Voltas

Stock Seen Moving In Tandem With Financial Performance, Trades At A PE Of 21
THE stock price of the engineering service provider, Voltas, halted from a declining trend of the past two weeks. Since early March, the stock price has increased more than five times, with most of the gains coming in the quarter ended June 2009.

Thus, Voltas stock performance seems in line with the company’s financial performance in the past three quarters. The adjacent chart compares net sales against net profit margin since the year ended September 2007. As can be seen with a significant jump in net sales in the year ended March 2009, the profit margin has gained momentum during the past four quarters.

For the quarter ended September 2009, the company reported a jump of about 11% in the net sales to Rs 1,098 crore compared to last year. However, the operating profit — profit before interest and depreciation — during the period jumped by more than 60% to Rs 119 crore. Net profit for the quarter has increased by about 48% y-o-y to Rs 91 crore.

The biggest contributor to the revenues as well as profit was the electro-mechanical projects and services business segment, which showed an average contribution of about 49% to each. On the other hand, the engineering products and services division continued to show a dismal performance because of a slowdown in the demand for capital equipment. The company designs and manufactures machine tools, mining & construction equipment and sells textile machinery under this division.

The Unitary cooling division, under which Voltas manufactures and markets cooling appliances and commercial refrigeration products, grew by 25% in the past quarter. The division accounts for about 18% of the company’s revenue, but its contribution to bottomline is much lower. In coming quarters, the company expects the electro-mechanical projects and services to remain the growth driver as the order book for the same stood at about Rs 4,300 crore. At the current market price, the stock is however trading at P/E of more than 21, which is higher than its average for 2008.

Voltas

A recovery in demand and robust order book augur well for Voltas

For now, the worries haven’t vanished totally and some concerns still exists, which pertain to the slowdown in the international operations (contributes 60 per cent to the project business); largely the gulf countries. For instance, during 2008-09, there was a 40 per cent contraction in flow of new orders from international markets, which analysts attributed to slow down in capital expenditure, particularly by crude oil producing countries due to lower oil prices.

In comfort zone

But, given the company’s current order book of Rs 4,700 crore, the same is good enough for the company to maintain a revenue growth at about 20 per cent this year. And, for the next year and beyond, if the recent improvement in the economic environment is sustained (including the rise in crude oil prices, which have crossed to $70 per barrel), then expect Voltas’ order book to swell further. Notably, the management, too, has guided for robust order inflows from countries like Qatar, from 20.5 per cent in 2007-08 to 11.6 per cent in 2008-09. While a meaningful recovery could take another 2-3 quarters, analysts believe that the company’s move to cut down its inventory levels coupled with the recovery in industrial activity and winning of an Rs 210 crore order for mining equipment from Hindustan Zinc, are all good signs. Nevertheless, the segment holds good long-term prospects.

Evolving opportunities

Meanwhile, the company’s second largest revenue contributor (22.5 per cent of sales) is the unitary cooling systems division, which includes residential and commercial ACs, commercial refrigeration and water coolers. This business is expected to report stable 10-12 per cent revenue growth on a sustainable basis. During 2008-09, revenues grew by 11.3 per cent, while operating profit margins were up at 7.4 per cent, albeit marginally. Although this is a highly competitive segment, the company is among the leading players (second in AC segment). In light of the rising income levels of individuals, increasing affordability, higher availability of electricity and demand from the commercial office and retail segments, the long-term prospects of this business too are good.

Outlook

The company operates in three growing segments, where the penetration levels are still low in India compared to some of the international markets. Its leadership in these segments and increasing focus on expansion into foreign markets should help it sustain healthy growth. Attributes like consistent revenue track record, regular dividend payments and negligible capex needs put the stock in better light. The stock trades at 16 times and 13 times its estimated 2009-10 and 2010-11 earnings.

Synonymous with air-conditioning, Voltas once again proved its mettle in the electromechanical project business when it bagged two larger orders worth Rs 300 crore pertaining to the Chennai and Kolkata airports. This comes immediately on the back of a good set of results declared on May 29. These events have led to the stock rising 35 per cent as against the BSE Sensex’s four per cent gain since then. For those who think they might have missed the bus, don’t lose hope as there is scope to make healthy returns in the long-run. Larger than perception

Many people view Voltas as an air conditioning (AC) company. Yes, it is a dominant player in the commercial and residential AC segment, but there’s a lot more to it. Post it’s restructuring in 2003, Voltas increased its focus on the engineering segment to emerge as a niche player in the electro-mechanical projects (MEP) and services business. This segment includes complete turnkey solutions for work related to central air-conditioning (airports, malls, offices, etc), refrigeration and solutions for water treatment and management.

The move helped Voltas de-risk its revenues as well as reduce its dependence on the low margin business, where stiff competition and seasonality were among concerns. It has also helped the company reach higher scale and tap upcoming opportunities in the projects business, where profit margins are relatively better.

The recently won orders worth Rs 300 crore for electro-mechanical work at the Kolkata and Chennai international airports is in addition to similar orders won in the past. For instance, while Voltas completed the project for the new Hyderabad international airport last year, it has completed similar projects for the worlds largest passenger terminus of Hong Kong International Airport as well as the Mumbai airport. Going by the various estimates, the opportunities in this segment is huge as the government is also planning to invest in over 30 new non-metro airports besides, modernising existing airports of the country.

There are equally large long-term opportunities in segments like metro railways (stations), shopping malls, hospitals, hotels, education institutes, corporate buildings, high rise towers, multiplexes and cold storage. The company has already has a successful track record of having executed several projects in these segments. However, over the last one year, analysts were worried about the slowdown in these segments and the impact of high raw material prices on the company’s profit margins. But, the MEP segment, which accounted for 62 per cent of total sales, reported a revenue growth of 53.7 %

VOLTAS

VOLTAS IS a major engineering service provider whose operations is organised into four independent strategic business units. Under the engineering products and services segment, the company designs and manufacturers, machine tools, mining & construction equipment and sells textile machinery. About 80% of the revenues from this segment comes from manufacturing of forklift, trucks, cranes, warehousing equipment and construction equipment and sale of accessories, spare parts and maintenance services, while the rest 20% comes from commission income.

The company provides electrical, mechanical, HVAC and refrigeration solutions under the EM projects and services division.

Water treatment and management is also a part of this business, which contribute the most to the total revenues and profits.

Cooling appliances and commercial refrigeration products are manufactured and marketed under unitary cooling products division. The company is also in chemicals trading business, but it contributes less than 1% to the top line. Voltas earns 5% of its revenues from its foreign operations, which mainly include execution of projects in Middle East, Far East and South East Asia.

FINANCIALS

The company posted a 29% growth in revenue during December 2008. In comparison, total operating expenditure during the quarter was up by 33% YoY. This resulted in contraction in its operating margin which hit its bottom line. On expense side, the employee cost rose over 40% in year ended December 2008.

GROWTH STRATEGY

In last few years, it has changed its business strategy to emerge as a one stop solution provider rather than a manufacturer. The strategy has paidit handsomely. At the end of September ‘08, its domestic order book in EM projects and services segment stood at Rs 1,000 crore, while international order book stood at Rs 4,500 crore with an average completion cycle of 24-30 months. For the domestic market, the company has formed industrial verticals in order to focus on areas like airports, power and steel, which are likely to have sustained growth.

RISKS

Historically, Volta’s tends to sit on higher inventories, which depressed its cash flows. In last few years, it has cleaned up its act but, its cash flows from operations continues to be erratic. The company is a big importer of equipment and cooling products. The recent depreciation in the rupee raised the cost imported goods which hurt its profitability. Bulk of Voltas’ overseas business is in West Asia especially UAE and Qatar. The global credit crisis and falling crude oil prices has hit these economies hard leading to a slowdown in construction activities. This will have an adverse impact on Voltas’s earnings in next few quarters.

TO SUM IT UP

Volta’s is expected to take a hit on its earnings and profitability thanks to its high exposure to the gulf countries as well as slowing construction and engineering activities in domestic market. The company earns substantial non-operating other income from recurring rental income and investment of surplus funds. However, this segment is likely to hit due to a gloomy realty sector and fall in yields across asset classes. It doesn’t have a track record of higher dividend pay. However, with a higher beta, the company could turn out a well fit for risk-loving investors.

Beta: 0.94
Institutional Holding: 26.54%*
Current dividend Yield: 3.34%
Current P/E 5.45
Current m-cap: Rs1337 cr

Stock views on Transformers & Rectifiers, State Bank of India, Voltas

India Capital Markets on Transformers & Rectifiers - Target Rs 160


India Capital Markets has recommended a buy rating on Transformers and Rectifiers (India) with a target price of Rs 160 in its research report. "TRIL’s revenues from furnace transformers have risen from Rs 205 million during fiscal 2005 to Rs 450 million during fiscal 2008. The Company has registered a top line growth of 41.65% y-o-y. The Company has also been able to achieve a growth of 26.25% at the net profit level. With the metal prices coming down we expect the net profit margin to stabilize around 9%-10% in the coming years. We recommend BUY with a target price of Rs 160 based on a P/E multiple of 4x its FY 10 earnings. We believe the company offers decent opportunity to play on the India T&D sector story," says India Capital Markets' research report.


Sharekhan on State Bank of India - Target Rs 1516

Sharekhan has maintained its buy rating on State Bank of India, SBI with a price target of Rs 1,516 in its research report. "During the year-to-date period in FY2009, the SBI has witnessed a strong 40%+ growth in its core fee income. This could be attributed to the strong credit growth coupled with better product offering to its clients due to technological advancement. SBI is confident of maintaining this high growth momentum in its core fee income in the quarters to come. The bank has restructured around Rs 2,000 crore worth of loans during the current year till date period. We maintain our Buy recommendation on the stock with a price target of Rs 1,516," says Sharekhan's research report.


PINC Research on Voltas - Target Rs 55

PINC Research has recommended a buy rating on Voltas with a price target of Rs 55 in its research report. "Voltas Ltd has a high cash generating business model. Cash from operation has been positive in the last three years. Cash & Bank balances and current investments were Rs 3 billion & Rs 2.3 billion respectively at the end of FY08. Robust order book for MEP/HVAC segment with significant presence in Middle East market coupled with diversified business model, Voltas has the potential to post revenues at a CAGR of 21% for the next two years. Hence, we recommend a ‘BUY’ with a price target of Rs 55 on a 12 month investment perspective," says PINC's research report.

Stock Views on VOLTAS, CORPORATION BANK, STERLITE INDUSTRIES, INDIA CEMENTS, IRB INFRASTRUCTURE

CITIGROUP on VOLTAS - RATING: SELL

CITIGROUP rates Voltas as ‘sell/medium risk’ with a target price of Rs 121. Voltas, a Tata group company, is the market leader in India’s heating, ventilation and air-conditioning (HVAC) segment, having 28% market share in electromechanical projects. But domestic demand is decelerating across all its divisions. Citigroup sees increased risk to the company’s earnings if the market environment worsens. It expects overall margins to be in the range of 7.5-8.3% over the next three years. Voltas’ target price is set at 15x September ’09E forward EPS and is supported by forecasts of 27% earnings CAGR for FY07-10E and 29-33% return on equity (RoE). At 15x September ’09E, Voltas will trade at a discount to power equipment stocks like Bhel and engineering & construction companies such as L&T. The 15x September 09E multiple is lower than the average one-year forward P/E of 22x over the past three years — reflecting reduced growth outlook. Key downside risks include: international projects risks, termination of principal agent relationships, increasing competition in domestic and international markets, manpower shortages and material prices. Key upside risks include: stronger-than-expected performance driven by the international business, and turnaround of the domestic operating environment.

INDIABULLS SECURITIES on CORPORATION BANK - RATING: BUY

INDIABULLS Securities reaffirms its ‘buy’ rating on Corporation Bank with a target price of Rs 335, which is 21% more than its current market price. The bank’s operating profit grew by a healthy 16.5% y-o-y in Q109. But net profit grew by merely 4.1%, primarily due to mark-to-market (MTM) losses during the quarter. While growth in net interest income (NII) was hit due to compression in net interest margin (NIM), other income, which grew at 14%, supported growth in operating profit. An increase in business productivity reduced operating expenses, further improving profitability. But pressure on NIM may ease in the next few quarters as the bank hiked its benchmark prime lending rate (BPLR) by 50 bps in August. Moreover, the CASA ratio has been improving consistently on the back of an aggressive increase in the number of branches. This should help maintain, if not increase, the bank’s NIM. There has been a sequential reduction in the bank’s net and gross NPAs. The bank is likely to maintain its asset quality, given that it is not aggressively focused on the priority sector.

MERRILL LYNCH on STERLITE INDUSTRIES - RATING: NEUTRAL

MERRILL Lynch remains ‘neutral’ on Sterlite Industries due to weak zinc outlook. The long-pending decision on the Lanjigarh bauxite mines in Orissa finally came through in Sterlite’s favour. This development is more positive for the parent company, Vedanta Resources, than for Sterlite. But it will have a positive impact on Sterlite too. The approval for the mine indicates the promoter group’s ability to execute growth projects in the country, where mining approvals are typically difficult to secure. Vedanta is setting up a 1.1-million tonne (mt) alumina refinery and 500-kt ally smelter in Orissa. Lanjigarh bauxite mines have estimated reserves of 77 mt and are located 5 km from the refinery. Sterlite will mine the bauxite and sell to Vedanta on a transfer pricing basis. The mine development is expected to take around nine months and will make Vedanta a fully integrated low-cost producer of ally. The benefit from this project is relatively small for Sterlite, since it has only a 29.5% stake in this project, and it will account for a mere 5% of Sterlite’s consolidated profit in FY10. Sterlite is trading at 11.1x FY09E. On MTM spot zinc price of $1,733/tonne, it is trading at 13x FY09E. Merrill Lynch believes the sharp year-to-date stock correction already factors in the zinc price crash. Given that zinc prices are now lower than the marginal cost of production, Merrill Lynch believes the probability of supply closures is rising. In addition, speculation on minority stake buyouts in the company’s zinc and aluminum subsidiaries is building up.

JM FINANCIAL on INDIA CEMENTS - RATING: HOLD

JM FINANCIAL recommends ‘hold’ rating on India Cements (ICL) and values the company at a target enterprise value/tonne of $100 to arrive at its June ’09 target price of Rs 168. JM Financial expects 20.3% and 13.2% yo-y growth in revenue for ICL in FY09E and FY10E, respectively. EBITDA is estimated at Rs 1,060 crore and Rs 1,070 crore in FY09E and FY10E, respectively, resulting in EBITDA margins of 29.0% and 25.7% in that order. ICL undertook corporate debt restructuring (CDR) in FY03, when the cement industry was passing through difficult times and ICL had debt:equity of 4.4x. As the cement sector’s prospects improved, ICL repaid most of its debt and its debt:equity stood at 0.5x in FY08. Subsequent to the CDR, the company has done equity issues that have led to a large capital base, thereby lowering sustainable return on capital employed (RoCE) at the corporate level to 11.8%. ICL is the key player in the South, where it enjoys higher realisations and consumption growth of 11.74%, compared to the all-India growth rate of 10% in FY08. ICL currently trades at 5.7x EV/EBITDA, P/E of 8.1x and EV/tonne of $98 for FY10.

LEHMAN BROTHERS on IRB INFRASTRUCTURE - RATING: OVERWEIGHT

LEHMAN Brothers initiates coverage on IRB Infrastructure Developers with an ‘overweight’ rating and a March ’09 price target of Rs 195. IRB is one of the largest road developers in India, and has 14 BOT road projects. The company’s key strength is its in-house construction capability that enables it to capture the entire economic value of road projects, and helps it to address execution risks. Historical projects have yielded substantially high-equity internal rate of return (IRR). IRB has strong cash flows and low leverage compared to other international road developers. Its operating cash flow is strong and will improve further after commissioning of the Bharuch-Surat and Surat-Dahisar stretches. Lehman estimates cash flows before capex at Rs 1,200 crore over FY09-11. The increase in cash flow is driven primarily by a rise in toll revenue. The net debt-to-equity ratio for IRB is only 0.9, and leverage is likely to remain comfortable at 1.3 in FY10. Lehman values IRB at: (1) Road concessions at Rs 129 per share; (2) Rs 36 per share as growth factor to account for potential new projects; (3) Construction business at Rs 26 per share based on a multiple of 10x FY10 earnings estimate of Rs 87 crore; and (4) Real estate at Rs 3 per share. The stock is currently trading at a multiple of 9.4x FY10 earnings estimate of Rs 520.5 crore and 2.1x FY10 book value of Rs 2,372 crore, and at a substantial discount to its global peers. The stock is currently trading at 1.08x concession portfolio NAV of Rs 4,293.8 crore, implying that not much value has been attributed to construction, real estate and future growth opportunities in road concessions.