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  • Stock Recommendation | SURYA ROSHNI LTD (SURL) – BUY – Target Price : 328

    Publish date: JANUARY 14, 2019

    We initiate coverage on Surya Roshni Ltd (SURL) with ‘BUY’ rating and a target price of Rs328 based on SOTP (Sum of the parts) valuation methodology. We believe that SURL valuations can get rerated on back of 1/ potential demerger of company’s consumer electrical and steel pipes business 2/ strong growth in company’s estimated consolidated profits through FY18-20E driven by a/ meaningful growth in fans & consumer appliance segments supported by improved penetration on the current lower base b/ stability in LED prices c/ recovery in the pipes business driven by improved public spending in infrastructure. We project c.18.7% CAGR between FY18-20 in consolidated profits from Rs.1.08 bn in FY18 to Rs 1.5 bn in FY20E, expect improved return ratios and balance sheet strengthening-building a case for stock re-rating. At current price of Rs 242, SURL stock is trading attractive -at 5x EV/EBITDA and 8.6x P/E on FY20E earnings.

    India’s Long-Term lighting/consumer appliances Story – Stays strong
    Data from ELCOMA shows that the lighting industry in India has been on the rise and would maintain growth at 16% CAGR between FY15-20. Growing at an exceptional rate (20% CAGR between FY18-20) to reach Rs 224 bn by FY20, Light Emitting Diode (LED) is now the dominant lighting technology across all applications.

    This transition has been driven by 1/ a swift change in technology globally towards cost/power efficient LED based solutions, 2/ increased affordability of LED bulbs, 3/ international mandate to arrest global warming 4/ massive government programs through EESL (Energy Efficiency Services Ltd) focused on changing street lights/commercial buildings light to LED and 5/ rural electrification augmenting demand in areas which were not present ever before.

    Second largest player in Indian Lighting Industry with dominating presence in tier-ii/iii cities and rural areas
    The company commands strong market positioning in tier ii/iii cities and rural India driven by its extensive reach across length & breadth of India. We tend to believe that Surya Roshni would likely outpace the industry growth, as tier ii/iii and rural parts of India are expected to remain buyout in the near to medium term. Various welfare schemes, introduced by the Indian government and rural electrification drive could potentially benefit company’s operations going ahead.

    Consumer Durable segment offers enormous potential to SURL
    Leveraging on its strong brand equity, SURL has also entered into consumer durable (CD) market in the fans (Domestic’ & Industrial) category in FY14. Commendably, in a short period of four years it could gain No. 6 position in the fan market on back of its wide categories of designer and colourful range of ceiling, pedestal & wall mounting fans.

    In FY15 company expanded its CD portfolio to include other contemporary electrical appliances (mainly brown goods) like- water heaters, room heaters, dry irons, steam irons, immersion heater and kitchen appliances like mixer grinder, induction cookers, toasters, glass cooktops etc.

    Despite intense competition from the domestic and international players, we believe that SURL has enough space to grow in this category, given large market potential and very little organized sector presence.

    Extensive distribution network across India
    The company has a strong distribution reach spread across India. Distribution franchise includes a wide network of over 2500 distributors and 2.5 lakh country wide retailers. This facilitates the company in rapidly scaling-up of new product into the market.

    SURL has a leadership positioning in various states such as- AP, Telangana, Madhya Pradesh, Chhattisgarh, Uttar Pradesh and Jharkhand. It also has a strong position in Karnataka, Delhi, Maharashtra, Bihar, Rajasthan and Uttaranchal.

    Recovery in steel pipes division; company likely to benefit from its marquee ‘Prakash Surya’ brand
    SURL has over four decades of presence and owns ‘Prakash Surya’ brand in the steel pipe industry. The company holds leadership position in ERW and Spiral API grade pipes which are used in transportation of oil and natural gas, city gas distribution, oil exploration, water pipeline etc.

    The company has commenced commercial production of 3LPe coated pipe unit at Gujarat. The facility provides an edge to the company in- ERW, Spiral, API, GI, 3LPE, OcTG, Section pipe, SCT, of various diameters /size due to its proximity to the port. This facility would also indirectly ascertain improved capacity utilization of Spiral/ API Pipes and saving in coating cost.

    We believe that the sophisticated manufacturing base and vast distribution network (with 70% of product sold through dealers network) makes SURL a unique play.

    Exports contributes to c.20% of Steel Pipes division revenues. While it has presence in more than 50 countries, it holds indomitable position in the GCC countries backed by ‘Prakash Surya’ Brand.

    High growth in revenue/PAT to flow into FY19/FY20; recovery in core business likely to aid to free cash flow generation
    We project growth at 13.9% CAGR between FY18-20 in revenues from Rs.49.3 bn in FY18 to Rs. 64 bn in FY20E on back of 1/ sustained (volume led and stable price) growth in lighting division, 2/ exponential growth in the consumer appliance segment supported by deeper penetration and lower base 3/ improving demand in the pipes business (including 3LPE coated pipes in oil and gas.

    We believe that the higher proportion of steel pipes sales would lead to margin contraction over FY19/20. Note that this trend does not speak adverse about company’s business as steel pipes business attracts lower margins than the lighting/CD business. In our projections, we build EBITDA margin at 6.7% and 6.6% in FY19E and FY20E respectively against 7% in FY18.

    In our projections, we build increased debt in FY19 (and subsequently reduction in FY20) driven by the increased working capital need in the pipe business. Note that our debt forecast does not include the advantages that can flow from channel financing.

    Rerating ahead- Conglomerate discount should get narrowed with the demerger of consumers and steel pipes business
    As per management, though at the nascent stage, company has been exploring the potential benefits/opportunities that can be achieved by the demerger of these two unrelated business. We believe that the corporate action would likely provide an enhanced focus on both the businesses and narrow the valuation gap of the B2C business vis-à-vis peer group.

    Attractive valuation; Initiate coverage on the SURL stock with BUY rating and a SOTP based target price of Rs 328
    At current price of Rs 242, SURL stock is trading at attractive valuation- EV/EBITDA 5 x (sharp discount to peer group, discussed later in this report). Going forward, we assume that the discount to the peer group would likely get bridged on back of 1/ improvement in company’s profitability and 2/ potential de-merger of the two businesses.

    We arrive at SOTP based target price of Rs 328 (implying 36% upside from current levels) and recommend ‘BUY’ on SURL stock.

    Key Concerns; 1/ fluctuation in input price can likely have a diminishing effect on company’s margins (mainly in pipes business) 2/ company has been trying to revamp its brand image in the urban areas to target the youth population in the premium segment. A weaker branding initiative can potentially disrupt company’s growth plans.

    BUY - We expect the stock to deliver more than 12% returns over the next 12 months
    ACCUMULATE - 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.

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