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Weak execution impacts earnings

Honeywell Automation India (HAIL) witnessed 7.2% YoY revenue decline and slight QoQ growth of 1.6% on low base to Rs6.8bn in Q1FY22, lower than our estimate of Rs8.5bn. Company reported an EBITDA margin of 17.1% (down 30bps YoY and 210bps QoQ) despite 130bps YoY decrease in raw material cost proportion to 47.7%.

Other expenses declined 9% YoY and staff expenses increased 2.4% YoY, impacting the margins. Factoring-in the revenue slip, we cut our FY21E and FY22E earnings estimates by 4.8% and 4.7% respectively. Given the rich valuations and near-term uncertainty of growth, we maintain REDUCE with a revised target price of Rs37,310 (earlier: Rs39.008).

* Maintain REDUCE on rich valuations and muted growth: The long-term secular growth drivers in process automation, diversification towards building and cyber security, and constant improvement in the company’s technical portfolio, will drive HAIL’s long-term growth. However, given the near to medium term growth uncertainty and the increase in working capital during FY21, we maintain REDUCE. In view of the outsourcing nature of the export segment, the multiple we assign to it is different from the one to the domestic segment. We assign 70x FY23E earnings to the domestic business and 30x FY23E to export, thus arriving at an SoTP-based target price of Rs37,310. We assume the percentage contribution of exports in the earnings to be similar to that in the revenues.

* Leadership in domestic process automation: HAIL is engaged inter alia in ‘smart city’ solutions in the areas of traffic management, etc. Company also has a healthy market share in automation solutions for other process industries such as chemicals, paper, sugar, metals, thermal power, etc. HPCL Barmer related tenders are expected to be finalised in the next six months and, we believe, HAIL will be a key beneficiary of the same. Company is also a key player in building and infrastructure automation, hence can benefit from government spend.

* FY21 witnessed higher decline of domestic vs exports despite pandemic: In FY21, domestic revenues dropped 11% YoY to Rs16.3bn post a gap of 3 years impacted by covid, while exports fell 4% YoY to Rs13.8bn. Travel restrictions resulted in 29% YoY reduction in travel expenses to Rs1.8bn. However, Rs199mn of debt write-off and Rs127mn of forex loss impacted overall margins in FY21 by 60bps. Adjusted for the same, FY21 EBIDTA margin would have been 20%.

* Tapping into building automation: HAIL is one of the major players in the domestic building automation market. The segment is expected to witness healthy growth given the general focus on security and safety.

Outlook and valuation

Honeywell Automation India (HAIL) is in a unique position as a secular play in the domestic process automation opportunity. It is also trying to hedge itself from the oil & gas industry by focusing on other areas such as building automation, ‘smart city’ solutions, cyber security, etc. Exports have been a major growth driver in the past 4-5 years. Given the weak execution and the increase in working capital, we believe growth momentum has been impacted for the near term.

Current valuations are high, hence we maintain REDUCE. The three major focus areas in the near term are: (i) healthcare and pharma, (ii) air quality and hygiene products and solutions, and (iii) products and systems to ease remote working and connected buildings. Given the diverse nature of its businesses, capabilities and returns of the outsourcingbased export segment and technology-based domestic process automation segment, we value the company by SoTP methodology.

We assume the percentage contribution of exports in the earnings to be similar to that in the revenues (the company does not share these data points separately). We assign a multiple of 70x FY23E earnings for the domestic automation segment and 30x FY23E earnings for the outsourcing-based export business.

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