Demand risks likely to keep Havells India stock under pressure

The company also faces margin headwinds due to rise in raw material costs

The stock of the country’s largest fast moving electrical goods maker, Havells India fell 9.5 per cent in trade over the last couple of trading sessions. In addition to the market selloff, margin pressures in the December quarter (Q3FY22), impact of future price hikes on demand and weak position of Lloyd led to the dip.

The key disappointment in the quarter was the 400 basis points y-o-y drop in operating profit margins to 12.1 per cent as compared to estimates which pegged the same 200 basis points higher. The pressure on margins, which was felt across segments, was on account of sharp rise in raw material costs, delayed price hikes and unfavourable product mix.

While margins of cable and wireless, the largest segment accounting for a third of sales, was down 90 basis points, the metric for lighting and fixtures and switchgears was down by 170-210 basis points respectively. Electric consumer durable segment saw a steeper fall of 520 basis points. Lloyds made losses at the operating profit level on the back of low volumes and higher costs related to a new washing machine plant.

Even as advertising expenses came back to normal levels, the impact on operating profit margins would have been much higher but for the cost cutting measures taken by the management. It was the cut in other expenses that helped limit the margin impact at the operating level to 400 basis points, while gross margins were down 580 basis points.

The margin trend going ahead will depend on demand trends, price hikes and the movement of commodity prices. Achal Lohade and Shrenik Bachhawat of JM Financial highlight that commodity price pressure continues to remain unabated with copper prices gaining 3 per cent on a sequential basis in the previous quarter. They believe that partial pass through of cost inflation will continue to hurt margins in the short term. The brokerage has cut its FY22 estimates of the company to reflect the pressure on margins.

On the revenue front, strong festive demand and price hikes led to a 15 per cent y-o-y growth on a strong base. The demand momentum was strong given the uptick in real estate and higher industrial and infrastructure activity. Demand however softened towards the end of the quarter and weakness has continued in January. Inventory levels are low which coupled with hopes of a revival in demand could drive volumes going ahead. Analysts at Nomura however believe that there are risks to consumption demand due to further price hikes required across segments on rising commodity costs. They expect the recovery of business to business segment, which is positive from the revenue standpoint though it is negative for the margin profile.

The Lloyd’s business continues to be under pressure. Severe competitive pressures in the room air conditioner (RAC) space meant that the company was unable to take price hikes. It reported a loss of Rs 42 crore at the operating level as compared to a profit of Rs 31 crore at the year ago level. The company expects demand in the RAC segment to be strong on a low base and loss over the last two peak seasons due to Covid.

Despite the price correction, the stock is trading at 51 times its FY23 earnings estimates. This is at a premium to the long term average of 37 times. Given the gradual passing on of price hikes, near term demand and margin headwinds, investors should await progress on these issues before considering the stock.