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High competition and near term challenges to keep margins under check; downgrade to ADD

Result Synopsis

Orient Electric (ORIENTEL) performance was below estimates with revenue declining 14%, with ECD declining 26%; while operating margins seeing decline of 814bps and 386bps on yoy and sequential basis; while other peers have reported better operating margins. Lower operating margin has been attributed to Investment in advertising and brand building  ?  High cost of consultancy to support ambitious initiatives towards “Go?to?market”, “Cost Optimisation” and “E?commerce. Trade Channel de?stocking and one?time set up of direct distribution affected primary sales in ECD, adjusting for loss of sales in fans on account of revamp in distribution ECD decline would have been restricted to 10%. Lighting and Switchgear continues to pose strong double?digit revenue growth. ORIENTEL has revamped its distribution set?up to direct distribution in 4 states viz. g UP, Karnataka, AP & Telangana which could create some near?term uncertainty as new system will take time to stabilize before generating results. We expect margins to be lower as there would be additional expenses incurred in revamping distribution system and higher spends towards promoting wires which company had launched in Q2.

We continue to expect revenue CAGR of 13%, while we trim our margin estimates considering higher spends towards revamping the distribution system. Change in distribution practice can result in some market share loss in short term before company the company starts realizing benefits in the longerterm. Considering shortterm disruption, and lower margin profile on back of higher investments, we downgrade the stock to ADD with revised PT of Rs298.

Result Highlights

* Quarter Summary ? Orient Electric (ORIENTEL) delivered a below par performance with revenue decline of 14.1% yoy. ECD segment registered de?growth of 26%; while lighting and switchgears saw revenue growth of 14.9%.

* ECD performance was below expectation – The Segment de?grew by 26% during Q2’FY23 and had a 2% growth YoY for H1’FY23. The negative impact was primarily from Fans owing to change in distribution towards direct distribution and impact of de?stocking due to transition to BEE rating.

* Margins – Gross margin contracted 222bps yoy as a result of high?cost inventory and lower price realization due to competitive pricing. Operating margins were lower on account of higher cost in setting up distribution network and negative operating leverage.   

* Working capital and operating cashflow ? Working capital at end of Q2FY23 stood at 39 days vs 45 days in Q2FY22. The Company aims to maintain a lean working capital cycle, where cash flows can be utilized to maximize the operating leverage of the company.  

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