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  • Stock Recommendation | Havells India - SELL - Target price : 490

    Publish date: OCTOBER 19, 2018

    Strong topline performance but cable business margins below expectations. Havells reported 2QFY19 EBITDA of ₹2.6 bn (+2% yoy), which was 10% below our estimates due to decline in margins in the cables segment driven by lead-lag impact of RM volatility. Revenue growth was strong at 23% yoy led by market share gain across segments and successful entry into new categories. Havells has built an impressive franchise, which will help it deliver strong double-digit earnings growth over the medium term. There is a lot to like in the company, except valuations. SELL stays.

    ▭ Havells reported 2QFY19 EBITDA of ₹2.6 bn (+2% yoy), which was 10% below our estimates due to lower-than-expected EBITDA margin. Revenues increased by 23% yoy (in line), which was driven by (1) 28% yoy growth in erstwhile Havells business (2-year revenue CAGR is 15%) and (2) 8% yoy decline in Lloyd revenues due to demand challenges in the AC industry.
    ▭ In terms of segments, revenue growth was driven by (1) 42% yoy growth in the ECD segment led by market share gains across segments and ramp-up of new categories such as water purifiers, water heaters, etc., (2) 28% yoy growth in the switchgear segment led by low base and increased traction in the industrial segment and (3) 35% yoy growth in the cables segment aided by growth in the industrial segment and price hikes. Lighting revenues were flat yoy due to negligible EESL revenues versus ₹450 mn in 2QFY18 (ex-EESL revenues grew 18% yoy).
    ▭ EBITDA margin came in at 12% (down 250 bps yoy), which was 130 bps below our estimates due to (1) 300 bps qoq decline in margins in the cables segment driven by lead-lag impact of RM volatility (margin would normalize in 2HFY19) and (2) weaker performance of the Lloyd business. Adjusted PAT at ₹1.8 bn (+4% yoy) was 9% below our estimates.

    Havells has a well-diversified product portfolio and it has built strong brand and distribution network over the years, which should enable it to penetrate deeper into existing categories and expand presence in newer segments. We believe that Havells has the potential to deliver strong double-digit revenue growth over the medium term. We build in 21% EPS CAGR over FY2018- 21E led by (1) 17% revenue CAGR and (2) 100 bps expansion in EBITDA margin.

    We cut our FY2019E EPS estimates to build in weakness in margins in 1HFY19. For FY2020- 21E, we lower our EPS estimates by 2%. While we like the company’s strong franchisee and premium brand positioning across segments, expensive valuations drive our SELL rating on the stock. DCF-based TP revised to ₹490 (₹485 earlier) on rollover to September 2020E EPS.
    ▶ Revenue growth in the cables and wires segment (+35% yoy) was driven by 20% yoy volume growth and 13% price increases. Demand is particularly strong in the industrial cables segment due to the government’s push in the infrastructure segment (rural electrification, railways, metro, etc.). Low base (revenues up 2% yoy in 2QFY18) also aided revenue growth in the segment. Contributions margins in the segment declined by 300 bps qoq to 14%. We believe this was driven by immediate price cuts in the market post recent decline in copper prices (down 7% qoq in rupee terms) while the benefit of reduction in RM cost will come with a lag of around two months. We expect segmental contribution margins to improve to 16-17% in 2HFY19.
    ▶ In the switchgear segment, 28% yoy revenue growth was driven by (1) low base (revenues down 5% yoy in 2QFY18), (2) increased traction in the industrial switchgear business due to the company’s increased focus and government focus on electrification, (3) strong growth in the modular switches segment led by replacement demand and possibly market share gains and (4) slight improvement in the residential segment. For the company, the residential segment accounts for 70% of segmental revenues while contribution of the industrial segment is 30%.
    ▶ In the electrical consumer durables (ECD) segment, revenues grew by 42% yoy (on base of 4% yoy growth in 2QFY18), which was driven by (1) continued strong growth in the premium fans category and market share gains for the company. Havells now has around 15% market in overall fans segment and 40%+ share in premium fans category, (2) strong growth in water heaters partly due to inventory build-up ahead of winter season. Havells has become one of the top three players in the water heater category, which is quite impressive, (3) acceptance of the company’s products in new categories such as air purifiers and personal grooming products and (4) pickup in demand for home appliances and market share gains for the company.
    ▶ In the lighting segment, EESL revenues were only ₹12 mn in 2QFY19 versus ₹450 mn in 2QFY18 and around ₹1.3 bn in FY2018. Ex-EESL revenues for the company grew by 18% yoy in 2QFY19 led by 30% yoy volume growth. In the EESL segment, we believe that pricing seems to have come down significantly because of which Havells has not participated in the bidding process. Due to lower mix of EESL revenues, segmental contribution margins improved by 260 bps yoy to 29.6%; we note that contribution margin in EESL business is only 6-7% for the company.
    ▶ Revenues of Lloyd business declined by 8% yoy and EBITDA margin came down to 3.3% in the quarter as compared to 7% in 2QFY18 and 8.1% in 1QFY19. Lloyd had a muted quarter owing to adverse season, channel inventory and forex headwinds. The company highlighted that industry has not seen price increases despite cost pressures. The company highlighted that it is continuously working on improving brand perception (through A&P spend and offering products with advanced features) and expansion of distribution network (both in terms of higher number of exclusive outlets and greater presence in large multi-brand outlets), which should drive market share gain over the medium term.
    The company is on track to commission its in-house AC manufacturing capacity by end- FY2019 with an initial capacity of 0.6 mn units and overall capex of ₹3 bn. We believe that this would help the company achieve greater control over product quality, reduce foreign currency exposure, expand product offerings (higher number of SKUs) and should also aid profitability.

    Definitions of ratings

    BUY - We expect this stock to deliver more than 15% returns over the next 12 months.
    ADD - We expect this stock to deliver 5-15% returns over the next 12 months.
    REDUCE - We expect this stock to deliver -5-+5% returns over the next 12 months.
    SELL - We expect this stock to deliver

    Our target prices are also on a 12-month horizon basis.

    Other definitions

    Coverage view. The coverage view represents each analyst's overall fundamental outlook on the Sector. The coverage view will consist of one of the following designations: Attractive, Neutral, Cautious.

    Other ratings/identifiers

    NR = Not Rated. The investment rating and target price, if any, have been suspended temporarily. Such suspension is in compliance with applicable regulation(s) and/or Kotak Securities policies in circumstances when Kotak Securities or its affiliates is acting in an advisory capacity in a merger or strategic transaction involving this company and in certain other circumstances.
    CS = Coverage Suspended. Kotak Securities has suspended coverage of this company.
    NC = Not Covered. Kotak Securities does not cover this company.
    RS = Rating Suspended. Kotak Securities Research has suspended the investment rating and price target, if any, for this stock, because there is not a sufficient fundamental basis for determining 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.

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