Havells India: The switch to higher gear

Long-term potential makes the stock a good bet despite its perceived high valuation

Long-term investors can consider the stock of Havells India, a key player in consumer electrical appliances. The company also makes cables and switch-gears. There are multiple drivers for the stock — rising urbanisation, the government’s thrust on housing and electrification of villages, consumer shift from unbranded to branded goods and the additional revenue from Lloyd’s consumer business acquired last year.

From our ‘buy’ recommendation in March last year, the stock has rallied 30 per cent. At the current market price of ₹550 a share, the stock trades at 41 times its likely earnings for 2018-19. A year back, it was trading at 35 times its one-year forward earnings.

Though the valuation looks a tad expensive, considering its growth potential over the long term, investors can take a bet on the stock.

Stock price correction, if any, can be used to accumulate the stock. V-Guard Industries, the company’s peer in the electrical appliances and cables space, trades at 46 times one-year forward earnings.

In 2016-17, Havells reported revenue of ₹6,135 crore. Revenue grew at a compounded annual growth rate of 11 per cent in the last five years.

40 per cent of the company’s revenue is from cables, about 25 per cent from switch-gears and the rest from electrical consumer durables, and lighting and fixtures. Switch-gears contribute the most to profits, and cables the least.

The GST rate for most electrical products is 28 per cent while earlier it was only 18 per cent. Demand for electrical consumer durables of the company, thus, has been impacted. However, as the market stabilises, and consumers adjust to the new reality, demand should recoup.

Growth opportunity

The shift from unorganised to organised players will drive growth for players in the consumer space over the next few years.

In switches and cables, the share of unorganised players in different categories is about 20-40 per cent.

In electrical consumer durables — fans, water heaters and other small appliances, the share of unorganised players is about 25-50 per cent.

While the shift to organised players started many years back, it will accelerate now, as GST will make it difficult for players to evade taxes.

And, given that the organised players are focusing on bringing innovative solutions and expanding the dealer-distribution network every year, they should see higher-than-industry growth in the next five years.

Havells is the largest player from the listed space as far as consumer electricals are concerned.

With over ₹6,000 crore in annual turnover and a market cap of ₹34,300 crore, it is a good choice for an investor who doesn’t want risks associated with small-cap stocks in the consumer electricals space at times of high market volatility such as the present.

The company’s plans to grow market share over the next two-three years include doubling its dealer-distribution network and increasing penetration in tier II/III cities, making available its products on more modern retail and e-commerce platforms, and expanding network of its exclusive stores.

The company also intends to increase product launches. In December, Havells entered the water purifier segment by launching six variants.

The company eyes a market share of 8-10 per cent in this category over the next five years by leveraging its existing distribution network and building a strong, in-house after-sales service team.

In switches, it wants to launch more products in the entry-level and mass premium (between the value and the premium segment). It recently repositioned its ‘Standard’ brand as a ‘value for money’ product eyeing tier II/III/IV markets.

In the first-half of 2017-18, Havells reported a y-o-y growth of 25 per cent in revenue. Of the total revenue of ₹3,759 crore, 14 per cent (₹537 crore) was from Lloyd. Revenue from switch-gears dropped by five per cent due to weakness in the construction sector, but sales of cables were higher by 10 per cent and that of lighting and fixtures by 17 per cent.

The electrical consumer durables segment saw revenue rise by 3 per cent. The sluggishness in the durables segment should change as consumers get accustomed to the new rates under GST. In the year to come, however, revival in sentiments in the construction sector, is going to be key for the company. Once the switchgear segment revives, profitability will also improve as it is the highest-margin product for the company.

Havells acquired the consumer business of Lloyd Electric & Engineering in February 2017 for ₹1,600 crore to foray into the white goods industry and grab the opportunity of low penetration in consumer durables.

Lloyd’s profitability improves

Over the last year, Havells has been strategically driving sales in the non-air conditioner category in Lloyd so that seasonality in growth reduces. Currently, Lloyd derives about 70 per cent of its revenue from air-conditioners and 25 per cent from LED TVs.

Havells intends to invest in branding and product technology for Lloyd and also build in-house manufacturing capability for its products.

In the December 2016 quarter, Lloyd’s consumer durables segment reported margin of 5.5 per cent at the operating level — way lower than its peers. But, in the recent September quarter, Lloyd reported operating margin of 7 per cent. The improvement was helped not by price hikes but by integration in operations of warehouses, supply chains and some back-end operations, says the management.

In the September 2017 quarter, Lloyd’s sales was up 11 per cent over the same period last year.

Commodity-price risks

Havells reported an operating profit margin of 12.8 per cent in the first-half of 2017-18 versus 13.8 per cent in the same period last year.

But, when seen at a consolidated level, including Lloyd’s financials, the margin in the first-half of 2017-18 drops to 11.8 per cent (as Lloyd’s is a lower margin business).

Though there has been a sharp rally in metal prices over the last year, Havells has effected price hikes. What actually weighed on margins was the lower sales volume in the June quarter. Going ahead, some pressure on margins is inevitable as metal prices are on a uphill journey in the global market.

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