Durable goods stocks

Higher aspirations, rising income levels and easy availability of consumer finance have led to boom times for consumer durable stocks.

By general consensus, the current rally, which has seen the markets soaring well above the 7,000 mark for the first time, has been a broad-based one.

Though mid-caps have been the flavour of the season for the most part, no sector has dominated investor mindset unlike the previous rally when IT stocks dominated the investor wallet share.

Even then, it would be wrong to assume that no sector has outperformed the markets in a big way. The prize for the top performer in the past 12 months goes to the consumer durable sector.

Consider this. The BSE Consumer Durable (CD) Index has risen 131 per cent in the past one year. The next best index performer was the CNX Midcap 200 Index which went up by 99.64 per cent.

In comparison the Sensex and the Nifty gained 44.17 per cent and 39.10 per cent respectively.

The stocks in the sector have been on fire. Titan Industries, the stock with the highest weightage in the CD index at 42.09 per cent, rose nearly 275 per cent in the past year. The stock prices of the next three in terms of weightage in the index "� Videocon International, Blue Star and Samtel Colour Systems "� also witnessed big spurts.

What are the reasons behind this big interest in the sector? The burgeoning middle class and the higher spending power of Indian consumers, for starters.

Needless to say the overall economic growth witnessed in the last few years has rubbed on the consumer durable sector, too.

Market capitalisation wise, the BSE CD index is only a minuscule percentage of the Sensex. The Sensex market-cap stands at Rs 9,22,231 crore compared to Rs 4,286 crore of the CD index.

Valuations are also cheap in the sector. The CD index P/E is at 10.43 compared to 15.50 for the Sensex. "The sector valuations are pretty low, which meant as the market moved up stocks in the consumer durable segment had to catch up," notes Rajat Jain, chief investment officer of Principal Mutual Fund.

Domestic mutual fund interest in the segment still remains pretty low, though it has gone up from the previous year. In May, 2004 the total market value of mutual fund investments in the consumer durables sector amounted to Rs 30 crore; it currently stands at Rs 46.13 crore, a rise of nearly 54 per cent.

According to Jain, there are several reasons for the improvement in the sentiment in the consumer durable sector.

"Downtrading seems to have stopped and people are moving up the value chain in terms of their spending preferences. This has led to considerable volume growth." Jain also that pricing pressure on consumer durable companies has also eased of late.

Key segments

The Rs 200,00-crore Indian consumer durables industry, of which the white good segment is the biggest, can be broadly classified into three segments "� television, refrigerators/air conditioners and washing machines.

The Indian television industry is estimated to have a size of Rs 9,600 crore, with the colour television (CTV) segment accounting for Rs 9,100 crore and black and white (B&W) television segment at Rs 500 crore.

After CTVs, refrigerators constitute the second-largest product segment within the industry with an annual turnover of Rs 3,900 crore.

The size of the air conditioner segment is Rs 2,400 crore while the total washing machine sales amount to Rs 1,100 crore. There is also a sizeable market for video/audio products apart from home appliance products.

According to a report by ORG-Gfk's (a joint venture between AC Neilsen ORG-MARG and Gfk Asia), the Indian consumer durable industry grew 6 per cent in 2004. "Growing affluence across demographic groups, easier credit financing and the sheer explosion in the variety of product offerings have created a propulsion for offtake," notes Bhuwan Singh, associate director of ORG-Gfk.

The increasing demand has not been without reason. "Durable marketers have addressed the two key issues of affordability and availability with heightened focus," notes Singh.

According to the report, value-for-money products, boosted by sustained consumer and dealer schemes within smaller markets, are likely to be carried forward, fueling growth through the current year.

Apart from the main companies, which cater directly to the consumer, there are firms like Samtel Color "� which is the largest domestic manufacturer of colour picture tubes "� in the sector.

Another segment is watch, clock and jewellery. The Indian watch market is about Rs 2,400 crore, though only 50 per cent of it is in the organised sector, where Titan Industries is the dominant player.

The gold jewellery market is estimated to be around Rs 45,000 crore, with players like Rajesh Exports and Su-Raj Diamonds dominating the organised segment.

Titan has made a mark in the jewellery sector, too, through its jewellery division Tanishq from where it derives about half of its revenues.

The personal computer segment is another growing sector, with players like HCL Infosystems, Zenith Computers and PCS Industries being the leading players.

It is estimated that sales of personal computers grew by only 20 per cent in FY05 (36.3 lakh units) after two consecutive years of over 30 per cent growth.

Shrinking margins

The durables market has also been witnessing wide-ranging price rationalisation as foreign competitors like LG and Samsung invaded the Indian markets and went on to dominate.

Latest estimates suggest that LG has hiked its market-share in refrigerators from nearly 19 per cent in FY02 to 29 per cent in FY05, while Samsung has moved up from 7 per cent to over 11 per cent.

Similarly in the washing machine segment, LG's share has moved from up from 24 per cent to 35 per cent whereas Samsung has increased its pie from 12 per cent to 14 per cent.

Analysts note that as a result of the entry of multi-nationals since the 1990s, the Indian consumer durables industry has become highly competitive, which has led to significant price erosion over the past few years.

Besides, increased consumer choices led to reduced brand loyalty, which resulted in lower pricing power for durable manufacturers.

The financial performance of players in the industry has been characterised by declining price realisations and shrinking margins.

For example, the net margin for Blue Star for FY05 stands at 6.28 per cent, while it was even worse at 5.71 per cent in FY04. The corresponding figures for Videocon International stand at 4.45 per cent (FY05) and 2.91 per cent (FY04) respectively.

However, things are expected to improve at least in the near future. The ORG-Gfk report notes that the sharp drop in price points appears to have halted towards the end of the year (2004), led primarily by an increase in the input costs of household appliances.

The report also notes that while prices have shrunk, volumes have shot up which enabled durable companies to keep their heads above water.

It notes that in a country like India, where affordability is the key to expanding the consumer base, value growth and volume growth are often at cross purposes.

"As price realisation slows down value growth for the market, volume growth must move up to compensate. Fortunately for Indian durables market, this has happened."

The outlook

Analysts point out that demand for the consumer durable industry in India is very low compared to the rest of the world.

For example, penetration level of television sets in India is about 25 per cent compared to 98 per cent in China and 333 per cent in the US. Penetration levels in the refrigerator segment are also pretty low at 2 per cent.

Considering the low penetration levels, analysts are optimistic about future growth. This is especially true when one considers that India has a big middle-class population with rising income levels and growing aspiration levels.

This coupled with the easy availability of consumer finance is expected to drive demand for consumer durable companies.

CTV, AC to see big growth

While the sector has performed well recently, the outlook is even better. According to estimates, CTV and AC segments are expected to grow the maximum.

One estimate puts the expected growth rate in the CTV segment at 10-15 per cent, while ACs are likely to grow by 20 per cent.

In contrast, refrigerators and washing machines are expected to record a moderate growth of 5-10 per cent.

According to a report by the Federation of Indian Chambers of Commerce and Industry (Ficci), the consumer durable sector is among the two (the other being capital goods sector) poised to attain double-digit growth in Q1 FY06, though the actual figures are yet to come in.

According to the report, personal computers were set to record the highest rate of growth at 30 per cent compared with air-conditioners (20-25 per cent), colour TV sets (15-20 per cent), watches, clock, leather and leather products (10 per cent), and refrigerators (10-12 per cent).

Washing machine segment was expected to grow only 5-10 per cent, while B&W TV sets were expected to see a negative growth of 20 per cent.

Within the various segments in the industry, customers prefer technologically upgraded versions of existing products, which means companies that are quick on the uptake on the innovation front stands to gain more market-share than the others.

According to Krishnamurthy Vijayan, chief executive officer of JM Financial Mutual Fund, the fortunes of consumer durable companies depend a lot on technological innovations they are able to bring in on their products.

"Those who are able to provide quality products and very good after sales services are likely to dominate in the days ahead," he notes.

In short, the bulging middle class population and their increasing spending power allied to higher aspirations are likely to give a fillip to the consumer durable market.

However, on the downside, increasing competition and lower price realisations may hit the margins of domestic companies "� at least in the short to medium term.

"Our outlook is that it is for the consumer durable segment to grow in line with the markets," says Jain.

The big three

Titan Industries "� ticking, finally
Titan Industries is India's leading watch manufacturer. Its business activities cover watches, clocks and jewellery. Titan markets watches under the Titan and Sonata brands.

It enjoys a 25 per cent share of the domestic market and close to a 50 per cent share among nationally recognised brands. 

Titan Industries
Rs crore	Q4FY05	Q4FY04	% chng	FY05	FY04	% chng
Net sales	331.31	287.5	15.24	1134.66	958.52	18.38
Other income	0.65	0.66	-1.52	2.73	2.09	30.62
Operating profit	59.73	48.65	22.77	118.05	99.99	18.06
OPM (%)	18.03	16.92	111bps	10.4	10.43	-3bps
Net profit	14.88	9.49	56.8	24.95	11.18	123.17
NPM (%)	4.49	3.3	119bps	2.2	1.17	103bps
EPS (Rs)	3.29	2.04	-	5.15	1.75	-
Trailing 12-month P/E		56.53

Titan Industries posted a net profit of Rs 24.95 crore in FY05, up 123.17 per cent compared to FY04. Net sales improved 18.38 per cent to Rs 1,134.66 crore.

The company has reduced its debt to Rs 320 crore as of March, 2005 from Rs 410 crore in March, 2004 and expects debt levels to decline to below Rs 300 crore in FY06.

Both the watch and jewellery divisions recorded significant increases in their sales and profits. The watch division's sales income grew 13 per cent, going up from Rs 534 crore to Rs 601 crore, while jewellery division recorded a sales growth of 26 per cent to Rs 535 crore in FY05.

The company is expected to make and market over 7 million watches in 2005, making it the sixth-largest global player in the category of 'manufacturer brands'.

At a trailing 12-month P/E of 50x, the stock is considered expensive. However, considering the potential upsides, many analysts have chosen it as the best pick in the sector.

Blue Star "� it's cool
Blue Star is India's largest central air-conditioning firm with a market-share of 30 per cent. It also has a 5 per cent share in room air-conditioners.

It manufactures and markets air-conditioning and refrigeration systems and products. These include large central air-conditioning plants, packaged air-conditioning systems, and split and window air-conditioners apart from commercial refrigeration equipment such as water coolers, deep freezers, etc. 

Blue Star
Rs crore	Q4FY05	Q4FY04	% chng	FY05	FY04	% chng
Net sales	312.42	250.67	24.63	920.77	697.46	32.02
Other income	7.07	11.81	-40.14	10.15	18.8	-46.01
Operating profit	25.82	22.1	16.83	57.85	39.8	45.35
OPM (%)	8.26	8.82	-55bps	6.28	5.71	57bps
Net profit	20.88	20.52	1.75	39.16	32.55	20.31
NPM (%)	6.68	8.19	-151bps	4.25	4.67	-42bps
EPS (Rs)	11.61	11.41	-	21.77	18.1	-
Trailing 12-month P/E		14

The company reported a 32.02 per cent rise in net sales in FY05 to Rs 920.77 crore, whereas net profit improved 20.31 per cent to Rs 39.16.

Blue Star is setting up its fourth manufacturing facility in Himachal Pradesh at Rs 30 crore, which should help it get a higher market-share in the air-conditioning segment.

Trial production in the new unit, being established for making room air-conditioners, is expected to commence in October, 2005. The stock trades at a 12-month trailing P/E of 14x.

Videocon International "� colourful
The company has been in the thick of news in the past few days. First came it's acquisition of the colour tube manufacturing business of France's Thomson SA.

The deal was struck for euro 240 million, which in rupee terms translates to about Rs 1,265 crore. Last week, the Videocon group expanded its global footprint by acquiring the business interests of Swedish white goods company AB Electrolux (ABE) in India. 

Vidoecon International *
Rs crore	Q2FY05	Q2FY04	% chng	FY04	FY03	% chng
Net sales	1135.26	1043.68	8.77	3990.4	3601.53	10.8
Other income	3.82	1.58	141.77	7.49	2.69	178.44
Operating profit	160.95	159.57	0.86	607.48	569.39	6.69
OPM (%)	14.18	15.29	-111bps	15.22	15.81	-59bps
Net profit	50.34	46.48	8.3	177.48	104.94	69.13
NPM (%)	4.43	4.45	-2bps	4.45	2.91	153bps
EPS (Rs)	7.07	6.53	-	24.92	14.95	-
Trailing 12-month P/E		2.7
* Fiscal year ending September 30

In return ABE will invest $94 million (Rs 410 crore) in Videocon Industries' GDR plans. The Swedish partner will have a stake of 5 per cent in Videocon Industries.

The Videocon group has also decided to merge Videocon International with Videocon Industries, which has interests in oil and energy sectors at a swap ratio of 1:5.

The combined market capitalisation of the two companies stood at around Rs 9,500 crore. The merger is in line with the group's plan to bring all the Videocon companies under one umbrella.

For the quarter ended March 31, 2005, Videocon International posted an 8.30 per cent rise in profit to Rs 50.34 crore on sales of Rs 1,135.26 crore.

Sales rose 8.77 per cent. While the consumer electronics division posted a 10.08 per cent rise in sales to Rs 3,297.99 crore, the glass shell (used in the manufacture of TVs) business reported a 14.33 per cent rise in revenues to Rs 692.48.

Analysts note that it is still early to see how the new developments will play out. Constantly falling market-share has capped the stock performance to an extent, Videocon International's 12-month trailing P/E is pretty low at 3.13, but with the new developments the stock could be in focus. But analysts prefer to wait and watch.

 

Research Calls

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KARNATAKA BANK
(buy, target price: Rs 124)

Motilal Oswal Securities has recommended a 'buy' on Karnataka Bank, noting that a steady growth in balance- sheet, coupled with firm margins and lower provisioning requirement will drive earnings going forward.

With the technology infrastructure in place, the bank is targeting a growth of over 20 per cent in its loan-book and 16-17 per cent in its deposit base.

Motilal Oswal notes that net NPAs are expected to decline further on the back of controlled slippages and aggressive recoveries.

According to a report, current RBI norms make it difficult for any foreign bank or any corporate to acquire Indian banks.

As such, Karnataka Bank is likely to be the most sought- after bank if takeover of banks is allowed as it offers an ideal platform of 385 branches, an 'in place' technology platform and a clean loan-book.

The firm expects an earnings growth of 20 per cent in FY06, followed by a growth of 16 per cent in FY07.

JUBILANT ORGANOSYS
(buy)

Edelweiss Capital has reiterated its 'value buy' call on pharma firm, Jubilant Organosys. Jubilant had recently acquired Trinity Laboratories, along with its wholly owned subsidiary Trigen Laboratories.

The company will pay $24.72 million for a 75 per cent stake. Edelweiss notes that the acquisition is synergistic, as Jubilant's APIs will provide the backward integration for the formulations.

This gives Jubilant access to the hitherto untapped US market that should help it take its pharma business to the next level.

The acquisition also gives Jubilant access to formulations via the FDA-approved plant of Trinity, increasing its presence in the last link of the value chain.

According to an Edelweiss report, the new deal will be earnings-accretive from the first year itself. The firm has also increased EPS estimates marginally from Rs 63 to Rs 65 for FY06 and from Rs 90 to Rs 95 in FY07.

INFOSYS TECHNOLOGIES
(buy, target price: Rs 3,000)

CLSA has recommended a 'buy' on Infosys, noting that it will lead the sector with a 29 per cent earnings CAGR over FY05-08.

According to a report, timely investments in new services, an efficient cost model and superior client mining abilities have driven the Infosys 'differential' through the years, best exemplified by a 6-8 basis points EPS CAGR lead over frontline peers in FY02-05.

The years to come will see aggressive expansion in India by global majors and upward pressure on salary costs. Against this background, Infosys has the lowest execution risks.

The revised target price of Rs 3,000 is based on 24x FY07CL earnings.