yoy basis on back of weak demand conditions. Spurt in demand witnessed in
the past few years, particularly led by telecom players, has corrected over the past few
quarters on the back of (1) slower rollout of incremental telecom towers and (2) lower
power consumption.
Powerica. Genset OEM for Cummins highlighted weak demand, thus missing its target
for FY2012E. However, the company highlighted some sequential pick-up in the month
of December versus a very weak period between July and November 2011.
Thermax: Downgrade on strong outperformance, fear of prolonged slowdown
We downgrade our rating on Thermax to REDUCE (from ADD) based on (1) strong stock
performance over the past few weeks, leaving limited upside to our target price (trades at
15X FY2013E EPS, 3.1X P/B with an RoE of 22%), (2) potential disappointment in order
booking traction; we build 10% decline in inflows versus commentary of 30-50% decline
from peers (Cethar)/ecosystem companies (Triveni turbines), (3) continued margin pressures
and (4) strong operating performance so far; creates possibility for significant
underperformance against high expectations.
We retain our estimates of Rs32.8 and Rs31.4 for FY2012E and FY2013E, respectively and
our target price of Rs440/share based on 14X FY2013E EPS.
Weak commentary from peers (Cethar Vessels) related to order inflow traction and
competitive intensity
Our recent call with the management of Cethar Vessels indicated weak takeaways for
Thermax with respect to potential slowdown in order inflows and a stiff competitive
environment. Key takeaways from the call included:
Sharp slowdown even in base orders as IPP orders remains absent; increased
competition further reducing share. Cethar Vessels expected about Rs15 bn of base
order inflows in FY2012E (Rs12 bn in FY2011) and is likely to close the year with only Rs4-
5 bn worth of base order inflows. The company also cited increased competition from
smaller players, including players that have JV with Chinese players.
Lower execution and order inflows to affect revenue growth; expect flat yoy sales in
FY2012E now versus 20%+ growth expected earlier.
Weak takeaways for Thermax as 2HFY12E may be much weaker than 1HFY12
performance so far, in terms of order inflows. Sharp decline in incremental order
booking for Cethar as well as commentary about competition provide us weak takeaways
for Thermax as well and highlight a possibility of disappointment in 2HFY12E versus a
strong performance so far in 1HFY12 in terms of order inflows.
Increasing competitive intensity in a weak demand environment would also adversely impact
future margins of the company.
Potential for disappointment over high expectation on strong operations in FY2012E
so far
Thermax recorded a strong revenue growth of 25% in 1HFY12. We believe that this strong
growth momentum is unlikely to continue and growth would moderate in 2H. Hence, we
highlight potential for sharp disappointment over likely high expectation based on the
strong performance recorded in 1H.
3QFY12E: Likely to lose growth momentum versus 1H; PAT may decline yoy on lower
margins
We expect Thermax to lose revenue growth momentum, slowing down to about 9% in
3QFY12E versus a strong yoy growth of 25% recorded in 1HFY12 likely led by slowdown in
order inflows and execution of exiting orders. EBITDA margin is also expected to decline by
about 130 bps yoy to 10.5% in 3QFY12E (relatively flat on a sequential basis). The decline in
EBITDA margin is likely to lead to a net PAT decline—we expect net PAT of Rs944 mn in
3QFY12E, down 5.8% yoy from Rs1 bn in 3QFY11.
Voltas: Downgrade to REDUCE on outperformance while business environment
remains weak
We downgrade our rating on Voltas to REDUCE from ADD on recent sharp outperformance
(trades at 11X FY2013E EPS, 1.6X P/B with an RoE of 16%) while the business environment
remain challenging as (1) cost escalation issues in Middle East projects may remain, leading
to lower near-term margins, (2) likely lower margins in consumer business (UCP segment),
especially with high inventory, higher prices by Chinese suppliers, depreciating Rupee and
weak demand environment and (3) lack of visibility on agency business as well.
We retain our estimates of Rs6.4 and Rs7.6 for FY2012E and FY2013E, respectively and our
target price of Rs90/share based on 12X FY2013E EPS.
Cost escalation issues in Middle East projects may remain, marring near-term
margins
We believe that the cost overrun issues in the Qatar projects (Sidra Medical & Research
Centre – Rs8-9 bn order and Barwa – Rs5 bn order) would continue in 3QFY12E as well
which may mar near-term margins of the company. Note that Voltas reported very low EMP
segment EBIT margin of 70 bps in 2QFY12, negligible compared to 8.2% last year. Voltas
was expected to conduct a techno-commercial audit of the projects by end of 3QFY12
which may lead to additional provisions etc. during the quarter. While the management
believes that eventually cost escalations would be settled with the client, the near-term
margins of the segment are likely to remain under pressure
Consumer business may also face margin headwinds, especially in a depreciating
Rupee environment
We believe that the consumer business of Voltas (Unitary Cooling Products segment) may
also face margin pressure, especially with high inventory, higher prices by Chinese suppliers
and a weak Rupee environment as a significant proportion of sourcing for this segment may
be US$ denominated. We believe that in a weak demand environment (on unfavorable
weather and the general economic downturn), the company may not be able to pass on the
increased costs to its customers.
Lack of clarity on engineering products business
The company is still awaiting clarity on CAT’s plans for product distribution in India (also
expects some product-line expansion).
In the mining & construction equipment business, some of the international principals
represented by Voltas sold their businesses to Caterpillar Inc (CAT). CAT already has two
agents in India (GMMCO and TIPL).
3QFY12E: Expect flat revenues and sharp margin decline to lead 28% lower net PAT
We expect Voltas to report revenues of Rs10.6 bn in 3QFY12E, relatively flat over 3QFY11
revenues of Rs10.4 bn. We expect a sharp margin decline of 230 bps yoy to 5% in 3QFY12E
on cost escalations in Middle East projects and weak UCP segment margins; this is, however,
versus almost negligible EBITDA margin (of 0.7%) in 2QFY12. Flat yoy revenues and sharp
margin decline is likely to lead to a 28% decline in net PAT to Rs406 mn in 3QFY12E.
Downgrade Crompton to ADD (from BUY) with a revised TP of Rs155/share
We downgrade our rating on Crompton to ADD (from BUY earlier) with unchanged
estimates of Rs9.2 and Rs10.3 for FY2012E and FY2013E, respectively. We revise our target
price on Crompton to Rs155/share (from Rs135/share earlier) based on 15X FY2013E EPS
(from 13X earlier). The stock is currently trading at 13.2X FY2013E EPS and P/B of 2X with
an RoE of 16.5%.
Key risks to the business relate to (1) weaknesses in the consumers segment on demand
slowdown and margin pressures on recent Rupee depreciation, (2) potential slowdown in
industrials segment and (3) lack of expected stability in domestic power and improvement in
overseas power business
Risks relate to weakness in consumers and industrials segments
We believe that the consumers segment of Crompton may face margin pressures, especially
in a depreciating Rupee environment as the segment sourcing is primarily in US$ terms while
revenues are in INR. The pricing levels may not have changed materially in the light of
slowing demand environment and hence, Crompton may not have been able to pass the
entire cost increase to customers.
We also note that the consumer segment witnessed a slowdown in business with some lag
(slowdown only reflected since 1QFY12 versus strong growth in preceding six quarters) and
hence, recovery may also happen with some delay.
However, Rupee depreciation would benefit Crompton on overseas business and
exports
We highlight that Crompton’s overseas subsidiaries business accounts for about 40% of
sales and about 33% of EBIT. These subsidiaries do the majority of business in Euros and
US$ and would therefore benefit from the recent depreciation of the Rupee. Unlike ABB and
Siemens, Crompton is a net exporter (exports of Rs10 bn and imports of Rs6 bn in FY2011)
and would also be benefitted from translation gains.
We note that on an average Rupee depreciated by about 13.7% versus the Dollar and about
6% versus the Euro in 3QFY12 against the similar period last year.
Domestic power business may stabilize; however, incremental demand may continue
to remain weak
We believe that the domestic power business of Crompton may stabilize related to price
corrections/margin contractions and intensifying competition. However, demand
environment may continue to remain challenging; while PGCIL activity has been good in the
past few months, incremental demand may be weak. Moreover, slowdown witnessed in
power generation capacity addition is likely to eventually affect transmission-related capex as
well.
3QFY12E: Expect moderate revenue growth; however, net PAT may decline on yoy
margin contraction
We expect Crompton to record a moderate revenue growth of about 12.6% yoy to Rs27 bn
in 3QFY12E from Rs24 bn in 3QFY11. The revenue growth is expected to be driven almost
entirely by overseas business based on a reasonably strong order book, strong execution in
2QFY12 and currency translation benefit. Standalone revenues are expected to remain
relatively flat yoy as domestic consumer (sedate demand conditions, Rupee depreciation and
higher souring costs) and industrial (sedate demand) businesses may come under more
pressure versus reported so far. We expect Crompton to report consolidated EBITDA margin
of 9.2% in 3QFY12E (versus 14.2% in 3QFY11), a sequential improvement of about 80 bps
on higher overseas business margins. The sharp yoy decline in margins is likely to lead to a
net PAT decline of 40% yoy to Rs1.4 bn in 3QFY12E
Reiterate REDUCE on L&T with an unchanged target price of Rs1,175
Reiterate REDUCE on L&T based on (1) a weak capex cycle impacting quality and quantity of
order inflows, (2) potential disappointment in near-term earnings performance versus
expectations potentially led by execution and margins, (3) increasing competition across
sectors along with clients breaking orders in small parts, reducing L&T’s size advantage, (4)
L&T size (Rs800 bn inflows in FY2011) implies that several sectors have to be in momentum
for business to grow and (5) incremental investments in BOT assets potentially at lower
returns. L&T is currently trading at 14.7X FY2013E EPS (12.7X standalone P/E adjusted for
subs), 2X P/B with RoE of 16.4%.
Retain estimates and SOTP-based target price of Rs1,175/share
We retain our estimates and our SOTP-based target price of Rs1,175/share comprised of (1)
Rs800/share from the standalone EPC business (on 12X FY2013E EPS), (2) Rs177/share from
the service subsidiaries (Finance, Infra Finance and Infotech), (3) Rs42/share from the
manufacturing subsidiaries and associate companies, (4) Rs107/share from 1.2X book value
(1.5X earlier) of infrastructure SPVs and (5) Rs34/share from other subsidiaries and
investments of the company.
3QFY12E: Revenue momentum may continue but margins would be key to watch for
We expect L&T to record a 21% yoy revenue growth in 3QFY12E in line with 1HFY12
performance (though note that this is below management guidance of 25%). Margins
would be the key to watch for, considering recent sharp downgrade of margin guidance in
the 2QFY12 results conference call. We expect the company to report EBITDA margin of
10.2%, about 60 bps lower on a yoy basis leading to a net PAT of Rs8.9 bn, a growth of
11% over 3QFY11 net PAT of Rs8.05 bn.
L&T has announced orders worth Rs95 bn in 3QFY12. This is in addition to reported order
inflow of Rs323 bn in 1HFY12. We are expecting order inflows of Rs720 bn for the full year
FY2012E.
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