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New launches, rural expansion intact in a COVID-disrupted year

HAVL’s FY21 Annual Report emphasizes on operations in a COVID-19 disrupted year. The management continued to focus on expanding distribution, particularly in rural areas, and launching newer and innovative products. All these measures led to HAVL’s capitalizing on pent up demand arising post the lifting of lockdown restrictions, leading to a recovery in lost sales. Here are the key highlights:

* Expansion into rural geographies aids in a quick recovery:

Over the last few years, HAVL has focused on expanding its distribution reach in semiurban and rural markets under the ‘Rural – Vistaar’ initiative. In FY20, the company had 1,700 rural distributors covering 18,000 outlets, which was further ramped up to 2,500 distributors covering 28,000 outlets in FY21. Since the rural channel was more resilient during the first COVID wave, HAVL disproportionately gained from pent up demand after the lifting of the first lockdown. The management plans to scale its rural reach to over 3,000 distributors and over 40,000 outlets by FY22-end.

* Strong in-house manufacturing complements supply chain ramp up:

The company manufactures over 90% of products in-house (v/s 20-50% for its peers) across its 14 manufacturing locations. It is adopting the same philosophy in the Lloyd’s business as well. With the Neemarana AC plant fully ramped up, HAVL has decided to set up its second AC plant in Sri City, Andhra Pradesh.

* Price hikes and persistent cost rationalization measures aid margin expansion:

Despite pent up demand aiding secondary sales post 1QFY21, HAVL continued with its cost rationalization measures. Ad spends fell to 1.3% of sales in FY21 (3.4% in FY20 and 3.8% in FY18-19). Travelling costs halved in FY21 (0.3% of sales v/s 0.8% in FY20). Employee count was flat YoY, with employee costs at 8.5% of sales (v/s 9.5% of sales in FY20). Coupled with pricing action of a 10-15% increase across all products (higher for Cables and Wires), HAVL expanded its EBITDA margin to 15% (+410bp), thus reporting its best ever margin in the last 15 years.

* Focus on higher technology usage and innovative launches:

Even in a COVID-19 disrupted year, HAVL utilized the latest technology to launch innovative products, with sustainability as a key criteria. Several first-time innovative products launched in the market were: a) Silencio mixer grinder, b) Carnesia-I and Stealthwood-I fans, c) 16A Smart Socket and smart accessories for home automation, d) Intellilogic – the country’s first AC with energy-efficient simultaneous control of temperature and humidity. The company has filed 133 new IPRs (intellectual property rights) and designs in FY21. In all, HAVL has filed 686 patents and designs up to FY21.

* Expansion into new product categories intensifies:

HAVL launched 21 new product categories in FY21, with 4,766 new SKUs, more than double as compared to FY20. New products launched in FY20 and FY21 form ~43% of total sales (~29%/~14% in FY20/FY21). This is significantly higher than ~8% in FY18 and FY19 combined.

* Working capital cycle elongates YoY:

The working capital cycle has increased to 24 days in FY21 from around 3 days in FY20, with higher inventory in anticipation of a strong demand environment. Debtors increased YoY owing to a decline in usage of receivable buyout facility (the latter stood at 23% of total receivables in FY21 v/s 58% in FY20).

* Overall capex intensity moderates:

Capex stood at INR2.1b in FY21 (v/s INR3.7b in FY20), as a large part of the capacity expansion for Cables and Wires, ECD, and Switchgear segment was performed in FY20, with the management truncating any non-critical capex in FY21.

* FY21 performance highlights: a) P&L highlights:

Revenue rose 11% YoY to INR104.3b, with its core portfolio/Lloyd business increasing by ~12%/6%. EBITDA increased by 52.4% to INR15.7b as EBITDA margin rose 410bp YoY to 15% in FY21. Ad spends stood at 1.3% of sales v/s 3.4% of sales in FY20 as other expenses declined by 10% YoY. PBT grew to 54% YoY, while adjusted PAT was up 41% YoY to INR10.3b owing to a higher effective tax rate of 25.8% (FY20: 18.7%). b) Balance Sheet highlights: Net cash position stood at INR13.2b (v/s INR11b in FY20).

* Net debt/equity remained comfortable at -0.2x. c) Cash flow highlights:

Cash flow from operations fell 20% to INR6.6b owing to higher working capital requirements. Owing to moderate capex, FCF generation stood strong at INR5.4b (FY20: INR4.7b). d) Return ratios: On account of higher operating profit, RoE rose to ~20% from 17% in FY20. RoIC increased to 24% from 18.7% in FY20.

* Structural changes visible as brand Lloyd bounces back:

In FY20, Lloyd reported losses at the operating level owing to multiple challenges like: a) a sharp price erosion in TVs (~25% of FY19 revenue) due to fierce competition from Chinese players; b) loss of market share in ACs in 1HFY20 due to revamp of the distribution network from traditional channels to a Multi-Brand Retail format. A lockdown during the peak season also impacted AC sales towards FY21-end. However, Lloyd has turned around in FY21 (against our estimation of losses), aided by a revamped distribution network and an established manufacturing facility. The brand is well positioned to gain advantage from the ban on import of ACs with refrigerants. It has entered into the Refrigerator category and is setting up a facility for manufacturing Semi-Automatic Washing Machines inhouse. With this, it is now present across key Consumer Durables categories.

* PLI scheme and work from home (WFH) key structural changes:

HAVL is of the view that the PLI schemes announced across different sectors will lead to increase in capex intensity, while WFH has led to higher spending on housing products. Both these measures act as structural boosters for growth across all key categories of HAVL and Lloyd.

* Valuation and view:

HAVL rightly utilized all its cost levers (ad spends, employee costs, travel costs, etc.) in FY21, thereby resulting in an expansion in EBITDA margin to 15% (+410bps YoY) and EPS growth of over 40%. While near-term ad spends may remain low due to the second COVID wave, other levers (such as employee costs) may be difficult to utilize going forward. We expect margin to settle at 13% by FY24, closer to its margin trend, as ad spends return. Thus, our FY21-24E EPS CAGR stands at 12% (v/s revenue/EBITDA CAGR of 14%/9%). We maintain our Neutral rating, with a TP of INR1,030 (50x FY23E EPS).

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