Stock Review: Voltas

 

 

Voltas is an air conditioning and engineering services provider. Its businesses can be segregated into three segments: electro-mechanical projects and services (accounts for 61 per cent revenue), engineering products and services (10 per cent revenue), and unitary cooling products for comfort and commercial use (29 per cent revenue). The company is controlled by the Tata Group which owns 30.61 per cent stake in it through Tata Sons and Tata Investment Corporation.

 

Industry overview

The two key industries that hold sway over the company's prospects are mechanical, electrical and plumbing (MEP), which the electro-mechanical projects and services segment caters to, and the air conditioning industry.
The MEP segment's outlook does not look bright in the coming one-two quarters. In India this industry is going through a subdued phase due to a glut in the supply of commercial realty projects. In the near term, visibility of fresh orders appears to be muted, with only a few top IT companies looking to set up new facilities. Internationally as well, especially in the Middle East, increased competition is undercutting the margins of existing players.
The air conditioning segment, on the other hand, is in a rapid growth phase. In 2010-11, the industry saw volume growth in excess of 20 per cent. Moreover, the air conditioning industry has a diverse user base comprising both commercial and retail customers. Hence, a slowdown in one industry gets offset by an uptrend in others. Moreover, seasonal demand has also started picking up from Q1FY12.

 

Strengths

Strong MEP order book: Voltas has an MEP contracting business order book of Rs4,700 crore, comprised of Rs1,600 crore from India and the rest from the Middle East and Singapore. According to the company, the outlook for the Middle Eastern countries where it operates continues to be positive with no signs of a crisis. Rather, the governments there are pushing for investments in their countries' infrastructure. Both Saudi Arabia and Oman have announced investment plans worth $50 billion each.

Opportunities in Singapore: The company's renewed focus on Singapore is evident from its aggressive bidding and its order pipeline (Singapore accounts for 10 per cent of its international order book). Singapore offers enormous opportunities as the government there plans to offer Rs15,000 crore worth of projects per annum in the infrastructure space between 2010 and 2013. Voltas has already established a track record of executing large iconic projects in Singapore.

Diversified operations: The company has operations in five countries: Abu Dhabi, Qatar, Oman, Saudi Arabia and Singapore. This gives it the advantage of balancing its order pipeline, as contraction in one region can be compensated for by expansion in another. For example, right now India is plagued with an oversupply in commercial realty, while in the UAE competition is not too high because of high entry barriers in the form of regulatory clearances. Similarly, Singapore fits in nicely in the company's international strategy as it helps negate the geo-political concerns arising from events in the Middle East.

Second-largest AC brand: In the last few years, Voltas has been able to leverage its brand to grow faster than the industry and has increased its market share from 12 per cent to 19 per cent today.

JV with KION Group: Volts and KION Group GmbH of Germany (the second largest player in industrial trucks globally) have entered into a joint venture in India for manufacturing and marketing forklift trucks and warehousing equipment. Voltas will manufacture material handling products, while marketing and selling will be dealt with by the joint venture company, Voltas Materials Handling, controlled by KION. This arrangement will help Voltas increase its revenue from the material handling segment (which was 2.6 per cent of total revenue in FY10).

 

Concerns

High dependence on the Middle East: Almost 90 per cent of the company's international order book comes from this region. So far the countries where it operates haven't been affected by the ongoing Middle East crisis, but the crisis could spread from one country to another. This raises the potential risk of operating in this region.

Rising material prices: Increase in prices of inputs like copper and steel could put pressure on Voltas's margins. However, Voltas has expressed confidence that it will be able to pass on the price hike. Even though the demand for air conditioners is strong and strengthens around April-May, the softening of sales year-on-year in Q4FY11 raises concerns regarding how much of cost inflation it will be able to pass on.

Higher working capital requirement: Voltas's working capital requirement has been rising progressively through FY09-10 because of factors like change in the nature of work, and longer approval cycle for projects. The company's project mix has changed from it being the main contractor in MEP projects to being a subcontractor in infrastructure projects. The longer certification and approval cycle is increasing its working capital requirements.

Rohini: Rohini Industrial Electricals (67 per cent subsidiary) is into the execution of large turnkey electrical contracts for power and industrial projects. It had entered into a number of large projects by bidding competitively. However, higher input costs have squeezed its margins. For the last nine months ending Q3FY11, it had a cumulative PBIT loss of Rs21 crore. The management expects to complete most of these unprofitable projects by March 31, 2011. FY12 will be a year of consolidation, with break-even coming in FY13. If due to execution delays the unprofitable projects spill over into FY12, then Rohini could once again drag down Voltas's performance.

 

Financials
Voltas has shown spectacular performance between FY05 and FY10. Its net worth expanded at 39 per cent (compounded annual growth rate) to Rs995 crore in FY10. At the same time, its bottom line grew at 47 per cent over these five years. It ended FY10 with a return on equity (RoE) of 39.93 per cent (5-year average 43.47 per cent). The management's endeavour to improve the company's performance is reflected in its rising operating margin. In FY06, its operating margin stood at 5.20 per cent; by FY10 it had increased to 10.79 per cent. Currently, it has an outstanding debt of Rs190 crore with a debt-equity ratio of 0.02.

In the trailing 12 months, Voltas has expanded its revenue by 13.52 per cent y-o-y, while its PAT has improved 29.60 per cent on the back of better operating profits. The order book of Rs4,700 crore provides revenue visibility for 19 months, which is adequate.

 

Valuation
Voltas is currently trading at 14.47 times its 12-month trailing earnings, while its five-year median P/E stands at 19.73. Moreover, its price-earnings to growth ratio stands at 0.67, well below the cut-off of one. Considering the company's potential and the opportunities available in the space that it operates in, we recommend that investors consider this stock for their portfolio with a three-year horizon.