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Stock Recommendation | SURYA ROSHNI LIMITED (SURL) – BUY – Target Price : 330
Publish date: FEBRUARY 19, 2019
SURL Q3FY19 result met our expectations; sales grew on back of improved demand in lighting and steel pipe division. EBITDA margin contracted y/y due to inventory write-down in the Steel pipe division. We note that 9MFY19 revenue trend signals sustainable recovery in company’s financials across divisions, supporting our investment thesis.
■ SURL revenue reported at Rs 16 Bn in Q3FY19 (+22.3% y/y) was driven by steel pipes and lighting & consumer appliances segments. EBITA margin contracted y/y to 6% in Q3FY19 vis-à-vis 7% in Q3FY18 due to inventory write-down in steel pipe division.
■ Lighting and consumer appliances division reported significant growth with revenues reported at Rs 4.1 Bn in Q3FY19 vis-à-vis Rs 3.4 Bn in Q3FY18. Steel pipe division reported encouraging y/y revenue growth of c. 23% in Q3FY19.
At current price of Rs 202, SURL stock is trading at attractive valuation- FY20 EV/EBITDA 5.0x. While we acknowledge that a conglomerate discount is warranted, we highlight that the implied upside remains attractive. We value SURL using SOTP valuation methodology- ascribe EV/EBITDA of 14x to the lighting business and 6x to the steel pipe business, arrive at a target price of Rs 330 (Rs 328 earlier).
Sales continues to report traction on robust demand across divisions
SURL revenue reported at Rs 16 Bn in Q3FY19 (+22.3% y/y) was driven by steel pipes and lighting & consumer appliances segments. EBITDA margin contracted y/y to 6% in Q3FY19 vis-à-vis 7% in Q3FY18 due to inventory write-down in steel pipe division.
Lighting and consumer appliances division reported significant growth with revenues reported at Rs 4.1 Bn in Q3FY19 vis-à-vis Rs 3.4 Bn in Q3FY18. Management sounded confident of maintaining the growth trend going ahead. Within lighting, SURL reported robust growth of 59% in LED which now constitutes to nearly 73% of total lighting sales. On contrary, the conventional lighting including CFL de-grew 23% y/y.
We note that SURL has outperformed the industry growth in the lighting division. Lighting division performance was in line with Havells India (Havells reported lighting growth at 16% ex-EESL in Q3FY19) and higher than Crompton Greaves Consumers which reported 2% decline in lighting revenues.
Our interaction with industry players suggests that ‘Surya’ holds a strong brand positioning in the tier ii/iii areas. SURL is the second largest player in the Indian Lighting Industry with14% market share. For SURL c.82% of lighting sales is derived from the rural/tier ii areas. We tend to believe that Surya Roshni is favouably placed vis-à-vis other players, as meaningful growth is expected in tier ii/iii and rural parts of India.
Steel pipe division reported encouraging y/y growth of c. 23% in Q3FY19 (c. 17% y/y growth in 9MFY19) driven by increased public spending in infrastructure, primarily oil & gas transportation and city gas distribution. Recovery in the global economy has also supported the demand in the last few years.
Company has been observing reasonable traction in its newly set-up 3LPE Coated Pipe Manufacturing Unit at Anjar-Kutchh (Gujarat) by higher capacity utilization of its existing ERW and Spiral API Pipe facilities. Additionally, the South Indian market has also shown strength. The company has contemplated to enhance the installed capacity of ER W Steel Pipe & Strips Unit at Hindupur, A.P. by 12,000 M.T per annum-from 1,50,000 MTPA to 1,62,000 MTPA.
Margins, however contracted in steel pipe division to 3.2% in Q3FY19 due to inventory write down (c. Rs 80 mn hit in the quarter). Management believes that the company shall restore margins in the succeeding quarters. We highlight that the company sources inventory on order to order basis, thus mitigating inventory risk to a large extent.
Finance cost increased 16% y/y to Rs 298 mn (in line with our estimates) due to working capital requirement in the pipes business. However, we expect borrowings/financial charges to peak out at current level of Rs 12 Bn. We estimate interest expense at Rs 11.5 bn and Rs 11bn in FY19 and FY20 respectively. Note that our debt forecast does not include the advantages that can flow from channel financing.
We also project moderate reduction in working capital form 84 days in FY18 to 79 days in FY20 with inventory/debtors at c.61/53 days in FY18 to 61/51 days in FY20.
Conglomerate discount should get narrowed with the demerger of consumers and steel pipes business
Typically, consumer durables companies trade at a much premium valuations vis-à-vis steel pipe companies due to the higher capital efficiency, better return ratios and lower capital requirements.
SURL management has recognized the need of having two separate entities-having a precise focus and dedicated bandwidth for both the lighting/consumer durable and pipes business. We believe that the corporate action would likely provide an enhanced focus on both the businesses and finally lead to the re-rating of company’s stock.
Attractive valuation on relative basis; maintain BUY rating and a SOTP based target price of Rs 330
At current price of Rs 202, SURL stock is trading at attractive valuation- FY20 EV/EBITDA 5.0x. While we acknowledge that a conglomerate discount is warranted, we highlight that the implied upside remains attractive. We value SURL using SOTP valuation methodology- ascribe EV/EBITDA of 14x to the lighting business and 6x to the steel pipe business.
SURL (estd. 1973), founded by Mr J.P Agarwal, is a manufacturing company with business interest aligned broadly divided into two areas- Lighting and Steel pipes. Under Lighting, the Company offers a wide range of lighting products- from GLS, CFL, Luminaries to LEDs and luminaries. Company also operates its fans and appliances business where it offers several models of fans and kitchen appliances. The Company’s lighting manufacturing units are located in Uttarakhand and Madhya Pradesh. While company manufactures an array of pipes, it has been the largest manufacturer of ERW-GI pipes in India. The company’s pipe manufacturing units are located in Haryana, Gujarat, Andhra Pradesh and Madhya Pradesh. SURL has a wide presence across the length and breadth of India along with considerable overseas presence spread across 50 countries.
BUY - We expect the stock to deliver more than 12% returns over the next 12 months ADD - We expect the stock to deliver 5% - 12% returns over the next 12 months REDUCE - We expect the stock to deliver 0% - 5% returns over the next 12 months SELL - We expect the stock to deliver negative returns over the next 12 months NR - Not Rated. Kotak Securities is not assigning any rating or price target to the stock. The report has been prepared for information purposes only. SUBSCRIBE - We advise investor to subscribe to the IPO. RS - Rating Suspended. Kotak Securities has suspended the investment rating and price target for this stock, either because there is not a Sufficient fundamental basis for determining, or there are legal, regulatory or policy constraints around publishing, an investment rating or target. The previous investment rating and price target, if any, are no longer in effect for this stock and should not be relied upon. NA - Not Available or Not Applicable. The information is not available for display or is not applicable NM - Not Meaningful. The information is not meaningful and is therefore excluded. NOTE - Our target prices are with a 12-month perspective. Returns stated in the rating scale are our internal benchmark. Kotak Securities Limited established in 1994, is a subsidiary of Kotak Mahindra Bank Limited. Kotak Securities is one of India's largest brokerage and distribution house.
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