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Buy V-Guard Industries Ltd For Target Rs.285

V-Guard Industries Limited’s (VGRD) having a strong diversified product portfolio witnessed mixed performance in Q2FY23 where revenues improved 8.6% YoY better than estimates given a higher base same quarter last year while some softness witnessed in latter part of the Q2FY23. On segmental basis continued traction seen across the Consumer Durables segment reporting strong growth followed by the Electronics segment which has sustained its improved trajectory of performance. The Electricals segment was nearly flat, reflecting the effect of price reduction in Wires. Region wise South grew 2.6% while Non-South continues strong growth (+17.8% YoY) and contributed 42.7% to total revenues (39.4% in Q2FY22). Non- South continues to gain scale across regions which has been the argument from some time. Gross margin compressed 231bps YoY to 28.6%, on liquidation of higher cost Wires inventory at relatively lower realizations due to fall in copper prices. Management also indicated that even in the other categories, input costs remain significantly higher than long term averages, despite some reduction seen in the last few months leading to lower profit (-27% YoY). Management expects margins to revert to pre-pandemic levels of 32- 33% in H2. Margins are likely to improve as higher cost inventory largely liquidated while lower cost inventory to support margins and no further price hike is required. In the long run the management expects margins to improve over the next 3-5 years, led by a) rising share of own manufacturing to make V-guard products more competitive, and b) increasing premium mix. We believe the company’s strong balance sheet, cash flows and reputed brand while management constant focus on 1) evolving category mix and product mix, 2) in house manufacturing from current 60% to 75% to improve the product offering supply chain and gross margins, 3) distribution enhancement in smaller town and rural along with increase in non-south region to offer significant growth potential provides positive outlook ahead. We have tweaked our estimates after the H1FY23 performance and maintain Buy on the stock with a price target of Rs.285 (36x FY24E).

Q2FY23 summary:

V-Guard’s Q2FY23 sales grew at a 3-year CAGR of 16.6%% (+8.6% YoY on high base; -2.9% QoQ) to Rs.9.8 bn better than estimates. Electricals remained flat YoY while Electricals and Consumer Durables grew at 8.7%/ 20.7% YoY despite softness seen in later part of the quarter. Gross margin compressed 231bps YoY to 28.6%, on liquidation of higher cost Wires inventory at relatively lower realizations (~Rs160mn hit taken) due to fall in copper prices.

Higher other expenses including freight and Ad spends leading to EBITDA decline by 24.4% to Rs.707mn and EBITDA margin compressed 315bps YoY (-90bps QoQ) to 7.2% while PAT declined 27% to Rs.431 mn. Working capital levels stood at 88 days on lower inventory (103 days) and improvement in both debtor and creditor days, which enabled CFO at Rs2.3bn in H1FY23 (vs. Rs.262mn in H1FY22). However, management indicated that due to some softness in demand towards the end of the quarter, the reduction in inventory days was not as sharp as anticipated. While it may take a little longer than planned, it will revert to normal inventory levels in the coming months, thereby further improving cash flows. The demand across its ECD business comprising fans and water heaters being largest revenue contributors expected to remain buoyant and the company has been focusing more on products like fans, water heaters, wires, and switchgears and increasing its share in premium products. Further traction could be seen given 40-50% sales in celling fans are premium fans and will improve further post BLDC norms, as 85-90% of manufacturing plant output is geared towards premium fans. Water heaters expected to do well in coming winters and company gained back lost market share in FY22 and further inching up. ECD margin were lower, management expects improvement in H2 with improvement in volumes and product mix.

Margin tailwinds (RM softness, in-house manufacturing) in sight:

Over the past 12-18 months, unprecedented RM inflation in key commodities put pressure on margins across categories. However, with the recent softening in prices of key commodities, the management expects gross margin to revert to the pre-pandemic levels of 32-33% in H2FY23. With increasing share of own manufacturing in key categories such as water heaters, stabilizers, inverter batteries and fans (premium, super premium and TPW), the management expects sustained margin improvement over the next 3-5 years.

Non-South market expansion progressing well and increased to 42% in Q2FY23:

South grew 2.6% while Non-South continues strong growth (+17.8% YoY) and contributed 42.7% to total revenues (39.4% in Q2FY22). Non- South continues to gain scale across regions which has been the argument from some time. VGRD has been steadily expanding its operations into the nonsouth market in an effort to de-risk its geographical concentration. It is transforming into a leading multi-product pan-India player in consumer electricals. It has more than 41,000 touch points in India; will add 5,000-6,000 every year over 2-3 years which has been the strategy from some time now, mainly in the non-south market. In the last 2-3 years, it has also been able to build a strong dealer network for products such as C&W (wires), water heaters, and fans (52% of VGRD sales) in the non-south market. We expect all these efforts will help it to gain market share in these regions and help its non-south contribution to increase to 50% over 2-3 years.

Outlook & Valuation

We believe the company’s strong balance sheet, cash flows and reputed brand while management constant focus on 1) evolving category mix and product mix, 2) in house manufacturing from current 60% to 75% to improve the product offering supply chain and gross margins, 3) distribution enhancement in smaller towns and penetration into organized retail to offer significant growth potential. We have tweaked our estimates after the H1FY23 performance and maintain Buy on the stock with a revised price target of Rs.285.

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