The monsoon is playing truant, with average rainfall being 23 per cent below normal till July 10. By default, this means good business for listed air conditioner (AC) companies, such as Whirlpool, Blue Star and Voltas in an otherwise off-season quarter. It’s thus not surprising to see their stocks do well recently—up 8-15 per cent in July.
For Voltas, which has emerged as the number one player (market share of 18.3 per cent) in room ACs, the fastest growing category in the AC market, there are clear gains. However, the news is unlikely to have a positive impact on margins of the company’s unitary cooling products (UCP) division, which forms 30 per cent of total sales. First, competition continues to be intense, especially from the unlisted Korean and Japanese manufacturers. Second, there has been pressure on input costs.
The outlook for its other businesses, namely electromechanical projects (EMP) and engineering products and services (EPS), is also subdued in the medium term.
| FY13: PROFIT PRESSURE | |||
| In Rs crore | FY12 | FY13E | FY14E |
| Net sales | 5,186 | 5,227 | 5,690 |
| Y-o-Y change (%) | -0.1 | 0.8 | 8.9 |
| Operating profit | 337 | 327 | 405 |
| Y-o-Y change (%) | -27.0 | -3.1 | 24.0 |
| Adjusted net profit | 313 | 273 | 320 |
| Y-o-Y change (%) | -1.3 | -12.8 | 17.3 |
| EPS (Rs) | 9.5 | 8.3 | 9.7 |
| P/E (x) | 11.5 | 13.2 | 11.2 |
| E: Estimates Source: Company, Analyst reports | |||
Says Shreyans Mehta, analyst at Aditya Birla Money: “EMP and UCP businesses are currently facing turbulent times and intense competition, which is likely to continue in the medium term.”
Amish Shah, an analyst at Credit Suisse, in a report last month noted: “We expect EPS margins to decline, led by rising share of the low-margin, after-sales service business.”
After reacting positively to the bad monsoon data, the Voltas stock is marginally down on a weekly basis and looks fairly valued at 14 times FY13 estimated earnings.
UCP business to gain from bad monsoons...
Kunal Sheth, analyst at Prabhudas Lilladher, in a post-result note, pointed out that the Indian AC industry declined 20 per cent in sales volumes in FY12. Voltas’ volume fell 10 per cent. The UCP business faced challenging times in FY12, where sales declined 1.4 per cent, after clocking an average of 30 per cent growth in the last two financial years and earnings before interest and tax (EBIT) margin dipped to 8.4 per cent from an average 10 per cent in the previous two years.
Companies had resorted to price cuts to clear inventory pile-ups. Hence, if the current demand continues to be good, it will only correct the imbalance though structural growth drivers like harsher temperatures, rising incomes and growing urbanisation, which provide good visibility. Voltas will gain as room ACs form 70 per cent of the segment revenues and its strategy is to expand its reach in Tier-II and Tier-III cities. The company is already doing well in the new “all- weather” ACs.
Despite becoming number one and considering the price rises taken in recent months, there is no let-up in margin pressure, given the intense competition and rupee depreciation as most of the components are sourced from China (rupee down 26 per cent versus the yuan in FY12). Says Sheth: “The outlook on margin continued to be subdued due to intense competition from the more recent Japanese entrants, which makes it difficult to pass on cost increase.”
Adds Deepal Delivala, analyst at Citigroup Global Markets: “The introduction of stricter energy efficiency norms puts pressure on margins on account of possible inventory liquidation of lower efficiency products before the implementation deadline. Under the upgraded Bureau of Energy Efficiency norms, ACs that were five-star rated in 2011 shall be marked four-star in 2012 and three-star in 2013.”
…but will be negated by other businesses
The EMP division showed stability in the previous quarter with sales down only three per cent year-on-year and a 100 basis points sequential increase in margins. But downside risks persist as the domestic market continues to be in a downturn, led by commercial real estate and information technologyIT/IT-enabled services sectors, and international clients are deferring decision-making.
Voltas is diversifying into new geographies and new sectors like industrial (automotive) and infrastructure (airports, power and water), which is a positive move, but will take time to reflect in the financials due to longer execution cycles, especially of infrastructure projects. A key catalyst in the medium term would be the outcome of the winner for the EMP component (approximate size of Rs 4,500 crore) in the Abu Dhabi airport order, which has been just awarded. Voltas has a 33 per cent share in the joint venture with ETA and Drake and Scull.
The EPS business, where the company acts as an agent for global equipment manufacturers, is also going through a challenging phase. The outlook is not robust for textile machinery and the mining sector faces serious regulatory hurdles. Overall, analysts expect the company to report a decline in profits in FY13 before things improve in the next financial year. They say the management had expressed caution about its various businesses in a post results concall.
