Published on 15/03/2021 9:24:44 AM | Source: Motilal Oswal Financial Services Ltd

Buy Orient Electric Ltd For Target Rs.350 - Motilal Oswal

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Reinventing through innovation

* Orient Electric (OEL), since its demerger from Orient Paper & Industries in FY17, is fast emerging as a serious competitor in the Electrical Consumer Durables (ECD) space. It is the third largest player in the Fans segment and has been in operation for over 60 years. Recently, it diversified into related product categories like Lighting, Switchgears, Air Coolers, Water Heaters, etc. OEL’s 13.5% revenue CAGR over FY18-20 has outpaced Havells India (+7.6% CAGR) and Crompton Greaves Consumer Electricals (+5.9%).

* OEL enjoys a similar gross margin as its peers, but has one of the lowest EBITDA margin. This is on higher employee cost and advertising spends, suggesting that OEL is perhaps in the investment phase. There is a strong case for margin convergence, with leading players like Havells and Crompton in a steady state.

* Despite higher investments in people and branding-related spends, and hence potentially lower margin at present, OEL generates a RoE of over 22%, which is superior to many peers. We forecast revenue/EBITDA/PAT growth of 20%/18%/21% over FY21-23E. We initiate coverage on the stock with a Buy rating, assigning a TP of INR350 per share.


New management - New Energy - New aspirations

The biggest change in OEL’s ECD business has been appointment of new management. The company got demerged from Orient Paper & Industries in FY17. Mr. Rakesh Khanna was appointed MD & CEO from 23 Jan’18 for fouryears and has been instrumental in building an altogether new team. The average age of employees stood at 37 years in FY18. It introduced an Employee Stock Option Scheme and a Long-Term Cash Incentive Plan to retain and incentivize key members of the senior management team. This aligns the interest of the senior management with the company’s prospects. Since its demerger, OEL’s 13.5% revenue CAGR over FY18-20 has outpaced Havells (+7.6% CAGR) and Crompton (+5.9%).


Established brand in the Fans segment; new product offerings encouraging

OEL is a 60-year old brand in the Fans segment and is the third largest player at present after Crompton and Havells. Owing to its long presence, it enjoys a superior brand recall in the Fans segment. Recently, it started diversifying into related categories including Lighting, Switchgears, Air Coolers, and Water Heaters, along with growing its market share in the Fans segment. The ECD segment, comprising Fans and other appliances, has grown by ~11% CAGR over FY11-20 and forms ~70% of the revenue, while the Lighting and Switchgear segment has grown ~29% CAGR and constitutes the remainder of revenue. We expect revenue to grow by ~20% CAGR over FY21-23E, helped by a lower base. Over the longer term, we expect the product portfolio to witness 12% revenue CAGR structurally.


Innovation at the heart of its growth strategy

Even though the company is an established player in the Fans segment, it continues to re-invent its product offerings, thereby negating any complacency. OEL has impressed with its innovative noise reducing ‘Aeroquiet’ Fans, thereby creating a new price category. It has introduced a range of aerodynamic fans, showcasing its in-house R&D capabilities. In the Lighting segment, it has launched LED Lighting products, which have improved the lighting quality by controlling the flickering of LED bulbs. It has introduced new modular switches with Triple Arc Blocking (3AB) technology to provide the highest level of safety.


Expect EBITDA margin differential with leading companies to converge

OEL enjoys a similar gross margin as its peers, suggesting that the brand is at par with leading companies on account of its pricing/procurement strategy. However, it has one of the lowest EBITDA margin compared to peers. EBITDA margin stood at just 8.6% in FY20 v/s an average of 11.1% for its peers. In fact, its EBITDA margin is 4.6pp below Crompton, despite the fact that both companies have a similar product portfolio. Our analysis of overheads suggests that such a differential can be attributed to employee cost, ad spends, etc. and OEL is perhaps in the investment phase. There is a strong case for EBITDA margin to converge with the 13-15% range enjoyed by Havells and Crompton. It has already reached double-digit margin in FY21, thus validating the potential of our thesis.


Initiate with a Buy rating and TP of INR350/share

OEL’s near-term earnings doesn’t capture the true value of the franchise as the company is currently in the investment phase (brand building) and hence its margin is below peers. Earnings are also depressed on higher depreciation v/s peers (absolute depreciation is higher than the leader in the Fan industry, i.e. Crompton) due to greater in-house manufacturing content. Despite higher investments in people and branding-related spends, and hence potentially lower margin at present, it generates a RoE of over 22%, which is superior to many peers. We value OEL at a target multiple of 45x on Mar’23E EPS to arrive at our TP of INR350/share. Note that our target multiple is at a discount of ~10% to Havells, but at a premium to Crompton (target multiple of 40x) as our thesis is based on the narrowing of the margin differential over the next five years. At CMP, the stock trades at 25% discount to Havells on a FY23E P/E basis. However, the discount increases to 37% on an EV/EBITDA basis. While it trades at ~10% premium to Crompton on a P/E basis, our EV/EBITDA analysis suggests a discount of 17%.


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