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Hold Honeywell Automation India Ltd For Target Rs.31,400

Healthy margin and cashflow

Honeywell Automation India (HAIL) has witnessed 8% YoY drop in revenue to Rs7.6bn, implying slow pickup in execution. The company has reported EBITDA margin of 19% (up 80bps YoY) as material costs decreased 150bps YoY to 49.6% and 11% YoY drop in other expenses due to cost reduction measures supporting margin. We believe margin expansion is aided partly by rupee depreciation and partly be reduction in travel given the Covid-19 pandemic related restrictions. Given the market leadership in domestic oil & gas space (both in the refinery segment and retail stations), strong parent’s expertise and sustainable growth in export segment, we maintain our HOLD rating on the stock with an unchanged target price of Rs31,400.

* Working capital increased, however, in control: There has been an increase in receivables, which we believe, might be due to higher mix of government contracts. Despite this, the cash from operations has been healthy at Rs1.3bn vs Rs1.6bn in H1FY20. We believe this should normalise going forward.

* Leadership in domestic process automation: HAIL is also engaged in ‘smart city’ solutions in areas of traffic management, etc. The company also has healthy market share in automation solutions for other process industries such as chemicals, paper, sugar, metals, thermal power, etc.

* Secular growth in exports: Exports witnessed strong growth at 17% CAGR during FY16-FY20 and contributed 44% to FY20 revenue. Majority of these exports are towards overseas entities related to the parent comprising global engineering services. Given the low-cost advantage of outsourcing to the Indian entity by the parent, HAIL’s export growth trend may continue, in our view.

* Tapping into building automation: HAIL is one of the major players in the domestic building automation market. This segment is likely to witness healthy growth given the focus on security and safety. Additionally, energy optimisation solutions are evolving as a potential growth area.

* Maintain HOLD given rich valuation: Given the long-term secular growth drivers in process automation, diversification towards building and cyber security, and constant improvement in the company’s technical portfolio, we maintain our HOLD rating on the stock despite rich valuation. Given the outsourcing nature of the export segment, we assign a different multiple for this segment than domestic segment. Hence, we value the stock by SoTP methodology. We assign multiple of 60x FY22E earnings to the domestic business, 30x FY22E to export business and hence, arrive at SoTPbased target price of Rs31,400. We assume the percentage contribution of exports in earnings will be similar to revenues.

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