Havells India- Revenue recovery in the offing; upgrade to Buy
Our recent channel checks suggest that the company has taken corrective measures to regain the lost market share in Fans, and the benefits of such measures are already reflecting from Dec’19. Rural distribution expansion has been bearing positive results and the company is increasing product offerings for upcountry markets. It is also planning to launch economy Fans under ‘Reo’ brand to increase product offering for rural markets. In the case of Lloyd, it had already effected price cuts in Jan’20, while recently industry has started to increase prices to offset the impact of higher costs. We are already factoring in 15% revenue growth for Lloyd in FY21/22, with recovery from Q4FY20. Market share trends in the upcoming summers will be critical given the sustained increase in competitive intensity.
Valuations: Havells had seen significant re-rating from Nov’16 to Aug’18 (from 30x to 41x one-year forward PE) despite an EPS CAGR of 4% over FY16-19.
The valuation re-rating was driven by:
1) sustained revenue growth (13% CAGR; ex-Lloyd)
2) market share gain from unorganized players post Demon and GST
3) acquisition of Lloyd
4) government spending over infra and other projects.
The de-rating seen in the last six months is attributable to 20% EPS cut. We believe that downside is limited in the stock as our channel checks suggest a rebound in growth in the core business has started to reflect in Q4. However, sustained underperformance in the core business and inability to turnaround of Lloyd by safeguarding market share could risk current valuations. Key risks: delayed macro recovery, sustained weak performance in the core business, longer-than-expected time for market share rebound in Fans, lack of acceptance of new product launches, continued market share loss in Lloyd, adverse commodity prices, and prolonged disruption due to Covid-19 in China.
Positives: 1) Management has a proven track record with strong execution capabilities and market share gain through product launches and distribution expansion; 2) it is the No. 3 player in almost all the categories; 3) strategy to further deepen distribution expansion in rural with product extension in ‘Standard’ and ‘REO’; 4) strong focus on processes and digital transformation; 5) strong cash generation even in a weak year; and 6) in-house manufacturing focus enables it to have better quality control.
Negatives: 1) Recent market share loss in Fans; 2) inability to turnaround Lloyd can raise questions on capital allocation for inorganic expansion as the buyout in Sylvania in the past had also not proved right; 3) sustained moderation in the core business or underperformance vs. peers; and 4) prolonged macro slowdown.
Large order win provides solid revenue visibility; maintain Buy
NFIL announces biggest-ever order win: NFIL has signed a major contract of Rs29bn, with a global company for a period of seven years. The contract is for manufacturing and supplying a high performance product (HPP) in the Fluorochemicals space, which is a brand new addition to NFIL’s existing portfolio. Although the HPP is currently manufactured by the new partner, favorable tailwinds have compelled the partner firm to grant NFIL royalty-free access to the technology. Both the product and technology remain patent-protected and would allow NFIL to diversify into an entirely new segment, in addition to running its four existing business units. The entire product value chain, starting from raw material to finished good, will remain under NFIL. NFIL plans to expand the product portfolio and applications under the new segment in ensuing years. Revenues from the new project would partially flow from Q4FY22, with major benefit coming in from FY23. We expect >Rs1bn incremental EBITDA from this project from FY23.
New capex in line with growth strategy: The project requires an investment of Rs3.65bn for setting up a manufacturing facility, along with Rs710mn for a captive power plant (located at Dahej, Gujarat). These plans shall be executed through NFIL’s wholly owned subsidiary Navin Fluorine Advanced Sciences Ltd. This is part of the larger capex plan of about Rs4.5bn as indicated earlier by management in Dec’19, out of which Rs900mn had been approved for land acquisition and development in Dahej, Gujarat. Management is confident of meeting the funding needs through internal accruals and debt. It expects asset turnover of 1.2x, and payback period of 4.5-5 years. The company has declared an interim dividend of Rs4 per share for FY20.
Strategy gains momentum; maintain Buy: Such big order win enhances NFIL’s long-term revenue visibility and raises confidence in its capability to win large orders in the future. We raise our multiple to 29x FY22E EPS (25x earlier), discounting two-year forward earnings to start accruing from the new project, and arrive at a TP of Rs1,600. Maintain Buy and remain OW in sector EAP.