Havells India: Beating the heat

Investors with a two-year perspective can consider buying the stock of electrical appliance and cable maker Havells India. The company has overcome demonetisation blues by incentivising channel partners. It reported healthy sales growth in the recent December quarter, helped by market share gains.

The recent acquisition of Lloyd’s consumer business is also an argument in favour of the stock.

With this, Havells gains entry into the residential air-conditioner market. Lloyd’s has 10,000 distributors across the country with a large number of them in the tier II/III markets.

The stock trades at a valuation of 37 times the expected earnings of 2017-18. In the last five years, it has traded in the band of 23-45 times. The one-year forward multiple for peer V-Guard Industries is 40 times.

Havells’ sales (₹5,437 crore in 2015-16) have grown at a compounded annual rate of 14 per cent in the last five years. Profit (₹513 crore in 2015-16) in this period has grown at 16 per cent annualised.

The company has four segments — cables (revenue contribution 40 per cent), switchgears (24 per cent), electrical consumer durables (21 per cent), and lighting and fixtures (15 per cent).

Increasing urbanisation, growing middle-class, low penetration of white goods, and the shift in consumer preference for products of organised players post GST are positives that can help sales grow strongly over the next three to five years for Havells.

In the December quarter, despite demonetisation, the company recorded 13.1 per cent revenue growth. In cables and consumer durables, sales was up 18 per cent y-o-y. The company’s management indicates that sales was helped by market share gains following higher ad spends.

In the first nine months of 2016-17, ad spends were ₹150.2 crore — about 3.4 per cent of revenue — among the highest in the industry. Efforts to establish better market connectivity by reaching out to more dealers and retailers too lifted sales. Post demonetisation, Havells took measures to ensure that cash in the system doesn’t dry up.

It provided working capital support to dealers by releasing funds invested in financial instruments (to incentivise channel partners, Havells runs this scheme where disbursements to dealers are invested in mutual fund scheme and paid to them in the year-end). It also gave discounts on payments made within 20 days.

A portion of the market share gains for Havells has also come from unorganised players because of increasing brand awareness among consumers. When GST is rolled out, there will be further gains in market share, as the price difference between products of unorganised players (market share of 40 per cent) and organised players will narrow down.

In the first nine months of 2016-17, Havells recorded revenue growth of 13 per cent. Profit growth was 28 per cnet helped by higher other income (on interest earned from funds received from Sylvania divestment).

Havells acquired the consumer business of Lloyd Electric & Engineering last month (February 2017) for ₹1,600 crore, part payment (₹500-700 crore) of which is likely to be settled through borrowing.

Lloyd’s holds about 13 per cent market share in residential air-conditioners. In the recent December quarter, the company’s consumer durable segment saw revenue growth of 43 per cent y-o-y.

Margin at the operating level was 5.5 per cent. While other consumer durable players enjoy an operating margin of 10 per cent-plus, Lloyd’s thin margins may be attributed to its high marketing spends. Given the history of successful integration of companies (CrabTree, T-Series’ fans, Promptec) it had acquired in the past, Havells may be able to improve Lloyd’s business too.

The company estimates that in the first year, the new business (from Lloyd’s) will record sales of ₹1,850 crore and profit of ₹110 crore.

But given that Havells will be redeeming its deposits in banks partially to pay for the acquisition, and borrow for the rest, its ‘other income’ will drop and there may not be any meaningful contribution from the new business in the first year (2017-18).

The price agreed to be paid for the acquisition appears reasonable. Based on the full year 2016-17 earnings estimate for Lloyd’s consumer business, the deal value translates to EV/EBITDA of 14.5 times. Peers including Voltas, Hitachi, Blue Star and Whirlpool of India trade at 22-24 times EV/EBITDA.

Havells’ operating profit margin in the December quarter declined to 12.7 per cent from 13.8 per cent in the same quarter previous year.

This can be attributed to the discounts and incentives given to dealers after demonetisation. As the incentive schemes are still continuing, there would be an impact on margins in the March quarter too.

However, margins may come back to 13-14 per cent levels in 2017-18 with focus on improving product mix.

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