Consumer Durables-Demand hits unknown zone; recovery to be stretched

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 The ongoing lockdown and its impact on the economy in the near term have led to 8-39%
cut in our FY21-22 earnings estimates for both consumer electrical and durable
companies. We bake in zero business in April and a gradual recovery from Q2FY20.
 We have not assumed an increase in working capital cycle due to the liquidity crunch faced
by the distribution channel. Weak demand and tight liquidity could also lead to price
disruption in an effort to liquidate existing inventory (especially for summer products).
 Although it is difficult to assess when the demand will be fully recovered, we believe that
companies with dependence on seasonal products and B2B segments will take longer to
recover. In our coverage universe, this could adversely affect Havells.
 We prefer Crompton and Dixon, and have Buy rating on both. We maintain Hold on Blue
Star, V-Guard and Voltas, while the risk of delayed recovery and premium valuations lead
us to downgrade Havells, Whirlpool and Amber to Hold.
Peak summer season demand to get washed out; delayed recovery in other segments
as well: Due to the ongoing lockdown and weakness in the economy, even after country
returns to normalcy, demand for summer products will take a toll. In our view, the following
factors will be key: 1) finished goods inventory in the channel and the company’s warehouses;
2) with demand expected to remain weak even after normalcy returns, it could lead to price
disruption by distribution channels to liquidate inventory and create liquidity at their end; 3)
labor shortage during initial days of resumption which can affect production schedule of
manufacturers; 4) lack of aggression from financing companies can also adversely demand;
5) benign commodity prices could be the silver lining, while sustained weak demand could
mean companies passing on benefits to consumers; and 6) B2B segments are expected to
struggle for a longer period with potential postponement of private capex and a gradual
spending uptick from the government.
Changes in our estimates: We have changed FY21 estimates on account of: 1) production
disruption until 30 April; 2) muted demand even in Q2 even if the economy returns to normalcy;
3) we factor in a recovery starting from Q4FY21; 4) delayed B2B growth; and 5) improvement
in gross margins, aided by benign commodity prices. FY22 estimates factor in a recovery but
not to the extent of strong bounce-backs in the past. Our base case assumes 30 days of
revenue loss in Q1FY21 with a gradual recovery from Q4, while our worst-case scenario
assumes gradual recovery starting from H2FY22. Our estimates for contract manufacturers
does not account of any meaningful export opportunity which can drive numbers in FY22E.
Outlook: There is still a lack of clarity on the lockdown timelines and the resumption of
economic activity; however, we assume that production activities will gradually start from May
with a gradual uptick in utilization. The demand scenario is expected to remain grim in H1FY21
for both B2B and B2C segments, while replacement demand, which constitutes ~30% of sales,
should continue to see traction. Key factors that will be closely watched out for over the
next 12 months: 1) liquidity condition, which can have an impact on working capital of both
distribution channels and receivables of companies; 2) changes in the market positioning of
stronger players as financially weak/fringe players might find it difficult to operate; 3) market
share shift from unorganized to organized sector (although did not happen post DeMon and
GST); 4) replacement demand in highly penetrated categories such as Fans and Lighting; 5)
weak fresh residential demand; 6) penetration-led story in durables will also see a delay due
to a lack of easy availability of finance and drop in discretionary incomes; and 7) companies
with exposure to project businesses in India and overseas could potentially see cost inflation
or value knockdown along with execution delays.