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Margin normalization to start in Q3

* Havells’ Q1FY23 revenue was a 5% beat, but margins were significantly lower due to the volatility in commodity prices and the normalization of other costs during the quarter. The lighting segment surprised positively on both the revenue and margin fronts.

* Contribution margins for C&W saw ~370bps contraction due to the steep fall in commodity prices that led to cost pass-through to end-customers, despite holding high-cost inventory. The margins of Lloyd and the ECD segment were impacted by higher Ad spends.

* The company is seeing stable demand in consumer and residential segments, with a slight deferment in the industrial and infra segments. Management expects margins to normalize in Q3FY23, with both C&W and Lloyd seeing major improvements over Q1FY23.

* The weak Q1 margin print and its expected gradual recovery make us cut our FY23E EPS by 8%, while FY24-25E EPS remains unchanged. Maintain Hold with a Jun’23E TP of Rs1,240 (the implied PE of 41x is based on a 2-stage DCF model).

* Havells’ Q1FY23 revenue was a 5% beat, but margins were significantly lower due to the volatility in commodity prices and the normalization of other costs during the quarter. The lighting segment surprised positively on both the revenue and margin fronts.

* Contribution margins for C&W saw ~370bps contraction due to the steep fall in commodity prices that led to cost pass-through to end-customers, despite holding high-cost inventory. The margins of Lloyd and the ECD segment were impacted by higher Ad spends.

* The company is seeing stable demand in consumer and residential segments, with a slight deferment in the industrial and infra segments. Management expects margins to normalize in Q3FY23, with both C&W and Lloyd seeing major improvements over Q1FY23.

* The weak Q1 margin print and its expected gradual recovery make us cut our FY23E EPS by 8%, while FY24-25E EPS remains unchanged. Maintain Hold with a Jun’23E TP of Rs1,240 (the implied PE of 41x is based on a 2-stage DCF model).

Margins disappoint: Revenue grew by 63% yoy to Rs42.3bn (3-yr CAGR: 16%), with Lloyd/Switchgear/Lighting/C&W surpassing our estimates by 2-21%. Revenue, ex-Lloyd, grew by 50% yoy to Rs31.5bn. EBIT margins, ex-Lloyd, contracted by 291bps yoy and 256bps qoq to 12.9%. Gross margin further contracted by 669bps yoy and 32bps qoq to 29%. EBITDA, at Rs3.6bn, was up just 2.3% yoy. EBITDA margin stood at 8.5% (-505bps yoy and 324bps qoq). Ad spends rose to 2.7% of sales from 1.6% in Q4FY22, while absolute spending was still down 6% on 3-yr CAGR basis. Other expenses and employee costs were 19% and 9% above estimates, respectively. RPAT was adversely affected by weak operating profit and rose 3.4% yoy to Rs2.4bn.

Outlook: Havells continued its outperformance on revenues despite heavy de-stocking in the C&W segment. In the ensuing quarters, C&W revenues should be impacted by the sharp correction in commodity prices. Strong festive demand is key for revenue growth as H2Y22 had a high base. Are penciling margins normalization from Q3FY23 with the impact of lower commodity prices (if sustained at current levels) fully reflected. Capex recovery, govt spending and sustained demand from the real-estate sector should support volume growth. Lloyd’s revenue growth is expected to be strong as the focus remains on market share gains, while profitability path will be gradual. Continued losses in Lloyd beyond FY23 could be potentially negative and RoCE-dilutive. Valuations, which already reflect a lot of potential positives, continue to be an area of discomfort for us. Upside risks: sustained market share gains and faster-than-expected margin recovery. Downside risks: continued cost inflation, slow economic growth, sustained margin pressure, adverse commodity and currency movement

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