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Electrical Consumer Durable (ECD) companies saw a sustained demand recovery in 2QFY22 that was broad-based across categories and geographies. Notably, there has been a revival in real estate led categories such as switchgears while B2B began to see good traction. However, rising commodity prices have been a challenge leading to margin pressures as companies delayed price hikes fearing potential impact on demand/market share. While gradual demand recovery augurs well, given a high base in 2HFY21 driven by pent-up demand, we expect 2HFY22 growth to be moderate vs. 1HFY22 on YoY basis. While we continue to monitor the demand trajectory and commodity inflation, we remain positive on the space from medium to long-term perspective given macro tailwinds, low penetration for some of the categories and category expansion opportunities for companies. Bajaj Electricals and Crompton Consumer are our top picks.

* Strong demand momentum: In 2QFY22, ECD companies sales grew 32% YoY (+15% 2- yr CAGR) led by a) sustenance of demand momentum since Jun’21 (post-unlocking) and revival in real estate, b) Price hikes taken to pass on the commodity price inflation and c) Channel stocking for the festive season that happened in 2QFY22 now vs. 3QFY21 last year. In ECD segment, Havells and Bajaj Electricals led the pack with 23% and 21% sales growth on a 2-year CAGR basis, respectively.

* Commodity price inflation impacts margins: Despite the strong sales growth, gross margins compressed across the board with rising commodity prices (Aluminium / Copper up 46%/52% since Sep’20). Despite the sharp increase in commodities, price hikes were calibrated with fears of potential impact on demand momentum. However, we believe companies such as Crompton consumer sacrificed some volumes to protect margins. Further, some of the cost cuts taken in FY21/1QFY22 are reversing as employee costs and other expenses grew 16% YoY/8% QoQ and 21% YoY/26% QoQ. We expect the costs to inch up as 2QFY22 hasn’t seen a complete reversal of costs (eg: Havells A&P spend at 1% of sales in 2QFY22 vs. 3-3.5% of sales usually). However, the impact is expected to be offset by a healthy recovery in sales growth.

* Elevated Working capital levels: While working capital levels moderated on a QoQ basis, it still remains high as Cash Flow from Operations (CFO) fell 34% YoY (+12% 2-yr CAGR). This is driven by an increase in inventory levels with a) Conscious decision by companies to build-up inventory in the event of any supply-side disruptions and b) high inventory of summer category products that lost sales due to lockdowns.

* Remain positive from medium-term perspective on the space, though punchy valuations constrain us: While a gradual recovery in demand augurs well for ECD companies, rising commodity prices remain a challenge though companies are passing it through calibrated price hikes. Further, with a high base in 2HFY21 driven by pent-up demand, we expect 2HFY22 growth to be moderate vs. 1HFY22. While we continue to monitor the demand trajectory and commodity price, we remain positive on the space from medium to longterm perspective given macro tailwinds, low penetration for some of the categories and category expansion opportunities for companies. However, as shown in Exhibit 2, current share price of companies imply 19%-43%CAGR in sales over FY20-31E for companies under cover coverage. This is significantly higher than a) Historical track record (14%- 15% in FY10-20), and b) growth in ECD categories. We roll forward the Target Price for our coverage universe to Dec’22 (refer Exhibit-1) and maintain BUY on Crompton Consumer, Bajaj Electricals, V-Guard Industries and Stove Kraft Ltd.

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