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Margins disappoint; revenue growth outlook robust

Havells’ 2QFY23 print surprised negatively with contribution margins declining across most categories QoQ by 60-240bps (Lloyd turned negative) due to absorption of high-cost inventory against falling RM / sales prices. This offset another strong revenue performance with sales growing by 18% on 3-year CAGR to INR 36.7bn (10% above JMFe) and broadbased growth across categories. Volume grew c.12% YoY (at company level) as per the management. EBITDA grew by 7% on 3-year CAGR to INR 2.9bn (24% below JMFe) while Adj. PAT rose by 2% on 3-year CAGR to INR 1.9bn (31% below JMFe). With liquidation of high-cost inventory (except Lloyd) and soft RM prices, margins have hit a trough in 2QFY23. Having said that, the management unequivocally indicated its focus on RAC market share gains and ramp-up in other categories in the medium term, suggesting weak margins in Lloyd. The company continues to point towards a healthy revenue growth outlook in medium term led by a) steady demand for consumer and residential portfolio b) recovery in real estate, c) Lloyd being amongst the top 3 Room AC players with export opportunities, and d) improving capex cycle, aiding industrial and infra segments. We cut our FY23/FY24 EPS estimate by 15%/3% respectively (maintain FY25 estimates) to reflect 2QFY23 performance and outlook. We maintain BUY with a Sep’23TP of INR 1,400, basis 48x Sep4 EPS (earlier INR 1,420).

* Strong revenue growth momentum: Havells’ 2QFY23 revenue grew 18% on 3-year CAGR (+14% YoY;-13% QoQ) to INR 36.7bn (10% above JMFe/4% above consensus). Havells (ex-Lloyd) grew 17% on 3-year CAGR (+13% YoY; +3% QoQ) while Lloyd grew by 32% on 3-year CAGR (+21% YoY; -62% QoQ on seasonality). On a 3-year CAGR basis, Electrical Consumer Durables (ECD), Cables & Wires, and Lighting and Switchgears grew 16%, 18%, 16% and 10% respectively. Excluding Lloyd and C&W segments, Havells posted 3-year CAGR of 15%.

* Margins disappoint: Havells (ex-Lloyd) contribution margin was 19.6% in 2QFY23 (530bps YoY/-180bps QoQ largely due to full absorption of high-cost inventory. Barring Switchgears (+20bps QoQ), margins declined QoQ across segments with ECD (-240bps QoQ), Cables (-90bps QoQ on already low base) and Lloyd (-1.7%) being the most impacted. Overall, gross margin slumped 340bps YoY while EBITDA margin fell 590bps YoY to 7.8%. EBITDA grew 7% on 3-year CAGR (-35% YoY/-21% QoQ) to INR 2.9bn (24%below JMFe/ 27% below consensus). PAT grew by 2% on 3-year CAGR (-37% YoY/ -23% QoQ) to INR 1.9bn (28%/ 31% below JMFe/ consensus).

* High-cost inventory impacts margins in 2QFY23; margins likely to have hit trough: Overall contribution margin was impacted in 2QFY23 (-400bps YoY) due to full absorption of high-cost inventory against falling RM/ sales prices. The impact was more pronounced in cables and Lloyd. ECD margin was impacted due to lower volume in fans in lieu of BEE rating change. Having said that, with higher cables inventory now fully exhausted, margins should improve hereon, in line with long-term trends. In Lloyd, although the management’s focus on market share gains in RAC is likely to keep margins underpressure in the medium term, improving scale of operations and price hikes in 4QFY23 will aid margin improvement from current levels. We believe margins have hit a trough and should improve sequentially hereon.

* Festive season demand stable; medium-term outlook positive: Initially there was some demand sluggishness witnessed at the beginning of the festive season owing to inflationary pressures, which impacted primary sales. However, the channel is witnessing good traction over the past couple of weeks. Moreover, the management remains optimistic on medium-term outlook with encouraging runway for growth within existing categories led by a) residential and consumer portfolio b) tailwinds from real estate cycle revival aiding switchgear demands, and c) improving capex cycle, aiding industrial and infra portfolios.

* Working capital level expands due to higher inventories (mainly AC and Fans): Inventory levels increased to 89 days (67 days in 1QFY23) due to build-up for festival demand and seasonality (fans & ACs) while debtor days increased to 14 days (13days in 1QFY23). This was partially offset by increase in payable days to 61 days (57 days in 1QFY23) led by better credit terms. Overall working capital days increased to 42 days vs. 23 days in 1QFY23. Operating cash flow (OCF) turning negative in 1HFY23 to INR 1.1bn while FCF stood at negative INR 2.8bn. Net cash decreased QoQ to INR 20.7bn.

* Cut EPS estimates; Maintain BUY: We cut our FY23/24 estimates by 15%/3% respectively to reflect 2QFY23 performance (maintain FY25 estimates). We value Havells at 48x Sep’24EPS to arrive at a Sep’23TP of INR 1,400 (INR 1,420 earlier). We maintain BUY and expect Havells to be a key beneficiary of the softening commodity price environment given its premium positioning. Key risk: Demand softness and heightened competitive intensity, particularly in RAC.

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