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On a wing and a prayer
The management is hopeful that during FY19 the summer demand for room AC will be healthy supporting the overall growth of the UCP segment. There are some lead indicators in terms of buoyancy in primary sales especially from certain pockets in South, however, a clear trend will emerge only post last week of March.
We believe, the margins under UCP are unlikely to return to the 14% levels and given the medium to long term challenges, we believe the current valuations are expensive and maintain SELL with a revised target price of Rs461. Voltas has not taken any price increase and plans to take pricing action when demand picks up during the peak of summer sales.
Supported by leadership under window and fixed speed room AC, aided by non-presence of major MNC competitors like LG in this segment, we believe, in the near term, Voltas can maintain overall market leadership. However, the margins and return on capital employed is expected to be under stress.
The EBIT contribution from the UCP segment is expected to drop to 48% in FY19 and remain at 53% level for FY20/21E impacting the overall valuations. Hence, we believe that the stock is expensive, and maintain SELL rating with a revised target price of Rs461. We have baked in Voltas-Beko JV valuation in our target price since the plant will be ready and USD 100 mn of investment is expected to be completed by December 2019.
* Trudging through tough terrain -
Going forward, with increasing competition, change in policy structure discouraging imports (increase in import duty), change in efficiency norms favoring technically superior inverter ACs dominated by MNC companies like LG, Daikin, Hitachi etc., Voltas is treading through tough terrain. The company is forced to put up a local manufacturing facility and has committed Rs 5 bn of capital for the same. This will in a way impact the ROEs and the asset light business model of the company relying on low cost import from China.
* Inventory situation improve, demand buoyancy yet to pick up:
Given the uptick from the primary sales, the company expects the overall demand to gradually improve leading to lower inventory situation. How the summer season pans out will be critical and the initial estimates indicate a normal summer versus a weak summer in FY18. We believe, with selective price hikes during summer and reduction in commodity cost and favourable currency, the margins can improve, however, it is unlikely to return to the previous levels of 14.5-15% range, even on a medium to long term basis.
* Investment in new plant and Voltbeck JV near term loss to impact returns:
Given the initial cost on marketing, advertisement and promotional activities, the JV loss is expected to continue in the near term. Voltas has earmarked Rs 5.5bn investment over 4-5 years in a plant at Tirupati and will complete the investment under JV by December 2019. Hence, the overall return on capital employed is expected to be under stress.
* Maintain SELL:
The expected reduction in EBIT contribution from the UCP segment (which is B2C) from 62% in FY18 to 53% in FY21E, will keep the overall valuation multiples to be lower. We bake in the value of Voltbeck at 50% discount to the current P/BV of Voltas to arrive at an overall target price of Rs 461.
Valuation and outlook
The stock is currently trading at 33.9x FY20E earnings; going forward, the EBIT contribution from the UCP segment is expected to reduce from 63% in FY18 to 53% in FY21E which will result in overall valuation multiple de-rating. Our target multiple of 24x FY20E is based on weighted EBIT contribution average of 30x for UCP segment, 15x for EMP projects and 20x for engineering products. Given the structural headwinds in terms of higher cost structure for domestic AC companies vs. MNC and the high initial marketing related expense towards the newly formed Voltbeck JV we maintain SELL with an SoTP based target price of Rs461. Assuming USD/INR at 74, the total investments by Voltbek JV stands at Rs7.4bn (USD 100mn). We value the standalone business at Rs438 (24x FY20E earnings) and Voltbek Rs 23 (2.1x of BV) arriving at an SoTP-based target price of Rs461. Since there isn’t any data available regarding Voltbek JV, we have arrived at a valuation of 2.1x P/BV assuming 50% discount to 4.3x FY20E P/BV of Voltas.
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