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January 2015

CAPITAL GOODS

Bhargav [email protected]: +91 22 3043 3252

Deepesh [email protected]: +91 3043 3275

Fading gloryAnalysts:

2014 - 20242014 - 2024

Rising competitionRising premiumisation

New categories

??

Saturation inWhat new categories ? Security systems

premiumisation ?

2008 - 20142008 - 2014

2004 - 20082004 - 2008

PremiumisationRising share of organised players

2004

Capital Goods

January 06, 2015 Ambit Capital Pvt. Ltd.

CONTENTS

SECTOR

A stellar past for light electricals………..………………………………………….. 4

However, industry growth would likely decline in the coming decade.….…….7

Channel checks hint at demand deceleration since November 2014………… 9

Valuation multiples have been re-rated…………………………………………. 13

We prefer V-Guard over Havells………………………………………………….. 17

COMPANIES

Havells India (SELL): Euphoria only gets you thus far!........................ 21

- Havells has grown materially faster than the industry …………………….. 22 over the last decade

- However, we expect Havells to lose market share in.…………………….…27 the next decade

- Life after QRG’s demise may not be the same ……………………………… 32

- Poor capital allocation.………………………………………………………….. 33

- Assumptions………………………………………………………………………. 35

- Is Havells’ consistent valuation re-rating justified?…………………………. 37

- DCF valuation at Rs270/share.……………………..…………………………. 39

V-Guard (BUY): Emerging as a pan-India player………………………... 45

- Fast emerging as a pan-India franchise…..………………………………….. 46

- Growth in non-south is EBITDA margin accretive .…………………………..48

- Upgrading EBITDA margin estimates from FY17 onward………………….. 50

- Key assumptions………………………….…………..………………………….. 51

- Premium valuation justified……………..…………..…………………………. 52

Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit Capital may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decision.

Fading glory

Revenue growth of the Indian light electricals (LE) industry would likely decline to the low teens in FY14-24E (after a stellar 18% growth in FY06-14). Bulk of this lower growth is likely to come from tier-III and tier-IV cities (where per square feet spending is at least 30% lower than tier-1 and tier-II cities). Also, rising premiumisation would lead to lower growth in the replacement market (as the average life of switchgears, lightings, appliances and fans increased 20% in the last decade). Thus, we are SELLers on pan-India players like Havells and Bajaj Electricals. However, we prefer regional players like V-Guard that are expanding into pan-India franchises with higher PAT growth (35% PAT CAGR over FY14-17E vs 14% and 8% for Havells and Bajaj Electricals non-E&P).

A stellar past for light electricals The Indian light electricals (LE) market has recorded 18% revenue growth in the last eight years led by: (a) rising urbanisation (at 32% in CY13 vs 27.8% in CY00), (b) increasing middle income households (25mn in CY10 vs 4mn in CY91), and (c) rising premiumisation—share of premium switches increased to 50% in FY14 from 10% in FY04, for fans 50% in FY14 from 3% in FY04 and for small appliances 20% in FY14 from 2% in FY04. Industry growth to taper down in the coming decade Industry growth in the next decade should decelerate to the low teens, as: (a) we expect deceleration in the shift to the organised market; (b) bulk of the industry growth in the next decade will come from tier-III and tier-IV cities wherein the per square feet spending is at least 30% lower than tier-1 and tier-II cities, and (c) rising premiumisation will reduce the growth in the replacement market; average life of switchgear, lighting, appliances and fans has increased by 20% in the last decade.

Discount to paints sector to prevail LE stocks have seen significant P/E re-rating over the past five years. Compared with the paints sector, the discount has narrowed by 150% points to 30% points in the last decade. We see limited scope for further narrowing, as: (a) LE is a fragmented market (top-4 players control 36% market vs 65% in paints), (b) paints enjoys strong brand recall with intermediaries given the requirement of timely availability, and (c) paints is a single large category unlike LE which comprises several sub-categories and hence different competitive dynamics.

We prefer V-Guard over Havells We prefer V-Guard over Havells, given: (a) V-Guard’s higher potential to sweat the brand (regional going pan-India), higher aggression led by combination of recruitment of senior talent from the industry and increasing investment in branding rising ad (27% CAGR vs 12% CAGR for Havells over FY11-14); and (b) undeserving valuation discount of 19% relative to Havells’ standalone despite FY14-17E EPS CAGR of 35% vs Havells’ 14% and FY17E RoE of 31% vs Havells’ 23%.

THEMATIC January 06, 2015

Capital GoodsNEUTRAL

Key Recommendations

Havells India SELL

Target Price: ̀ 270 Downside 3%

Finolex Cables UNDER REVIEW

Target Price: NA Upside: NA

V-Guard BUY

Target Price: ̀ 1,310 Upside: 15%

Bajaj Electricals SELL

Target Price: ̀ 208 Downside: 15%

P/E multiple of light electrical companies have seen a re-rating

Source: Ambit Capital research

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Coverage summary

Source: Bloomberg, Ambit Capital research, Note: the size of bubble indicated FY17 RoE; we have taken standalone figures for Havells and non-E&P figures for Bajaj; colour coding: RED: BUY; GREY: SELL; and AMBER: UNDER REVIEW

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Finolex Cables

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(%) Analysts Details

Bhargav Buddhadev +91 22 3043 3252 [email protected]

Deepesh Agarwal +91 22 3043 3275 [email protected]

Capital Goods


A stellar past for light electricals The organised pie of the Indian light electricals (LE) market has seen a growth of 18% over the past eight years led by strong growth (of 34%) in consumer durables and fans. Premiumisation drove the strong growth in fans (share of premium fans increased from 20% in FY04 to 50% in FY14); moreover, addition of SKUs in several categories like iron, mixer, grinder, toaster, and OTG, alongside launch of new categories like induction cooktop, food processor and air fryer drove the strong growth in small appliances. Switches and cables & wires have seen a reasonable growth of 19% led by premiumisation; modular switches and fire survival/heat resistant cables have been sold as premium products. However, high penetration of switchgears, lighting and luminaries has led to a modest growth of 7-12% for these categories.

Organised pie of LE industry has recorded a CAGR of 18% over the past Exhibit 1:eight years

` bn FY06 FY14 CAGR over FY06-14

Domestic switchgears 12 24 10%

Industrial switchgears 16 38 11%

Switches 5 21 19%

Electric cables and wires 51 209 19%

Lighting 14 23 7%

Luminaries 14 36 12%

Consumer durables + fans 11 120 34%

Light electrical industry 124 472 18%

Source: Industry, Ambit Capital research

Growth drivers of the past eight years (1) Rising demand for housing: As per Census 2011, housing units in India increased 31% to 245mn in 2011 from 187mn in 2001. Housing loans (from banks and other financial institutions combined) expanded at 44% CAGR over FY01-07 and sustained a healthy 17% CAGR over FY07-14. Apart from the increase in housing units, the quality of housing improved substantially; for instance, grass/thatch/bamboo/wood/mud/tile roof houses decreased by 16% whilst concrete roofs increased by 14%.

Sharp increase in residential housing stock Exhibit 2:(figures represent residential housing stock in mn)…

Source: Census 2011, Ambit Capital research

…which is corroborated by strong housing loan Exhibit 3:disbursals as well

Source: NHB, RBI, Ambit Capital research, Note data for FY14 is unavailable

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Organised pie of LE market has seen a growth of 18% over FY06-14

Capital Goods


(2) Rising urbanisation: India’s urban population expanded at 2.5% CAGR over CY2000-13 as against overall population growth of 1.4%. Consequently, urbanisation increased to 32% in CY13 as against 27.8% in CY2000. The shift in the employment pattern from agricultural activities to services has driven the migration from rural to urban areas. Despite the robust urbanisation in the last decade, there remains ample room for further enhancement in urbanisation rates, given that it was only 32% in CY13. In other developing countries like Brazil and China, the share of urbanisation is much higher at 85% and 53%.

Urbanisation rates have been rising in India… Exhibit 4:

Source: World Bank, Ambit Capital research

…however, compared with other developing Exhibit 5:countries, it still remains low

Source: World Bank, Ambit Capital research

(3) Increase in penetration: Over the past decade, the penetration of light electrical equipment across India has improved due to: (a) improvement in power supply (percentage of villages without power has declined from 19.2% in FY04 to 4.4% in FY14); (b) improvement in the penetration of the large consumer appliances such as air conditioner and television, which led to an increase in demand for stabilisers, switchgear, high voltage wires, etc; and (c) increase in per capita income (6% CAGR in real terms over the last decade) driven by improvement in farm output, increase in employment (evident from strong growth in services GDP) and sharp jump in rural wages supported by welfare measures like MNREGA. Note that middle income households in India (defined as households with an annual income of `0.34mn-1.7mn on 2009-10 prices) increased to 25mn households (10% of overall households) vs a paltry 4mn households in 1991 (3% of overall households).

Increasing per capita income at 6% CAGR Exhibit 6:

Source: RBI database, Ambit Capital research

Mid-income households on the rise Exhibit 7:

Source: Industry sources, Ambit Capital research

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Capital Goods


(4) Rising premiumisation: The rise in penetration of light electrical products was accompanied by premiumisation. This has been visible across several product categories, which have seen several premium product launches (see the exhibit below). Switches and fans saw the highest premiumisation. The share of premium switches increased from barely 10% in FY04 to 50% in FY14, the share of fans increased from 3% in FY04 to 50% in FY14, and the share of small appliances increased from 2% in FY04 to 20% in FY14. This also led to EBIT margin improvement: from 10.2% in FY04 to 12.2% in FY14 for Havells (standalone); from 8.8% in FY04 to 11.9% in FY14 for Crompton (consumer); and from 7.8% in FY04 to 10% in FY14 for Surya Roshni (electric division).

Several premium launches in the last ten years Exhibit 8:

Product category Premium product Premium models

Fans

Decorative fans, kids fans with cartoon, fans with lighting

Bajaj - Magnifique, Bajaj Euro, Winstrim, Cruz

Usha - Fontana One, Fontana Maple, Fontana Orchid, Fontana Lotus

Crompton - Seagul, Oberon, Stubby, Radiance, Sail and Twirl ceiling fans

Kaithan - Fressco, Verazzano, Lugano, Mansion, Castilian

Havells - Oyster, Lumos

Orient - Subaris, Arista

Switches Shock resistant and aesthetic switches

Anchor - Roma

Havells - Peralz

Legrand - Mosaic

Small appliances Multi-function appliances

Havells - Max cook rice cooker, Insta Cook AT (induction cooktop), Convenio food processor

Preethi Aura - Grinder

Morphy Richard - Icon Dlx Food processor


Premiumisation led to EBIT margin improvement for light electrical Exhibit 9:companies

EBIT margin (%) FY04 FY08 FY14

Havells (Standalone) 10.2% 8.6% 12.2%

Crompton (consumer) 8.8% 10.4% 11.9%

Surya Roshni 7.8% 8.5% 10.0%

Source: Company, Ambit Capital research; Note: We have not compared Polycab and Finolex as electrical wires have seen limited premiumisation in the past ten years; Philips and Khaitan have seen a decline in market share; V-Guard saw a contraction in EBIT margin over the past five years due to its entry into non-south market and Orient has seen a contraction in EBIT margin over the past two years due to change in the management.

Capital Goods


However, industry growth would likely decline in the coming decade Industry growth would likely decline to the low teens compared with the high-teen growth over the past eight years on account of the following:

(1) Bulk of the growth in the past was led by a shift in market share in favour of organised players: Our channel checks and discussions with several light electrical companies suggest that the growth rate of 18% in the last eight years was led by a shift in market share from unorganised to the organised players; the share of organised players has increased from ~30% in FY06 to ~65% in FY14.

Share of organised players has increased from 30% in FY06 to 65% in FY14 Exhibit 10:

Share of organised players (%) FY06 FY10 FY14

Domestic switchgears 40% 43% 70%

Industrial switchgears 60% 72% 80%

Switches 25% 50% 70%

Cables and wires 20% 56% 62%

Lighting & Luminaries 25% 40% 55%

Fans 40% 55% 70%

Industry 30% 54% 65%


Various unorganised players act as vendors to organised players now and the share of outsourcing across companies like Bajaj Electricals, V-Guard, and Crompton Greaves is in excess of 60% in FY14. Moreover, gross block turnover across several players (Bajaj, Crompton, Khaitan, Philips, and V-Guard) in the industry has increased over FY04-14 (see the exhibit below). Also, several organised players have been able to launch multiple product categories in a short span of time due to the availability of several vendors.

Gross block turnover across several players in the industry has increased Exhibit 11:

Gross block turnover (x) FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14

Havells (standalone) 7.5 7.3 7.4 7.5 7.0 5.2 4.1 4.0 4.2 4.2 4.2

Finolex 1.2 1.5 1.7 2.2 2.8 2.1 2.1 2.5 2.4 2.5 2.4

V-Guard 5.1 4.6 4.6 4.9 5.4 4.4 4.1 5.2 6.5 7.7 7.2

Philips 2.5 3.3 3.9 3.8 4.2 4.7 4.6 4.6 6.3 5.5 5.5

Khaitan 4.2 4.5 7.3 9.7 9.8 8.2 9.6 11.7 10.7 12.4 12.4

Bajaj (non-E&P) 1.3 1.4 1.7 3.0 3.4 3.1 3.2 3.6 3.1 3.1 4.5

Crompton (consumer) 8.5 16.2 17.7 15.9 14.1 18.4 30.2 30.7 24.7 25.6 24.6

Surya Roshni 2.8 2.7 3.0 3.1 3.2 3.3 2.2 1.7 1.5 1.8 1.9

Source: Company, Ace Equity, Capital line, Ambit Capital research; Note: * We have used segmental capital employed turnover for Bajaj, Crompton and Surya Roshni, as the segmental break-up of gross block is unavailable and these companies have unrelated other businesses

Several new companies have entered into new product categories Exhibit 12:

Company Flagship product New products launched

V-Guard Stabilisers Fans, switchgears, induction cooktops

Havells Switchgear Consumer appliances

Polycab Electrical wires Fans, lighting, switches

Anchor Switches Electrical cables, lighting, switchgears

Luminous Invertors Fans, switches, CFL, switchgears

Source: Company, Industry, Ambit Capital research

18% growth for the LE industry was led by share of organised market increasing from 30% in FY06 to 65% in FY14

Various unorganised players act as vendors to organised players making entry into new product categories simpler

Capital Goods


(2) Per square feet opportunity to decline with incremental growth coming from tier-III and tier-IV cities: Our discussions with several company managements suggest that the bulk of the industry growth in the next decade will come from tier-III and tier-IV cities. Thus, companies like Havells and Anchor have launched products like Reo switches and Rider switches and Bajaj Electricals is guiding for a launch of a separate brand targeted towards the tier-III and tier-IV cities.

However, the spending capacity of people in tier-III and tier-IV cities is lower than that in tier-I and tier-II cities. Our discussions with channel partners suggest that the market size on a per square feet basis in tier-III and tier-IV cities is at least 30% lower, due to the lower per capita income, which also implies lower margins given the lower demand for premium products. However, if the pace of urbanisation picks up (which is currently not visible given the dismal 11% volume growth for cement companies YTD and disappointing YTD GFCF print of 3.4% growth YoY), then the size of the opportunity can increase.

Dismal volume growth for the cement sector coupled with poor GFCF print Exhibit 13:does not signal any pick up in urbanisation

Source: EA Industry, MOSPI, Ambit Capital research

(3) Premiumisation to lead to lower growth in the replacement market: With rising premiumisation, product quality has improved significantly and this in turn is likely to lead to lower growth in the replacement market. This trend is visible across multiple categories like fans, lightings, small appliances, switchgears and stabilisers, where the average life of a product has increased by at least 20%.

Our discussions with several industry participants suggest that the size of the replacement is large (ranging from 20% to 70% across product categories). In some categories like fans and small appliances the replacement market is as high as 70%, which has forced companies to launch premium categories and this in turn has fuelled their growth. Industry participants suggest that the share of premium products in fans from 20% in FY08 to 50% in FY14 and the share of small appliances has increased from 10% in FY08 to 20% in FY14.

Share of replacement market is high across several product categories Exhibit 14:

Product Market size (` bn) % share of replacement market

Electric cables and wires 209 30%

Small appliances 65 70%

Switchgear 62 50%

Switches 21 60%

Lighting 23 70%

Luminaries 36 40%

Fans 55 70%


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Per sq feet opportunity in tier III and IV cities is 30% lower vs tier I and II cities

With premiumization, average life across several products has increased by at least 20%

Capital Goods


Channel checks hint at demand deceleration since November 2014 Our discussions with 15 channel partners across India (Delhi, NCR, Lucknow, Mumbai, Pune, Ahmedabad, Jaipur, Chennai, and Hyderabad) in the last week of December suggest that the demand environment has weakened further in 3QFY15 led by a slowdown in real estate activities and project demand. The recovery in consumer-led demand has been weaker than our expectations.

Demand deceleration is evident from our channel checks Exhibit 15:

Product Market size (`bn) in FY14

Volume growth in

3QFY15 (YoY)

Volume growth in

2QFY15 (YoY)

Market share in FY14 Comment Unorganised

share Organised share Gainers Losers

Electrical cables and wires

Housing wires 84 5% 10% 35%

Polycab - 20% Finolex - 9% Havells - 9%

V-Guard - 6%

V-Guard Havells Slowdown in real estate activities has led to demand deceleration

Industrial and power cables 125 5% 10% 35%

Polycab - 20% KEI – 12%

Finolex - 11% Havells - 9%

Finolex KEI

Funding challenges have not only led to a slowdown in project (B2B) demand but have also stalled any hopes of a recovery over the next 4-6 months

Switchgear and switches

Domestic switchgears 24 5% 10% 30% Havells - 29%, Legrand - 25%

Schneider - 16% Legrand Havells

Similar to housing wires, domestic switchgears have seen a demand deceleration due to weak real estate activity

Switches 21 5% 10% 35% Anchor - 35% Havells – 20% Havells Anchor

Slowdown in real estate has impacted demand for switches

Fans

Premium 27 10% 15%

10% Crompton – 22% Orient – 13% Bajaj – 11%

Havells - 10%

Crompton Havells After an impressive growth in 1HFY15 due to an extended summer, demand has moderated in 3QFY15

Sub-economy and economy

28 35% Luminous, Polycab

Bajaj

Consumer appliances

Electric water heaters 6.5 20% 15% 35% Racold – 25%

V-Guard – 21% AO Smith – 9%

V-Guard AO Smith,

Racold, Bajaj

Strong winter (temperature dropped to the lowest in five years in Delhi) has led to strong demand for water heaters; V-Guard’s Pebble series is helping the company to gain market share

Small appliances 65

13% 20%

30% Philips + Preethi – 20%

Bajaj – 15% Maharaja – 9%

Havells Bajaj The demand recovery which was visible during the festival season in September and October has disappeared and the volume growth from November has decelerated compared with 2QFY15 Induction cooktops 6 50%

TTK Prestige – 23% Philips – 15%

Bajaj Electrical – 15%

TTK Prestige Bajaj

Stabiliser 12 10%

26%

67% V-Guard – 25%

Capri – 9% Premiere – 7%

V-Guard Everest After registering a splendid growth of 26% in 1HFY15, stabiliser, UPS and digital UPS have seen a moderation in growth due to decline in power outages across India UPS, digital UPS 79 10% 15%

Luminous – 23% Microtech – 12%

Sukam – 11% V-Guard – 1%

V-Guard Sukam

Lighting & Fixtures

CFL, LED, lighting 23

5% 10%

40%

Philips – 23% Bajaj – 24%

Crompton – 15% Havells – 7%

Syska, Philips, Chinese players

Bajaj, Crompton

The decline in LED prices by 60% over the past one year is leading to a fast shift in demand from CFL to LED Consequently, traditional CFL players are losing market share to Philips, Syska and Chinese players

Luminaries 36 40%

Philips - 35% Havells – 13% Bajaj – 11%

Syska, Havells

Bajaj, Philips,

Crompton

Weak industrial capex and consequent poor project demand (B2B demand constitutes 50% of the overall market) have impacted demand materially


Here are the key takeaways from our channel checks:

Deceleration in demand since November: Contrary to our earlier expectation of a pick-up in demand from October 2014, demand has actually slowed down across several categories as per our discussions with channel partners. Whilst the recovery in B2C demand has been slower than our expectation, B2B (project) demand has slowed down further. The liquidity challenges have stalled any hope of revival in project orders for the next 3-5 months.

Capital Goods


Consequently, demand for cyclical products, such as electrical cables and wires, switchgears and lightings, has been impacted more than the demand for consumer-led products such as consumer appliances and fans. Cyclical products such as electrical cables and wires, switchgears and lightings are likely to grow at a slower pace of 5% YoY vs consumer-led products such as consumer appliances and fans, which are likely to grow by 10-13% YoY. Stabilisers and inverters, which registered a healthy growth of 26% in 1HFY15, are likely to see a moderation in growth (13% YoY growth in 2HFY15E), as power outages have declined across India.

Falling raw material prices may lead to margin expansion: Margin expansion will likely be a silver lining for the light electrical companies. Our channel checks suggest that the prices of the final products have not declined (expect for wires), despite a 5% and 40% correction in copper and crude prices (key raw material for PVC and plastic) in INR terms over the last three months. Cables and wires have seen price cuts of 4-5%. Management teams suggest that companies are looking at improving margins, as topline growth has been lower than their expectation and industry margins have been depressed for the last two years.

Copper and crude prices have corrected by Exhibit 16:5% and 40% respectively over the past three months

Source: Bloomberg, Ambit Capital research

This should aid in margin expansion, as it forms a Exhibit 17:major component of the raw material cost FY14 (in ` mn) Finolex V-Guard Havells Share of cables and wires in total revenue

94% 36% 41%

Total plastic / PVC consumed 1,876 449 2,212

- as a % of revenue 8.0% 3.0% 4.7%

- as a % of total raw material consumed 10.6% 9.1% 8.7%

Total copper consumed 14,288 3,505 8,701

- as a % of revenue 61.1% 23.1% 18.4%

- as a % of total raw material consumed 80.9% 70.9% 34.2%

Source: Company, Ambit Capital research; Note: We have excluded the goods purchased from vendors, as the break-up of the raw material consumption therein is not available; we have excluded Bajaj Electricals from the above analysis as the break-up of raw material consumption segment-wise is not available and the company also operates in the E&P business

V-Guard continues to gain market share: The non-south dealers highlighted that V-Guard continues to gain market share in the non-south market. Whilst it is gaining market share from Havells and Polycab in wires, it is gaining market share from AO Smith, Racold and Havells in water heaters. V-Guard’s brand perception is improving in the non-south market. Bajaj continues to lose market share across categories due to the rollout of its new marketing strategy (‘Theory of Constraints’). In lighting, Syska is gaining market share from Havells, owing to its strong brand promotion and strong range of LED products.

Across categories, the market share for Havells has plateaued, given the rising competitive intensity in the industry, and the lower than industry incentives by Havells to dealers. Whilst the strength of the channel was the biggest competitive advantage for Havells in gaining market share across categories over the past decade, this advantage seems to be fading, with the company focusing more on controlling the channel to maximise profits.

V-Guard gaining market share in non-south market Exhibit 18:Product Gaining market share from

Housing wires Havells, Polycab

Stabiliser Everest, unorganised players

UPS, digital UPS Luminous, Sukam

Water heater AO Smith, Racold, Havells


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“The initial euphoria just after the elections is ‘over’, so the 20 percent growth that we were achieving (in 1HFY15) may not be possible to continue for the entire year” - Anil Rai Gupta (CMD, Havells

India) while scaling down Havells FY15 standalone guidance from 17-20% to 12-14%

Bajaj is losing market share due to the channel friction caused by the implementation of theory of constraints

V-Guard continues to gain market share in non-south market

Capital Goods


Rising competitive intensity The shift in market share towards organised players (increased from 30% in FY06 to 65% in FY14) has tripled the industry size to `472bn in the last eight years. This market expansion alongside low barriers to entry has led to rising competitive intensity. Not only have MNC players become aggressive but even regional players have started expanding on a pan-India basis.

Low entry barrier: The light electrical industry is characterised by low entry barriers. Asset-light model (as several unorganised players have turned vendors, with the share of the organised market improving), limited need of product innovation (R&D spend across companies is modest at 0.2% of revenues) and low brand loyalty (as most consumers are influenced by dealers) have led to low entry barriers. The only material entry barrier is the distribution network, as demand for the light electrical products requires ‘push’ marketing.

Distribution network is the only meaningful entry barrier in the light Exhibit 19:electrical industry Entry barrier in the light electrical industry

Degree of importance

Comment

Distribution network

As the sale of the light electrical products requires ‘push marketing’, a strong distribution network plays a critical role. Building a distribution network is a time-consuming process and hence acts as a critical entry barrier.

Brand

Unlike FMCG and white good companies which have a strong brand pull, light electrical companies do not enjoy similar brand pull. Whilst of late companies have started focusing on brand building, incentivising channel partners continues to be the biggest driver of sales.

Technology and innovation

Light electrical products are not technology-intensive. This is corroborated by their low R&D spends.

Manufacturing facility

Light electrical industry is characterised by the asset-light model. Barring few companies, more than half of the manufacturing is done by the vendors who were earlier part of the unorganised industry.

Capital intensity The capital needs of light electrical companies are low, due to asset-light outsourcing model and low inventory days.

Source: Industry, Ambit Capital research; Note: - High - Medium - Weak - Poor

Empirical evidence suggests that after every 5-6 years a new player emerges and an incumbent goes out of business. There have been several instances where a market leader in a particular category is marginalised to an irrelevant player few years hence; for example, Polar and Khaitan in fans, Laxman Sylvania and Fixo Light in lights, Cable Corporation of India, RPG Cables and Universal Cables in cables and wires, and Sumit in small appliances.

Success in E-commerce can further intensify competition: With e-commerce increasingly becoming popular, the importance of a distribution network is likely to decline. Some of the popular categories purchased online include water heaters, fans and small appliances. This should further increase the competitive intensity, as lack of a distribution network has kept many MNCs away from the market. Apart from Philips, all the major MNC players, which had a presence in the Indian light electrical industry, have entered the industry through acquisition/joint venture/tie-ups. Our discussions with various management teams suggest that the increasing popularity of online purchase of light electrical products is a big concern.

Acquisition of domestic brands by MNCs in recent years Exhibit 20:

Acquirer-Target Product Number of distributor at the time of acquisition

Year Deal value (`bn) (%) stake acquired EV/EBITDA (x) P/E (x)

Matsushita - Anchor Switches 10,000 dealers and 300,000 retailers

2007 20 80 14 15

Legrand - Indo Asian Fusegear Switchgear 250 distributors and 15,000 dealers and retailers

2010 6 100 20 NA

Schneider Electric - Luminous UPS, digital UPS 900 distributors and 25,000 retail outlets 2011 14 74 16 NA

Philips - Preethi Small appliances 7,000 dealers 2011 3.5 100 NA NA

Groupe SEB – Maharaja Whiteline Small appliances 330 distributors and 26,000 retailers

2011 4 55 NA NA


LE industry is characterized by low entry barriers; limited R&D, asset light model and low brand loyalty

Capital Goods


Moreover, E-commerce has opened the doors for small and regional players (majority of which were unorganised players till recently) to start selling on a larger scale at the pan-India level. Many brands which have little or no presence in the physical market are selling online. Whilst we believe the current market share of the newer brands in the e-commerce market is not material, with time some of these new brands may become tough competitors for the established players.

Product categories such as mixer grinders, induction cooktops, irons, voltage stabilisers and fans have the maximum number of such brands selling online. Interestingly, most of the manufacturing of these product categories for established players such as Bajaj, Crompton, Havells and V-Guard is done by vendors. This poses a larger risk to the established brands, as the vendors in the future could opt to sell on their own by leveraging the opportunity of e-commerce.

Companies with little offline presence selling online Exhibit 21:

Categories Companies

Mixer grinders Desire, Cambridge, Hylex, Aditi, Inalsa, SignoraCare, Euro Power, Lumix, Black cat, Vitamix, JSM, Chef Art

Induction cooktops Kitchen Knight, Inalsa, Soyer, ED Smart, Tranasen, Gilma Spectra, Asent, Savy, Marc

Irons Ozomax, Skyline, Machot, Singer, Remson, Leo Shine, Choice Chc, Picasso

Voltage stabilisers Sakthi, Sollatek, Vortex, White Lotus, Servokon, Arihant, Geesys, Altime, Electro, NTPL, Pixels

Fans Apson, ACS, Afco, Efab, Eon, Havemore, Lazer, Indigio, Juvas, Kent appliances, Superfan, Warmex, SKN, Remi fans

Source: Snapdeal, Flipkart, Ambit Capital research

Whilst light electrical companies are showing resistance to E-commerce by not allowing warranties on online purchases (more often when the transaction is below the minimum selling price), we believe with the growing popularity of E-commerce trade, the light electrical companies would eventually be compelled to throttle back their resistance.

E-commerce is emerging as a threat; already domestic appliances and fans have gained acceptance

Capital Goods


Valuation multiples have been re-rated Valuation multiples for light electrical companies like Havells, Bajaj Electricals, Finolex Cables and V-Guard, as seen in Exhibit 22 below, have seen a significant re-rating. One of the reasons for the multiples re-rating has been the expansion of the portfolio towards the B2C category (like consumer appliances, water heaters, and fans) which has higher margin and strong brand recall. However, going forward, we believe there is limited scope to launch more such categories aimed towards the B2C segment for all the companies except V-Guard. However, on the B2B side, there are product gaps like building protection systems (electronic security products, CCTV, video door phones etc) which can be filled. However, if companies enter such categories then the valuation multiples could see a de-rating given lower margins and lower brand recall. Lastly, note that the valuation re-rating for the sector has happened despite the deceleration in revenue growth for all the companies, as seen in Exhibit 23 below.

Despite the deceleration in revenue growth… Exhibit 22:

Source: Company, Ambit Capital research; Note: For Havells we have taken standalone financials; for Bajaj Electricals we have taken non-E&P revenues

…the one-year forward P/E multiple of light Exhibit 23:electrical companies have seen a re-rating

Source: Bloomberg, Company, Ambit Capital research; Note: We have calculated Havells standalone’s P/E by deducting Sylvania’s fair value of Rs10/share and Bajaj Electricals’ non-E&P P/E by deducting the fair value of E&P business of Rs14/share

Many investors want to know whether light electrical companies can trade at multiples ascribed to the paints sector. We believe it is unlikely because:

(1) Light electricals is largely a fragmented market: Paints is one of the least fragmented segments of consumption, with the top-4 players controlling over 65% market share in the total market of `320bn vs 36.1% for the light electrical players. Furthermore, these top-four players in the paints industry viz Asian Paints, Berger, Kansai Nerolac and Akzo Nobel have remained the top four for ~15 years, with Asian Paints being the leader over this period. This is unlike Light Electricals, where after every 5-6 years a new player emerges and an incumbent goes virtually out of business.

Whilst top-four players dominate 65% of the Exhibit 24:market in Paints…

in % unless specified FY14

Industry size (`bn) 320

Asian Paints 37.5%

Berger 10.9%

Kansai Nerolac 10.9%

Akzo Nobel 7.8%

Market share of top four players 65.0%


… the top-four players dominate only 36.1% Exhibit 25:of the market in light electricals

in % unless specified FY14

Industry size (`bn) 379

Philips 10.0%

Havells 9.2%

Polycab 9.2%

Bajaj 7.6%

Market share of top four players 36.1%


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Valuation multiples have been re-rated despite the deceleration in revenue growth for all companies

LE is a fragmented market; share of top 4 players is 36% vs 65% in paints

Revenue growth YoY (%)

Capital Goods


Whilst the top-four players in paints have remained the same over the Exhibit 26:past 15 years, light electricals has seen significant churn in the top four players

Top players 15 years ago Top players currently

Paints Asian Paints, Berger, Kansai Nerolac, Akzo Nobel

Asian Paints, Berger, Kansai Nerolac, Akzo Nobel

Light Electrical

Lighting Philips, Laxman Sylvania, Crompton, Fixo Light, Glow Light

Philips, Bajaj, Havells, Crompton

Fans Polar, Khaitan, Crompton, Orient Crompton, Orient, Bajaj, Usha, Havells

Consumer appliances Sumit, Philips Bajaj, Philips, Crompton, Havells

Cables and Wires Cable Corporation of India, RPG cables, Universal cables, Netco, Gloster Cables

Polycab, Finolex Cables, Havells, Sterlite


(2) High sustainability of competitive advantage in paints vs light electricals: Our consumer analyst, Rakshit Ranjan, highlighted that this sustainability of leadership for players like Asian Paints over the past several decades is due to the firm’s consistent focus on supply chain efficiencies, the most critical competitive advantage in the sector. Given the voluminous nature of paint products, dealers prefer an efficient supply chain, and hence high inventory turnover on the shop-floor. At the same time, given the diversity of SKU demand and cyclicality of demand across geographies and given the voluminous nature of the product, it will take more than a decade for either an incumbent like Akzo Nobel/Kansai or a new MNC player like Sherwin Williams or Nippon Paints to match Asian Paints’ supply chain efficiencies.

Asian Paints (market leader) has outperformed Exhibit 27:peers over FY04-14…

Source: Ace Equity, Ambit Capital research; Note: We have taken the standalone financials, as these companies have international subsidiaries operating in international market

…and consequently, Asian Paints’ revenue Exhibit 28:share amidst top-four players has consistently improved from 45% in FY04 to 55% in FY14

Source: Ace Equity, Ambit Capital research; Note: We have taken the standalone financials as these companies have international subsidiaries operating in international market

However, barriers to entry in light electricals are relatively lower. The distributor agrees to stock the inventory of a competing branded company if offered a higher incentive. This is corroborated from the strong growth of several regional players like V-Guard, TTK Prestige, and Finolex Cables which have seen strong growth in non-regional markets by offering higher commissions to the channel partners. Whilst Havells does enjoy a strong brand pull from its channel partners (given the investment in brand building and attractive schemes offered to the channel partners), this can be easily replicated successfully. This is unlike paints where the key competitive advantage of a lower replenishment cycle cannot be replicated.

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Asian Paints Berger Kansai Akzo

45% 46% 54% 55%

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Several erstwhile regional players have Exhibit 29:outperformed Havells over FY10-14…

Source: Company, Ambit Capital research; Note: for Finolex Cables we taken electrical cables’ revenues and EBITDA; for Finolex Cables we have assumed electrical cables’ PAT CAGR to be the same as EBITDA CAGR, as reported PAT is incomparable due to derivative losses and presence of communication cables and copper rods business; we have taken standalone financial for Havells

…led by higher advertisement spends Exhibit 30:

Source: Company, Ambit Capital research; Note: We have taken standalone financials for Havells

(3) Paint is a single large category unlike light electricals, which is a combination of several sub-categories: Whilst the addressable market for light electricals at `379bn is in line with paints at `320bn, light electricals has a combination of several large sub-categories like switchgears, cables and wires, lightings and consumer appliances, which together add up to `379bn of market opportunity. Hence, a light electrical company will have to demonstrate strength across several of these large sub-categories to become as large a company as say Asian Paints, which is challenging given the varied competitive advantages required across the various sub-categories in light electricals.

Product mapping in the light electrical industry Exhibit 31:

Category Product Havells V-Guard Bajaj Crompton Orient Finolex Polycab

Electrical consumer durables Fans Yes Yes Yes Yes Yes

Water heater Yes Yes Yes Yes

Irons

Yes Yes Yes

Kitchen appliances Yes

Yes

Stabilisers, Invertors

Yes

Lighting CFLs Yes

Yes Yes

LEDs Yes

Yes

Indoor Luminaries Yes

Yes Yes

Outdoor Luminaries Yes

Yes Yes

Switchgears Low Voltage Yes

Medium voltage

High Voltage

Switches Yes

Motors Yes

Cables and wires Low voltage Yes Yes

Yes Yes

High voltage

Yes Yes

Residential wires Yes Yes

Yes Yes


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CAGR over FY10-14

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Havells V-Guard TTK Prestige Finolex Cables

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Capital Goods


(4) Strong brand recall with intermediaries in paints relative to light electricals companies: As per Rakshit Ranjan, the brand recall enjoyed by Asian Paints with painters is very high given the timely availability of the product. Note that these painters work on daily wages and hence any delay in the availability of the product can impact earnings.

This is not the case with an electrician who is happy to use the product of any competitor in the event of non-availability of a particular brand. For instance, if Havells’ cables and wires are not available then he will instead use Finolex’s or V-Guard’s, given the ready availability of these products with the distributor, which is not the case with paints given the lack of product availability/resistance from the consumer.

Relative valuation of light electricals Exhibit 32:

Company CMP Mcap P/E (x) P/B (x) EV/EBITDA (x) RoE (%)

CAGR

(FY14-17)

INR US$mn FY15 FY16 FY17 FY15 FY16 FY17 FY15 FY16 FY17 FY14 FY15 FY16 FY17 Revenue EPS

Havells (consolidated) 279 2,748 37.4 29.2 21.6 8.7 7.2 5.8 21.4 17.1 13.2 28.7 25.4 26.9 29.5 10.9 22.1

Havells (standalone) 279 2,748 36.7 31.5 23.9 6.8 5.9 5.0 24.1 20.8 15.9 23.9 19.9 20.1 22.8 16.3 13.6

Finolex Cables 269 649 18.0 13.7 12.2 3.3 2.8 2.5 13.7 10.6 9.0 20.5 19.4 22.1 21.6 21.2 19.5

Bajaj 246 398 41.2 18.1 13.9 3.3 2.9 2.5 16.1 10.0 8.2 (0.7) 8.4 17.2 19.5 15.4 NA

TTK Prestige 3,513 629 30.0 22.4 17.6 6.7 6.3 5.7 19.3 14.7 11.7 22.8 29.0 34.2 38.3 19.8 30.4

V-Guard 1,138 533 34.3 25.8 19.4 8.6 6.9 5.5 21.0 16.5 13.1 24.3 27.8 29.6 31.4 20.7 35.2

Average (excl. Havells consol.)

32.0 22.3 17.4 5.7 5.0 4.3 18.9 14.5 11.6 18.2 20.9 24.6 26.7 18.7 24.7

Source: Bloomberg, Ambit Capital research; Note: Valuation as on 5 January 2015; we have calculated Havells standalone P/E, P/B and EV/EBITDA by deducting our fair value of Sylvania of Rs10/share from CMP

V-Guard deserves to trade at expensive P/E multiple Exhibit 33:

Source: Bloomberg, Ambit Capital research; Note: Valuation as on 5 January 2015; the size of the bubble represents market share in light electrical industry in FY14

Havells

Finolex Cables

Bajaj Electricals

TTK Prestige

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Capital Goods


We prefer V-Guard over Havells V-Guard has higher potential to sweat the brand than Havells, as V-Guard is currently a regional company Unlike pan-India players like Havells and Bajaj Electricals which have more than 60% of revenues coming from non-south, V-Guard is relatively a new player, as only 30% of its FY14 revenue came from this market. That said, it has done phenomenally well in this market, with revenue CAGR of 79% over FY08-14 vs 33% for the company as a whole. With scale, its EBITDA margins improved from -1.3% in FY12 to 1.5% in FY14 and working capital turnover improved from ~115 days in FY12 to 100 days in FY14 in non-south. There is scope for more expansion in non-south, given that its market share in non-south across product categories is less than 5% vs ~30% in southern states. Please refer to page 46 for more discussion on why we think V-Guard can continue gaining market share in the non-south region.

V-Guard’s non-south revenue has registered Exhibit 34:79% CAGR over FY08-14

Source: Company, Ambit Capital research

With scale, V-Guard’s EBITDA margin and Exhibit 35:working capital turnover in non-south have improved

FY12 FY13 FY14

Non-South's revenue share to total (%) 21% 25% 30%

Non-South's EBITDA margin (%) -1.3% 0.4% 1.5%

Non-South working capital days 115 109 100


On the other hand, Havells has not achieved much success in any of the new product categories (except domestic appliances) launched after FY11. Since FY11, Havells has launched domestic appliances, Reo switches, monoblock pumps and motors. Apart from domestic appliances, Havells has not seen much success in any of the other new product categories. Whilst Havells’ domestic appliances portfolio (revenue of ~`3bn in FY14) has seen a strong revenue growth since FY11 (launch year), we believe growth will decelerate from hereon given its presence only in the premium category where the market size is smaller at ~`10bn (20% of the appliances market) and Philips is a dominant player. As far as established product categories like cables and wires, switches, switchgears, lighting, fixtures and fans are concerned, we believe Havells is at a risk of losing market share, given rising competition and incremental growth from tier-III and tier-IV cities which are price-sensitive markets.

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For V-Guard, non-south accounts for 30% of revenues vs 70% for pan-India players

Capital Goods


Dependence on stabiliser (core product) has reduced significantly for V-Guard V-Guard was primarily a stabiliser company until the early 2000s. However, in the past two decades, it has diversified into a wider range of products in the light electrical space. V-Guard has not only added new products but has also expanded them into sizeable revenues. For instance, housing wires which were launched in FY96 registered revenue of `4.8bn in FY14 (now bigger than stabilisers); pumps which were launched in FY92, registered revenue of `2bn in FY14 (vs `2.6bn for stabilisers) and water heaters which was launched in FY96, registered revenue of `1.4bn in FY14 and will likely touch `2bn in FY15. Over the last three years, V-Guard has added induction cooktops, domestic appliances and switchgears to its product offering. Strong brand recall, aggressive marketing and effective sweating of the distribution channel has helped the company to be successful in several product categories (consistently gained market share across categories, as seen in the table below).

V-Guard has a diversified product range… Exhibit 36:

(` mn) FY08 FY09 FY10 FY11 FY12 FY13 FY14

Electronics

Stabilisers 938 968 1,220 1,667 2,006 2,378 2,664

UPS - - 180 272 421 483 363

Inverters - - 87 216 727 1,733 1,477

Total 938 968 1,487 2,155 3,154 4,594 4,504

Electromechanical

Pumps 561 662 764 1,212 1,515 2,053 2,022

Housing wires 596 695 1,199 2,061 2,779 3,735 4,757

LT cables - - 152 410 570 728 709

Water heater 271 331 362 600 863 1,103 1,358

Fans - - 254 532 638 797 1,024

Others (includes induction Cooktops, switchgears, etc)

- - - - - 268 410

Total 1,428 1,688 2,731 4,815 6,364 8,684 10,280

Others

Solar water heater 125 155 163 213 257 325 393

Others 80 160 160 80 160 - -

Total 205 315 323 293 417 325 393

Total Revenues 2,571 2,971 4,541 7,263 9,935 13,603 15,177


…and consistently gained market share across the categories Exhibit 37:

Product Market Size FY14 (` bn) FY12 FY13 FY14

Stabilisers 12,000 17% 20% 22%

UPS 4,000 11% 12% 9%

Inverters 75,000 1% 2% 2%

Pumps 20,000 8% 10% 10%

Housing wires 70,000 4% 5% 7%

LT cables 73,000 1% 1% 1%

Water heater 12,000 7% 9% 11%

Fans 50,000 1% 2% 2%

Solar Water heaters 6,500 4% 5% 6%


Capital Goods


Recruiting senior management To strengthen the franchise further, V-Guard has recruited senior marketing employees from leading competitors. In the past three years, V-Guard has hired LG’s chief strategy officer, Havells’ north India marketing head, and Surya Roshni’s East India head. After these recruitments, the company is strengthening its distribution network further, as the new recruits have strong relationships with the channel.

For instance, Havells’ north India marketing head has more than a decade of experience in dealing with north India’s dealers. He had played an instrumental role in building Havells’ north India franchise. The advantage of hiring such senior management is that it results in better quality sales with higher margins and favourable credit terms (for instance V-Guard does not sell much in the Bhagirath and Lohar Chawl markets, as the quality of sales are lower given high credit terms and higher discounts). This is corroborated in the numbers as well. Despite strong growth in non-south, V-Guard’s EBITDA margins in non-south has increased from -1.3% in FY12 to 1.5% in FY14 and cash conversion cycle improved from 115 days in FY12 to 100 days in FY14.

On the other hand, Havells has been facing attrition at the senior management level given rising competitive intensity creating several job opportunities. If this trend continues, then Havells may start losing market share, given that the senior marketing team has developed strong relationships with the channel partners which can be effectively leveraged to facilitate revenue growth of the new firm.

Valuation: V-Guard’s undeserving discount of 19% to Havells standalone At CMP of 1,138/share, V-Guard is trading at a one-year forward P/E multiple of 27.6x, a 106% premium over its five-year average forward P/E multiple of 13.4x. Premium is justified and is likely to widen further, as the company achieves scale in the non-south market, leading to improvement in margin by 180bps and in RoE by 700bps over FY14-17E.

Moreover, V-Guard is trading at 19.4x FY17E P/E, a 19% discount to Havells standalone despite higher FY14-17E EPS CAGR of 35% vs Havells’ 14% and FY17E RoE of 31% vs Havells’ 23%. We believe a ‘growth company’ like V-Guard deserves to trade closer to the price multiple of a ‘market leader’ like Havells. We value V-Guard at `1,310/share, implying FY17 P/E of 22.5x (a 6% discount to Havells standalone).

Whilst Havells is the market leader in light electricals, V-Guard is emerging as a high growth company which has consistently outperformed Havells over FY09-14 and is doing so by following the right processes. Whilst Havells standalone (for apple-to-apple comparison) posted strong revenue CAGR of 54% over FY04-08, the same has slowed down to 15% over FY09-14. On the other hand, V-Guard’s revenue CAGR has improved from 22% over FY04-08 to 37% over FY09-14.

Also, Havells’ standalone RoE has dipped from an average of 42% over FY04-08 to 21% over FY09-14, given the less-efficient deployment of cash (acquisition of Sylvania). On the other hand, V-Guard’s RoE has improved from an average of 19% over FY04-08 to 26% over FY09-14 given the strong revenue CAGR of 37% during this period as compared to 20% over FY04-09. In the future also we expect V-Guard to outperform Havells with PAT CAGR of 35% over FY14-17E vs Havells’ (standalone) 17% and average RoE of 31% over FY14-17E vs 20% for Havells.

A growth company like V-Guard deserves multiple of a market leader

V-Guard has consistently outperformed Havells on revenue and earnings growth over FY09-14

Whilst Havells’ standalone ROE declined from 42% over FY04-08 to 21% over FY09-14; V-Guard’s ROE improved from 19% over FY04-08 to 26% over FY09-14

Capital Goods


Whilst Havells standalone EBITDA margin of 13.5% in FY14 is 540bps higher than V-Guard’s 8.1%, the gap is likely to shrink, given that the decline in V-Guard’s EBITDA margin was due to its entry into a newer geography (non-south market). During FY06-08, when the four southern states accounted for more than 95% of revenues, V-Guard’s average EBITDA margin of 11.3% was 160bps higher than Havells’ EBITDA margin. The low EBITDA margin in the non-south market is due to additional discounts to distributors in the non-south market to compensate them for the lack of scale. EBITDA margin in the non-south market is 980bps lower than the south. However, with scale in non-south, margins should improve. The share of non-south has already improved from 5% in FY08 to 30% in FY14 and the management is guiding for 50% by FY17. Consequently, the EBITDA margin gap between V-Guard and Havells should reduce.

EBITDA margin gap between Havells and V-Guard should shrink by FY17 Exhibit 38:

Source: Company, Ambit Capital research; Note: We have taken standalone financials for Havells

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Euphoria only gets you thus far!

Havells emerged a successful brand in the last decade due to continuous portfolio expansion, pan-India franchise and Qimat Rai’s (QRG’s) aggression. However, we expect it to lose market share in the next decade due to rising competitive intensity, lower industry growth and rising senior-level attrition. Whilst new MD is able, he may not be able to match QRG’s aggression/foresight. As Havells loses market share, we expect its P/E to de-rate from its current 31.5x standalone FY16 P/E, a 58% premium to peers. This high premium is despite 13.5% standalone EPS CAGR in FY14-17E (vs 28.4% for peers) and 110bps RoE deterioration in FY14-17E vs improvement for peers.

Competitive position: STRONG Changes to this position: NEGATIVE Havells to lose market share Havells will lose market share from hereon due to rise in competitive intensity and attrition at the senior marketing level. Havells has not launched any blockbuster new products in the last three years apart from domestic appliances wherein its range is restricted to the premium category (20% of market). Losing market share is not uncommon in LE, given low barriers to entry and reducing scope for product innovation/portfolio expansion. Havells has already seen stagnation in market share in switchgears and fans. Life after QRG’s demise may not be the same

Our discussions with ex-employees and channel partners suggest that Mr Anil Gupta (CMD) is not as aggressive and as quick a decision maker as Mr QRG. However, he is more professional and process-oriented. His connection with dealers is good, but he does not enjoy the same ‘emotional’ bond as dealers enjoyed with QRG. The next 9-12 months will be a testing time for Anil, as he engages with channel partners (Havells’ key strength) in the absence of QRG. Poor capital allocation led to fall in standalone RoE Havells’ standalone RoE declined to 21% in FY14 from 47% in FY07, as its investment in Sylvania increased fivefold to `8.8mn in FY14 (38% of standalone capital employed). Since the acquisition, Sylvania has been making losses (except in FY11 and FY12). Recently, the management gave a profit warning on Sylvania, given volatile currency movements and the risk of rising pension provision from declining bond yields in developed markets. P/E to de-rate with loss in market share Havells’ standalone franchise (after adjusting for Sylvania’s fair value of `10/share; implied FY16E EPS of 8.8x) is currently trading at its all-time high multiple of 31.3x on FY16E EPS, a 64% premium to peers. This is despite its standalone PAT CAGR of 13.5% over FY14-17E vs 28.4% for peers. As this underperformance sustains, multiples should de-rate. Empirical evidence suggests no sustainable long-term competitive advantage for LE companies given no entry barrier; churn of market leader happens every five years. Risks: Decline in competitive intensity and stake sale in Sylvania.

COMPANY INSIGHT HAVL IN EQUITY January 06, 2015

Havells IndiaSELL

Capital Goods

Recommendation Mcap (bn): `168/US$2.7 6M ADV (mn): `747/US$11.8 CMP: `279 TP (12 mths): `270 Downside (%): 3

Flags Accounting: RED Predictability: AMBER Earnings Momentum: RED

Catalysts

Decline in EBIT margin for switchgears and fans over FY15-17E

Lower growth in domestic appliances over FY16-18E

Deterioration in profitability of Sylvania in FY15E

Performance


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Havells Sensex on RHS

Analysts Details Bhargav Buddhadev +91 22 3043 3252 [email protected]

Deepesh Agarwal +91 22 3043 3275 [email protected]

Key financials YE March (` mn) FY13 FY14 FY15E FY16E FY17E

Operating income 72,479 81,858 89,145 99,712 111,626 EBITDA (%) 9.3 9.1 9.1 10.2 11.8 EPS (`) 6.2 7.2 7.4 9.5 12.9 RoE (%) 32.3 28.7 25.3 26.8 29.5 RoCE (%) 24.1 19.8 17.7 19.2 23.5 P/E (x) 45.0 39.0 37.4 29.2 21.6 P/BV (x) 12.1 10.4 8.7 7.2 5.8 Source: Company, Ambit Capital research

Havells India


Havells has grown materially faster than the industry over the last decade Havells has grown the fastest amidst its peers in the last decade, with standalone revenue CAGR of 29% over FY04-14 vs its peers’ 15%. Further, its FY14 standalone EBITDA margin improved to 13.6% from 10.9% in FY04 and RoIC improved to 54% in FY14 from 20% in FY04.

Havells’ revenue growth has outperformed the industry Exhibit 1:Revenue in ` mn FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 CAGR (%)

Havells 3,633 5,820 10,035 15,472 20,556 21,984 23,712 28,817 36,156 42,250 47,197 29%

Polycab 9,331 10,824 12,556 19,674 21,304 22,473 25,114 31,767 37,756 37,195 41,052 16%

Philips 20,953 25,780 29,600 28,001 20,492 24,820 25,612 NA 27,822 37,912 40,601 7%

Bajaj 4,599 5,585 5,992 7,721 10,105 12,417 14,904 19,082 22,653 26,981 28,956 20%

Crompton 6,119 6,712 8,166 9,927 11,667 13,218 16,119 20,207 21,324 25,915 28,457 17%

Finolex 4,549 5,708 7,478 10,330 13,838 13,415 16,187 20,358 20,640 22,707 23,590 18%

V-Guard 1,252 1,341 1,701 2,227 2,786 3,174 4,547 7,266 9,936 13,602 15,176 28%

Orient Electric 1,566 1,648 1,919 2,425 2,851 3,414 4,808 6,423 7,557 9,118 11,033 22%

Surya Roshni 2,813 2,691 3,127 3,237 3,472 3,818 5,599 7,502 7,698 9,064 10,772 14%

Khaitan Electric 1,057 1,122 1,904 2,843 3,200 2,847 3,569 4,659 4,413 5,118 5,137 17%

Top ten players 55,872 67,230 82,477 101,856 110,269 121,581 140,171 146,080 195,956 229,861 251,971 16%

Excl. Havells 52,239 61,411 72,442 86,384 89,713 99,597 116,460 117,264 159,800 187,611 204,774 15%

Source: Company, Ace equity, Capitaline, MCA, Ambit Capital research; Note: We have taken standalone revenue for Havells; lighting and consumer appliances for Philips (which includes white goods, however we do not believe white goods are material in size for Philips); non-E&P revenue for Bajaj Electricals; consumer business revenue for Crompton; electrical business revenue for Orient; lighting revenue for Surya Roshni

Havells standalone profitability and RoIC have Exhibit 2:improved…


…led by a favourable operating leverage and Exhibit 3:

improvement in capital employed turnover


This has helped Havells in its P/E re-rating Exhibit 4:

Source: Company, Bloomberg, Ambit Capital research

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Havells India


Factors that helped Havells do well in the last decade… (1) Investment in brand building: Havells is perhaps the first Indian Light

Electricals company to focus on building a brand. In FY02, it started the trend of advertising its brand and since then it has not looked back; Havells’ average ad spend over FY02-14 has been at 2.6% of revenue vs its peers’ 2.3%. Havells chose cricket (the most popular sport in India) as the medium to drive its advertising and branding campaign by co-sponsoring the Indian Premier League (IPL), the T20 tournament in 2008 and the International Cricket Council’s (ICC’s) T20 World Cup in 2007. As luck would have it, India won the first ICC World T20 in 2007, and this was instrumental in entrenching Havells’ brand in the consumer electrical space. Havells continues to be the largest spender on ads, spending `1.1bn in FY14 (with a higher CAGR of 32% over FY02-14 as compared to 16% for its peers).

Havells’ ad spend as a percentage of revenue over FY02-14 at 2.6% has been higher than its peers’ 2.3% Exhibit 5:

Ad spend as a % revenue FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14

Havells (standalone) 2.1% 2.8% 1.9% 2.8% 3.1% 2.0% 2.6% 2.3% 3.5% 2.5% 3.1% 3.1% 2.4%

Finolex 1.1% 1.5% 0.6% 0.4% 0.3% 0.4% 0.5% 0.3% 0.4% 0.4% 0.5% 0.5% 0.4%

V-Guard NA NA NA 5.3% 4.7% 5.4% 5.7% 5.1% 5.1% 3.8% 4.2% 4.3% 3.9%

Philips 3.4% 3.5% 3.8% 3.2% 3.3% 2.9% 3.1% 2.8% 3.7% 3.3% 2.9% 2.7% 2.8%

Khaitan Electric 1.6% 3.3% 4.8% 2.8% 3.2% 2.2% 2.4% 2.1% 1.7% 2.3% 2.0% 1.2% 1.7%

Surya Roshni 0.9% 1.7% 1.0% 1.2% 1.0% 1.1% 0.6% 2.3% 2.0% 1.3% 0.6% 0.5% 0.4%

Bajaj (non-E&P) 3.1% 3.2% 2.3% 2.5% 2.6% 2.3% 2.1% 1.9% 2.2% 1.9% 1.8% 1.6% 2.2%

CRG (consumer) 0.7% 1.4% 1.1% 1.9% 1.8% 3.2% 3.6% 4.0% 5.2% 1.7% 2.2% 2.7% 2.7%

Average (excl. Havells) 1.8% 2.4% 2.3% 2.5% 2.4% 2.5% 2.6% 2.6% 2.9% 2.1% 2.1% 1.9% 2.0%

Source: Company, Ace Equity, Capitaline; Note: We have not included Polycab, as its advertisement spend is not available; for Bajaj we have taken ad spend as a percentage of non-E&P revenue; for CRG we have taken ad spend as a percentage of standalone consumer revenue; for Surya we have taken ad spend as a percentage of lighting and consumer division.

The growth in ad spends (in absolute terms) for Havells has been the Exhibit 6:highest in the industry over FY02-14

Company Advertisement CAGR (%)

Over FY02-14 Over FY02-05 Over FY05-09 Over FY09-14

Havells (standalone) 32% 32% 25% 18%

Finolex Cables 4% -18% 13% 19%

V-Guard 27% NA 18% 30%

Philips 10% 8% 4% 13%

Khaitan 17% 19% 13% 8%

Surya Roshni 7% 12% 22% -14%

Bajaj (non-E&P) 15% 3% 11% 22%

CRG (consumer) 30% 31% 33% 8%

Average (excl. Havells) 16% 9% 16% 12%

Source: Company, Ace Equity, Capitaline, Ambit Capital research

(2) Incentivising channel partners: Having started off his career as a light electrical dealer himself, Qimat Rai Gupta (QRG) always enjoyed a strong relationship with the channel partners than most of his peers. The key differentiator between Havells and its peers is the range of incentives offered by Havells to its channel partners: channel financing, Shahenshah scheme, mutual fund scheme and gold coins/prepaid shopping cards on achievement of targets are a few examples. Moreover, Havells took a few special initiatives to enhance its reputation amidst the dealer community. For instance, during the Lehman Brothers crisis, the prices of copper had declined sharply by 58%, leaving the dealers with high-cost inventory, as they had piled up inventories in September to cash in on the festive season. To share the losses of the dealers, the company announced a special trade discount of 1%. This was well accepted by dealers, as not many competitors matched this gesture.

Havells India


Various incentive schemes of Havells Exhibit 7:

Scheme Description

Shahenshah scheme Dealers/distributors who have achieved their annual targets are credited with points which can be redeemed against foreign/domestic holidays

Prepaid shopping cards

Prepaid shopping cards/gift card are given to dealers under this scheme

Channel Financing Bank funding is provided to dealers/distributors through introductions. Note Havells gives a recourse of 5-10% of the total exposure

Power plus loyalty Royalty points to channel partners, electricians and electrical contractors on purchase of Havells products

Travel incentives Free domestic/international tours are given to dealers under this scheme

Mutual fund and insurance scheme

Mutual funds and insurance policies are awarded to dealers on achievement of the targets

In-kind incentives In-kind benefits such as gold coins, consumer appliances, etc. are given on achievement of the target

Source: Company, Industry, Ambit Capital research

(3) Diversified product portfolio: Havells is one of the few companies to have sweated its brand far more efficiently than its peers. It currently sells more than 15 categories (further broken up into several SKUs) vs an average 7 by its peers. This is because QRG very early in the trade realised the power of building a brand and sweating it, as the channel is capable of selling multiple categories. Typically, there are two types of channel; one which sells cables and wires, switches, switchgears, lighting products and the other which sells fans, small domestic appliances, pumps and water heaters.

Dealing with a diversified company also works for the channel partners due to several advantages like: (a) scope for earning higher commissions as it becomes easier to meet annual targets with several categories housed in the same brand, (b) reduction in cyclicality given that the demand drivers are different across different categories and (c) cross selling of products.

Havells’ journey to becoming a diversified company Exhibit 8:

Year Key events

1958 Commenced trading operations in Delhi

1970s Bought Havells brand for `0.7mn from Havelli Ram Gupta Set up manufacturing units for rewireable switches, changeover switches and HBC fuses in Delhi

1980s Started manufacturing high quality Energy Meters Set up JV with Geyer (Germany) for manufacturing MCBs at Badli Acquired Towers and Transformers (Energy Meters manufacturing company)

1990s

Set up a manufacturing plant at Sahibabad, UP, for changeover switches and Faridabad, Haryana, for control gear products Acquired Electric Control & Switchboards at Noida for manufacturing customised packaged solutions Introduced high-end Ferraris Meters in a Joint Venture with DZG, Germany Was listed on the BSE on 8 February 1994 (Mcap on day of listing: US$4.5mn)

2000 Acquired controlling stake in Duke Arnics Electronics (P) Limited and Standard Electricals

2001 Acquired business of Havells Industries Ltd, MCCB of Crabtree India. (Mcap in FY01 at US$11.2mn)

2003 Launch of Fans, CFL and Lighting

2004 Set up manufacturing plant at Baddi, HP (domestic switchgear) and Noida (ceiling fans). Brownfield expansion at Faridabad plant for CFL. (Mcap in FY04 at US$21.3mn)

2005 Set up manufacturing plant in Haridwar (fans). Set up of R&D centre in Noida H.O.

2006 Crabtree India merged with Havells India; added CFL production unit in the Haridwar manufacturing plant

2007 Acquired Sylvania; Warburg Pincus invested US$110million in Havells India (Mcap before acquisition: US$411.3mn)

2008 Investment of `500mn in the Global Centre for Research and Innovation (CRI) (Mcap in FY08 at US$450mn)

2009 Launch of India's first HPF CFL. Launch of India's first BEE 5* rated fan (Mcap in FY09 at US$145mn)

2010 Acquired 100% interest in Standard Electricals. Sets up second unit for fan manufacturing at Haridwar. Launch of Havells brand in the US and Mexico (Mcap in FY10 at US$610mn)

2011 Launch of domestic appliances. Standard Electrical merged with Havells. Entered into a Joint Venture with Shanghai Yaming Lighting, China (Mcap in FY11 at US$775mn).


Havells India


Havells has a sizeable presence in most of the categories in the light electrical space Exhibit 9:Category Product Havells Philips V-Guard Bajaj Crompton Orient Finolex Polycab

Electrical consumer durables Fans

Water heater

Irons

Kitchen appliances

Stabilisers, Invertors

Lighting CFLs

LEDs

Indoor Luminaries

Outdoor Luminaries Switchgears / Switches Domestic switchgear

Industrial switchgear

Switches

Cables and wires Low voltage

High voltage

Residential wires

Source: Industry, Ambit Capital research; Note: represents amongst top four players, represents amongst top 5-10 players, represents weak presence

and represents absence in the category

(4) Geographical expansion: Amidst the contemporary companies, Havells is one of the few to have developed a pan-India franchise. Apart from west India, Havells is the top-3 player across north, east and south India, which comprises ~70% of the overall market. Havells has been successful amidst its peers due to: (a) strong brand recall given the significant spend on advertisement and promotion; (b) strong push from the channel partners given the attractive incentive structure; and (c) its diversified product portfolio

…and this has aided in strong ROIC generation Havells consistently improved its margins and working capital turnover over FY04-14 through a combination of: (1) product diversification, (2) aggressive ad spend (advertisement as a percentage of revenues increased from 1.9% in FY04 to 2.4% in FY14) and (3) investment in dealers through schemes like channel financing (facilitate dealers in getting access to capital and to release its own working capital tied-up in receivables) and the Shahenshah scheme. Consequently, its ROIC improved from 20% in FY04 to 54% in FY14.

Consistent product diversification… Exhibit 10:

Product Launched in

Fans 2003

CFL 2003

Lighting 2003

Electric water heater 2010

Domestic Appliances 2011

Pumps 2013


…increase in revenue share of the new products… Exhibit 11:`mn FY11 FY12 FY13 FY14

Switchgears 7,710 8,962 10,781 12,192

% of total revenue 25% 25% 26% 26%

Cables 13,615 15,930 16,925 19,264


Lighting & Fixtures 4,567 5,544 6,652 7,207


Consumer durables 4,724 5,721 7,893 8,534



Havells India


…consistent increase in market share… Exhibit 12:

Market share in % FY06 FY08 FY11 FY12 FY14 FY14 over FY11

FY11 over FY08

FY08 over FY06

FY14 over FY08

Switchgears 15% 28% 28% 28% 29% 1% 0% 13% 1%

Modular switches 5% 15% 15% 15% 20% 5% 0% 10% 5%

Industrial switchgear 6% 7% 6% 6% 20% 14% -1% 1% 13%

Cables and wires 9% 6% 9% 9% 12% 3% 3% -3% 6%

Lighting CFL 10% 11% 11% 11% 11% 0% 0% 1% 0%

Lighting luminaries 3% 11% 11% 12% 14% 3% 0% 8% 3%

Electrical consumer durable fans 6% 14% 14% 15% 15% 1% 0% 8% 1%

Source: Industry, Company, Ambit Capital research

…and consistent improvement in margins and Exhibit 13:working capital turnover…


…led to strong RoIC improvement Exhibit 14:


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Havells India


However, we expect Havells to lose market share in the next decade Market share across its most profitable categories has already stagnated over FY08-14 Until FY08, Havells saw significant market share gains across several product categories, like switchgears, modular switches, lighting luminaries, and fans (part of electric consumer durables segment which also includes appliances; however ~67% of electrical consumer durables is constituted by fans); but its market share since FY08 has started stagnating across most of its profitable product categories like switchgears, fans and lighting CFLs (part of the lighting segment which also includes lighting luminaires).

Slowdown in the revenue growth of switchgear (Havells’ most profitable product) from 38% over FY04-08 to 14% over FY09-14 led to a contraction in adjusted EBITDA margin by 60bps over FY11-14. However, reported EBITDA margin expanded from 10.1% in FY04-08 to 12.2% in FY09-14; but this we believe was partly led by the change in the method of accounting for turnover discount, incentives and rebates. Until FY10, Havells was accounting for turnover discount separately in the selling and distribution cost. However, since FY11, Havells has started deducting the turnover discount, incentives and rebates directly from the revenue. Had the method of accounting remained the same, Havells’ average standalone EBITDA margin over FY11-14 would have been 60bps lower than the reported EBITDA margin.

After a sharp market share improvement in FY06-08… Exhibit 15:

Market share in % Change in % points

FY06 FY08 FY08 over FY06

Switchgears 15% 28% 13%

Modular switches 5% 15% 10%

Cables and wires 9% 6% -3%

Lighting CFL 10% 11% 1%

Lighting luminaries 3% 11% 8%

Electrical consumer durable fans 6% 14% 8%


…the same has stagnated since then across Exhibit 16:key profitable categories like switchgears

Market share in % Change in % points

FY08 FY11 FY14

FY14 over FY11

FY11 over FY08

FY14 over FY08

Switchgears* 28% 28% 29% 1% 0% 1%

Modular Switches

15% 15% 20% 5% 0% 5%

Cables and Wires

6% 9% 12% 3% 3% 6%

Lighting CFL 11% 11% 11% 0% 0% 0%

Lighting Luminaries

11% 11% 14% 3% 0% 3%

Electrical consumer durable fans*

14% 14% 15% 1% 0% 1%

Source: Industry, Ambit Capital research; Note: *Key profitable categories

With switchgears’ revenue growth coming off, Havells’ blended gross Exhibit 17:margin has started declining


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Average gross margin of 36.7% over FY09-14

Average gross margin of 39.0% over FY04-08

Switchgears and Electrical consumer durables are the most profitable segments for Havells

Source: Company, Ambit Capital research; Note: CD – consumer durables, figures are standalone

Switchgears, 39%

Cables, 21%

Lighting ,

17%

CD, 23%

% share in segmental EBIT

Havells India


Rising competition in fans and switchgears can hurt margins Havells’ margins in domestic switchgears at 27% and in electrical consumer durables at 33% are the highest amidst its peers. Domestic switchgear is a very concentrated market, with the top-3 players (Havells, Legrand and Schneider) accounting for ~70% market share. This is because of the small market size of `50bn on a per annum basis which discourages bigger players like L&T, ABB and Siemens to tap this market. Secondly, the share of the unorganised players in this segment is relatively very low given that the application of domestic switchgears is to protect against any fire caused by short circuits.

Within fans, Havells had the best product offering in the premium and decorative segment. In the last five years, only Crompton and Usha had a good range in the premium and the decorative segment. Other players like Bajaj, Orient, Khaitan, and Polar concentrated on the mass and the economy segment. With the share of the premium and the decorative segment doubling from 25% in FY09 to ~50% in FY14, Havells, Crompton and Usha turned out to be the major beneficiaries.

Switchgears and fans (part of electrical Exhibit 18:consumer durables) dominate Havells’ standalone EBIT…

Source: Company, Ambit Capital research; Note 75% of Electric consumer durables’ revenue is contributed by fans

…given their superior EBIT margin Exhibit 19:


Several new players are entering fans with premium and decorative offerings

In the last one year, several new players like RR Kabel, Surya, Polycab, Luminous, and Schneider have entered into the fans segment. As the growth in the last five years has been led by the premium and the decorative segment, several new players have launched premium and decorative products. Even players like Bajaj, Orient and Khaitan have launched premium and decorative offerings. This should have an impact on the market share of Crompton and Havells which have been the top-2 players in fans since the last five years. Further, several of these players have also started marketing these premium offerings through advertisements.

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Havells’ margins in domestic switchgears and consumer durables at 27% and 33% is the highest amidst peers

Doubling of share of the premium and decorative fans to 50% in the last five years helped Havells immensely

In the last one year, more than five players have entered in the fans segment, offering premium and decorative products

Havells India


Several companies have launched premium Exhibit 20:and decorative categories in fans

Company Premium fans

BJE Magnifique, Bajaj Euro, Winstrim, Cruz

Usha Fontana One, Fontana Maple, Fontana Orchid, Fontana Lotus

Crompton Seagul, Oberon, Stubby, Radiance, Sail and Twirl ceiling fans

Kaithan Fressco, Verazzano, Lugano, Mansion, Castilian

Havells Oyster, Lumos

Orient Subaris, Arista

Source: Media Articles, Ambit Capital research

BJE’s Hakka Bakka advertisement of premium Exhibit 21:fans


Orient’s advertisement for premium fans Exhibit 22:


Luminous’ advertisement for premium fans Exhibit 23:

Source: Media articles, Ambit Capital research

Finolex’s switchgear entry can cause margin disruptions

Finolex Cables is planning to launch domestic switchgears in 4QFY15. Already the requisite machineries have started getting commissioned at its Roorkee manufacturing facility and the requisite certifications are likely to have been completed by the end of December. Our primary data checks suggest that Finolex will price these switchgears very competitively (15-20% EBIT margin vs more than 30% earned by Havells, Legrand and Schneider) to gain market share, which currently is concentrated amidst Havells, Schneider and Legrand (together control around 70% market share). We believe Finolex may first launch its switchgears in south India which is its strongest market and then plan a pan-India launch.

We believe Finolex can succeed in switchgears because:

Finolex’s brand perception is strong as a ‘safety’ brand

Our discussions with the dealer community suggest that the perception of Finolex’s brand in the mind of a consumer is very high as a ‘safety’ brand. Hence, if Finolex launches any new product, its product quality by default would be superior and will be accepted for any application where safety is of prime importance. Consequently, if Finolex is able to deliver a good quality product it can become a big threat to established players. However, for a player like Polycab to launch switchgears may not be the best idea given that its reputation in the market is of a ‘value for money’ product rather than a high-quality product.

“Finolex’s perception in the mind of the consumer is very high as a ‘safety’ brand; hence, any new product launched by Finolex with has a safety feature will find buyers.”

— A primary data source working in the strategy team of an MNC player which is strong in switchgears

Havells India


Leverage on the existing distribution network; ~50% is replacement market

Almost 50% of the market is the replacement given that the life of the product is 2-3 years, where the decision is driven by the dealer who sells the product to the final consumer. The remaining 50% of the market is driven by architects/consultants who certify vendors based on the product quality and pricing. Given that Finolex already has a distribution network, the gestation period to start selling in the retail market is minimal. Note that dealers selling electrical cables and wires also sell switchgears. Whilst Finolex is not a dealer-friendly company (which can play against Finolex), it is planning to launch an ad campaign for the launch of switchgears to simultaneously create a brand pull from consumer. Note that Finolex’s brand loyalty in the south is very strong and this being more than 30% of the market can act in favour of Finolex.

Our estimates are very conservative as compared to management guidance

The management is guiding for ~`2bn of sales in FY16, which is the first year of full operation. Our discussions with a few dealers suggest that this as an aggressive estimate because it implies a market share of ~4%. This appears to be very optimistic in the first year of full operation, given that: (1) the dealers have yet not seen the product catalogue, (2) the demand environment currently remains weak, and (3) the management has traditionally been a slow starter. Consequently, we have assumed `1.4bn in FY16 and then we expect this to double to `3.3bn by FY19. We are assuming EBIT margin of 15% in FY16 and 18% in FY17 vs ~34% for incumbents like Havells.

Reasons for Havells’ stagnation The company is facing rising competition from several regional/single product companies like Surya Roshni, Preethi, Polycab, V-Guard, Finolex Cables, and TTK Prestige. These companies have started launching new products like fans, lighting, appliances, and switchgears, have upped the focus on advertisement and sales promotions and have started expanding beyond their regional markets. Also, MNC players like Schneider (acquired Luminous in FY12), Legrand (acquired Indo Asian Fusegear in FY11 and Numeric Power Systems in FY12), Philips (acquired Preethi in FY11) and Panasonic (acquired Anchor in FY08) are adding new products, similar to several regional/single product companies. The MNC players are also increasing their presence nationally by expanding the regional distribution network of the acquired companies nationally.

Several players have launched new product Exhibit 24:categories…

Company Flagship product New product added

V-Guard Stabilisers Fans, switchgears, induction cooktops

Polycab Electrical Wires Fans, lighting, switches

Finolex Electrical Wires Switchgears, transformers

Luminous Invertors Fans, switches, CFL, switchgears

Anchor Switches Electrical cables, lighting, switchgears


...and consequently expanded their regional Exhibit 25:markets

Player Regional strength Expanded to

V-Guard South India Non-South

Finolex Cables South and West North and East

TTK Prestige South Non-South


Havells has been unable to establish a presence in west India despite market leadership in north and east India and despite being the top-3 player in south India. Whilst Havells has stopped giving the geographical break-up of its standalone revenues, our discussions with its dealers in Maharashtra and Gujarat suggest limited success for Havells in both these states. However, this is also true for regional players like V-Guard which has significantly expanded its nation-wide presence from being a regional player out of south India but is struggling in Maharashtra and Gujarat. This may be because of the dominance of strong regional players like Bajaj Electricals, Polycab, Racold, Anchor, and Crompton Greaves which are strong players in appliances, cables and wires, water heaters, switches and fans respectively.

50% of the market is the replacement, as the life of the product is 2-3 years in India; hence dealers are very influential

Whilst Finolex is not a dealer-friendly company, it is planning to launch an aggressive ad campaign at the time of launch to create brand pull

Our FY16 estimate for switchgears is ~50% of management guidance

Difficulty in gaining market share in west could impact Havells’ revenue growth as Havells is virtually a market leader in north, east and south

Havells India


This should impact long-term growth, as historically the strong revenue growth was a function of the company gaining market share across north, east and south India. Now with stagnant market share across north, east and south and difficulties in establishing traction in west India, the growth for Havells is unlikely to exceed the industry growth rate.

Havells has also seen limited success in new categories launched in the last five years. Havells has launched domestic appliances, monoblock pumps and motors in the last five years. Apart from domestic appliances wherein Havells has had some success, with its turnover touching ~`2.8bn in FY14, implying a market share of 5% in three years (launched in FY11), the other two categories have seen modest growth. However, we believe Havells’ strategy of focusing only on the premium appliances may backfire given that the share of this category is low at ~20% (`10bn market) and is dominated by Philips. This has also been corroborated in the dealer meetings that we have done for domestic appliances.

Attrition in Havells is rising. Our discussions with industry participants suggests that the attrition rate in Havells is on the rise (percentage of senior employees having spent more than five years at Havells is the one of the lowest amidst peers). This may be led by the rising competitive intensity in the market, with several companies now emulating the Havells model of sweating the brand more by launching new categories (see Exhibit 24 above).

For achieving success in new categories the confidence from the channel partners is very essential given that it is a push model. Recruiting senior territory sales managers can help new companies in establishing strong relationships with channel partners, as they enjoy a very strong relationship with the channel partners. Further, an experienced territory sales manager can also help in ensuring good quality sales (i.e. minimal bad debts and fast cash conversion), as he/she knows the channel very well.

The classic case study is that of V-Guard which has hired several senior marketing people from its competitors based in non-south regions. These hires have helped V-Guard in garnering the confidence of the channel partners, which in turn has resulted in V-Guard now earning 30% of its revenues from non-south as compared to 5% in FY08. Moreover, this growth has not come at the cost of diluting the working capital cycle, which at 61 days in FY14 is the lowest in the last six years (V-Guard’s share of non-south market was 15% of revenues in FY10).

Losing market share for industry leader is not uncommon Low barrier to entry and limited scope for product innovation (average R&D spend as a percentage of revenue low at 0.5% of FY14 revenues for the top-five players) have meant that sustaining leadership is next to impossible. Every 2-3 years, 3-4 new companies are seen launching new categories and one or two established companies slipping on market share at a rapid pace. Further, there have been several instances where an industry leader that has retained a leadership status for 3-4 years suddenly becomes a laggard due to higher aggression from a competitor either through offering higher commission to the channel partner or spending more on advertising and promotion or launching a new SKU. Even a technology superior player like Philips has seen stagnation, with revenue CAGR of only 7% in FY04-14 vs 20% for peers. This is despite it being technologically superior to its peers and its consistently strong advertisement spends at 3.2% of revenue over FY02-14 vs 2.2% for peers.

Leader one day, laggard the next Exhibit 26:

Category Leader in 2000 Leader in 2014

Electrical cables and wires Cable corporation of India Polycab

Fans Khaitan Crompton

Small appliances Philips Bajaj Electricals

Lighting Philips Philips


Havells India


Life after QRG’s demise may not be the same The late Qimat Rai Gupta (QRG) was one of the big reasons for Havells’ success, given his strong emotional connect with the channel partners (he himself was a trader in Bhagirath Palace) and his ability to take risks and execute successfully (often referred as a taskmaster).

Some of QRG’s key strengths were:

Strong ‘emotional’ connect with the channel partners: QRG knew most of the channel partners by their first name. He connected with them frequently (at least once a month) before taking any major decisions like new product launch/price hikes/advertisement strategy. This made them feel very special. Note that QRG started his business as a dealer and hence used to enjoy a very strong rapport with this community.

Visionary and a very aggressive executor: QRG was a visionary. He always thought about the ‘BIG’ picture and more often than not his vision was anti-consensus and risky. His philosophy was that if you can think bigger, automatically you will get the means to achieve it. To implement his vision, he also took very quick decisions and delegated responsibility to ensure that the execution happened seamlessly. More importantly, he monitored the execution aggressively. Aggressive targets by QRG could be a reason why the attrition rate in Havells has always been higher than the industry. Unlike large companies, in Havells you will seldom find people with more than 7-8 years of experience.

Some of the anti-consensus decisions taken by him were: (a) spend aggressively on advertisement, similar to what a FMCG company spends; during FY05-14 Havells had spent 2.7% of revenues on advertisements; (b) position the brand as a ‘premium’ brand across all categories; in categories like fans this was completely unheard of; and (c) acquire Sylvania for international diversification, again something unheard of.

Impulsive risk taker: QRG never shied away from taking risks, given his ‘emotional’ personality. Examples of this are: (a) The decision to acquire Sylvania was taken on the dinner table. Sylvania at the time of acquisition was triple the size of Havells (on revenues). (b) The decision to own multiple brands (Crabtree, Sylvania, Concord, Luminance, and Standard) without any fear of cannibalisation was also QRG’s decision. (c) Expansion of the business in the 1990s at a time when MNCs like Schneider, ABB and Siemens entered into India (there was a time when Havells invested its entire profits for ten years into capex for expanding the business) and in the late 1990s the Chinese entered with selling prices lower than the cost of production for several Indian companies.

Anil Gupta vs QRG: Anil Gupta, post the demise of QRG, has been appointed as the CMD of Havells. Our discussions with ex-employees and channel partners suggest that Mr Gupta is not as aggressive and as quick a decision maker as Mr QRG. However, he is more professional in decision making; unlike QRG he takes his decision by undertaking a detailed analysis. His connection with the dealers though is good; he does not enjoy the same kind of ‘emotional’ bonding as that enjoyed by QRG. Whilst the business at Havells is currently ‘as is’, the next 9-12 months will be a testing time for Anil, as he engages with the channel partners (Havells’ key strength) in the absence of QRG.

Havells India


Poor capital allocation Standalone RoE declined to 24% in FY14 vs 47% in FY07 (before Sylvania buyout) Havells’ investment in Sylvania has increased five-fold to `8.8bn (38% of standalone capital employed) since FY07. This is despite Sylvania making a loss of `0.3bn in FY14 and average loss of `1.2n over FY08-14, translating into a dismal ROI of -3.3% in FY14 and -19.3% over FY08-14. Whilst Sylvania turned into black with APAT of `417mn in FY11 and `617mn in FY12, it again slipped into the red, with adjusted loss after tax of `5mn in FY13 and `290mn in FY14.

Consistent increase in Havells’ investment in Exhibit 27:Sylvania led to Havells’ RoE declining from 47% in FY07 to 24% in FY14 as…


…Sylvania continues to incur losses Exhibit 28:


Limited room for Sylvania’s margin expansion and volume growth given benefits of employee expense and fixed cost have played out Sylvania’s EBITDA margin improved significantly to 7.3% in FY12 from 2.3% in FY09 due to the success of the two restructuring programmes (Phoenix and Parakram). Margins in FY12 were the highest historically reported by Sylvania. In FY13 and FY14, the margins already declined to 5.0% and 3.3% respectively. For margins to improve from hereon is challenging, given that the benefit from the two restructuring programmes has already played out. These benefits included reducing employee expenses and cutting fixed costs (through closure of factories) by outsourcing production to India and China.

Sylvania’s EBITDA margin after improving by Exhibit 29:13% points over FY10-12 has declined by 400bps over FY12-14


Margin improvement over FY10-12 was led by Exhibit 30:the reduction in employee and other operating cost; with this played out further expansion seems limited


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Havells India


Outlook on Europe and Latin America deteriorating

GDP growth outlook for Latin America is turning weak. The IMF has already lowered CY14 growth forecast for Latin American countries from 2.0% in July to 1.3% recently due to the slowdown in commodity demand from China. Chinese GDP according to IMF’s forecasts is likely to see a growth of 7.4% and 7.1% in CY14 and CY15 respectively which is the slowest in a decade. This should mean that the Latin American GDP will most likely remain under pressure.

GDP growth outlook for Europe is also turning weak

The European Union (EU) in the first week of November cut its GDP growth outlook for CY14 to 0.8% from 1.2% earlier and for CY15 to 1.1% from 1.7% earlier due to lower-than-expected growth in Germany, France and Italy. The lower-than-expected growth is led by lack of internal investment and by political tension in Ukraine and the Middle East.

Recovery in Sylvania’s EBITDA margin in FY15 is unlikely

Whilst Sylvania’s EBITDA margin improved by 80bps YoY (in constant currency terms) to 4.2% in 1HFY15, we believe the same would be impacted in 2HFY15 due to increase in pension liability and adverse currency movements. The decline in bond yields in the European market may result in an increase in the provisions related to the pension liabilities of Sylvania (lower bond yields result in a lower discounting rate of the pension liability) for FY15. Moreover, the significant currency volatility in Latin American countries such as Brazil, Mexico and Columbia vs the Chinese Yuan (Sylvania procures bulk of the raw material from China) may also have an adverse impact on the operating margins of Sylvania. We model Sylvania’s EBITDA margin of 3.3% (in INR terms) vs the management’s guidance of 5-6%.

Europe with 58% revenue share is the largest geography for Sylvania


Europe, 58%

America, 35%

Others, 6%

Revenue share % in FY14

Havells India


Assumptions The key assumptions to our estimate of standalone revenue and PAT CAGR of 14% 15% over FY14-17 have been mentioned in the exhibit below.

Key Assumptions - Havells standalone Exhibit 31:

`mn unless specified FY13 FY14 FY15E FY16E FY17E Comments

Key assumptions

Switchgears

Revenue 10,781 12,192 13,182 14,806 16,938 We expect the revenue growth in switchgear to recover in FY16 due to pick-up in the construction activities in 2HFY15 (benefit comes with a lag). However, we expect decline in EBIT margin due to increasing competitive intensity of this segment. Note that Finolex Cables is likely to launch switchgears in 4QFY15.

YoY growth (%) 20.3% 13.1% 8.1% 12.3% 14.4%

EBIT margin 33.9% 33.1% 33.0% 32.0% 31.0%

Cables

Revenue 16,925 19,264 22,990 27,588 32,554 We expect the growth rates in FY16 to pick up given our expectation of a pick-up in industrial capex and construction activity. However, we expect 100bps decline in EBIT margin in FY15 and 50bps in FY16, as the EBIT of 11% was the highest in seven years and is unlikely to sustain given no structural change in the pricing in the industry nor change of product range for Havells over the past two years.

YoY growth (%) 6.2% 13.8% 19.3% 20.0% 18.0%

EBIT margin 9.1% 11.0% 10.0% 9.5% 9.5%

Lightings and Fixtures

Revenue 6,652 7,207 7,720 9,264 10,932 We expect recovery in revenue in FY15, as Havells is gaining market share from Bajaj which is facing large decline in its lighting volume due to poor presence in LED and friction in channel. We expect strong revenue growth in FY16 and FY17 led by the recovery in the project demand for lighting.

YoY growth (%) 20.0% 8.3% 7.1% 20.0% 18.0%

EBIT margin 23.6% 24.8% 24.0% 24.0% 24.0%

Electrical Consumer Durables

Revenue 7,893 8,534 9,946 11,689 13,746 After the disappointing FY14 growth, we expect electric consumer durables to see a recovery in revenue growth in FY15 due to favourable weather conditions and incremental improvement in consumer sentiment. Note that growth in 1HFY15 has already been strong at 23% YoY due to strong demand for fans (led by extended summer) and small appliances (led by improvement in consumer sentiments).

YoY growth (%) 38.0% 8.1% 16.6% 17.5% 17.6%

EBIT margin 25.1% 27.0% 27.0% 27.0% 27.0%

Unallocable expenses as a % of revenue

9.4% 9.4% 9.0% 8.5% 6.8%

We expect reduction in unallocable expenses in FY17 as we have modelled discontinuance of royalty payment (1% of revenue) to promoter from FY17 and 50bps reduction in freight cost in FY17 due to the likely rollout of the GST.

Key estimates

Revenue 42,250 47,197 53,838 63,347 74,169 Based on the above assumptions, we expect revenue CAGR of 16% over FY14-17.

Sales (YoY growth) (%) 17% 12% 14% 18% 17%

EBITDA 5,349 6,416 7,037 8,153 10,658 Consequently, we expect improvement in EBITDA margin in FY17.

EBITDA margin (%) 12.7% 13.6% 13.1% 12.9% 14.4%

EBITDA (YoY growth) (%)

17% 20% 10% 16% 31%

PBT 4,572 5,951 6,351 7,446 9,878 Consequent to EBITDA growth.

Tax rate (%) 18.8% 19.6% 28.0% 28.5% 29.0% Higher tax rate based on the management’s guidance.

Adj. PAT 3,714 4,787 4,573 5,324 7,014 We expect PAT CAGR of 14% over FY14-17.

PAT (YoY growth) (%) 21.6% 28.9% -4.7% 16.2% 32.3%

CFO 3,778 6,525 5,529 6,499 8,867 We expect working capital cycle to improve by 1 day to -5 days in FY15 from -4 days in FY14. We expect 2 days improvement in working capital cycle in FY17 due to the implementation of the GST.

Capex 1,197 893 1,625 1,852 2,111 We have modelled maintenance capex.

FCF 2,581 5,632 3,904 4,647 6,755 The company will keep generating positive free cash flow.


Havells India


The key assumptions to our estimate of Sylvania’s revenue and EBITDA CAGR of 3% 30% over FY14-17 have been mentioned in the exhibit below.

Key Assumptions - Sylvania Exhibit 32:

`mn unless specified FY13 FY14 FY15E FY16E FY17E Comments

Sales 30,229 34,614 35,307 36,366 37,457 We expect modest revenue growth of 2% in FY15 and 3% in FY16 and FY17 given the challenging business environment in Europe (revenue share in FY14 is 57%). Sales (YoY growth) (%) 2.3% 14.5% 2.0% 3.0% 3.0%

EBITDA 1,525 1,137 1,059 2,000 2,510 We expect improvement in EBITDA margin over FY15-17 led by lower base impact and favourable operating leverage. EBITDA margin (%) 5.0% 3.3% 3.0% 5.5% 6.7%


-30% -25% -7% 89% 25%

Interest expense 924 472 458 489 327 We expect sequential reduction in interest expense led by the principal repayments.

APBT 99 -

64 133 1,046 1,696 Consequent recovery in APBT

Tax rate (%) 5% NA 35% 35% 35% Normal tax rate

APAT - 5

- 290

86 680 1,102 Consequent improvement in PAT

PAT (YoY growth) (%) NA NA NA 689% 62%

CFO 1,200 2,135 1,042 1,395 1,925 Consequent improvement in cash generation


Ambit vs Consensus – Havells standalone Exhibit 33:

Ambit Consensus Divergence (%) Comments

Revenue (`mn)

- FY15 53,838 54,500 -1% Whilst our estimates are 1% behind consensus for FY15, our estimates are marginally ahead of consensus for FY17.

- FY16 63,347 63,325 0%

- FY17 74,169 73,126 1%

EBITDA (`mn)

- FY15 7,037 7,469 -6% Our estimates are below consensus for FY15 and FY16, as we assume 60bps and 110bps lower EBITDA margin vs consensus for FY15 and FY16 respectively. In FY17, our estimates are 3% ahead of consensus, as we have modelled 150bps improvement in margin led by saving in freight cost (due to rollout of GST) and discontinuance of royalty paid to promoter (1% of revenue).

- FY16 8,153 8,834 -8%

- FY17 10,658 10,311 3%

EPS (`)

- FY15 7.3 8.4 -13% Our EPS estimates are lower than consensus, as we expect the tax rate to increase from 20% in FY14 to 28% in FY15, 28.5% in FY16 and 29% in FY17 (which is in line with the management’s guidance) vs consensus' assumption of 26% in FY15, 25% in FY16 and 26% in FY17.

- FY16 8.5 10.2 -17%

- FY17 11.2 12.0 -6%


Ambit vs Consensus – Sylvania Exhibit 34:

Ambit Consensus Divergence (%) Comments

Revenue (` mn)

- FY15 35,307 36,301 -3% Our estimates are behind consensus, as we are sceptical of significant revenue growth given the tough business environment in Europe (revenue share in FY14 ~57%). We have modelled revenue growth of 2% in FY15 and 3% in FY16 and FY17.

- FY16 36,366 38,345 -5%

- FY17 37,457 40,602 -8%

EBITDA (` mn)

- FY15 1,059 1,733 -39% Our estimates are behind consensus in FY15 and FY16, as we expect a lower EBITDA margin of 180bps in FY15 and 60bps in FY16 vs consensus. This is because we assume a 9% YoY increase in employee expenses in FY15 due to increase in pension liability, as highlighted above.

- FY16 2,000 2,320 -14%

- FY17 2,510 2,427 3%


Havells India


Is Havells’ consistent valuation re-rating justified? Standalone franchisee trades at 31.5x FY16 P/E, the highest point in the last ten years Havells has seen a consistent P/E re-rating since the successful turnaround of Sylvania. Its current one-year forward P/E multiple is trading at its highest point in the last ten years. The standalone franchise (assuming Sylvania is valued at Ambit’s fair value of `10/share; implied FY16E EPS of 8.8x) is currently trading at 33.5x FY16 P/E, a 48% premium to its light electricals peers.

Havells’ one-year forward P/E is trading at the Exhibit 35:highest point in the last ten years


Havells’ one-year forward EV/EBITDA is trading Exhibit 36:the highest point in the last ten years


Most expensive stock in the sector despite much lower standalone EPS CAGR and RoE than the sector average Whilst Havells is a market leader in the light electrical sector, it is also the most expensive stock in the sector despite its lowest EPS CAGR of 13.5% over FY14-17E (vs 19.5% for Finolex Cables, the second lowest, and 28.4% for the sector). Moreover, Havells standalone is likely to see a deterioration of RoE by 110bps over FY14-17E vs a 1,100bps improvement for peers over FY14-17E.

Havells standalone is trading at a 58% premium to peers on FY16E earnings Exhibit 37:

Company CMP Mcap P/E (x) P/B (x) EV/EBITDA (x) RoE (%)

CAGR

(FY14-17)

INR US$mn FY15 FY16 FY17 FY15 FY16 FY17 FY15 FY16 FY17 FY14 FY15 FY16 FY17 Revenue EPS


Havells (standalone) 279 2,748 36.7 31.5 23.9 6.8 5.9 5 24.1 20.8 15.9 23.9 19.9 20.1 22.8 16.3 13.6

Finolex Cables 269 649 18 13.7 12.2 3.3 2.8 2.5 13.7 10.6 9 20.5 19.4 22.1 21.6 21.2 19.5

Bajaj 246 398 41.2 18.1 13.9 3.3 2.9 2.5 16.1 10 8.2 -0.7 8.4 17.2 19.5 15.4 NA

TTK Prestige 3513 629 30 22.4 17.6 6.7 6.3 5.7 19.3 14.7 11.7 22.8 29 34.2 38.3 19.8 30.4

V-Guard 1131 533 34.3 25.8 19.4 8.6 6.9 5.5 21 16.5 13.1 24.3 27.8 29.6 31.4 20.7 35.2

Average (excl. Havells) 32 20 15.8 5.7 5 4.3 18.9 14.5 11.6 18.2 20.9 24.6 26.7 18.7 24.7

Divergence from Havells standalone

15% 58% 52% 19% 19% 19% 28% 43% 37% 720bps -130bps -580bps -490bps -300bps -1,480bps

Source: Bloomberg, Ambit Capital research; Note: Valuation as on 5 January 2015; we have calculated Havells standalone P/E, P/B and EV/EBITDA by deducting our fair value of Sylvania of Rs10/share from CMP

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Havells India


We believe P/E multiple will start getting de-rated as Havells loses market share A premium valuation to its peers is justified given the strong brand recall, diversified product portfolio and pan-India franchise; however, given our expectation of Havells likely to lose market share, as explained in the earlier section, we believe that the current premium valuation may come off (stock corrected by 20% since the time the management issued a profit warning on 10 December). As seen in Exhibit 37, we expect peers to grow at a much faster pace than Havells’ standalone business.

Whilst Havells standalone revenue and PAT Exhibit 38:grew by 52% and 74% over FY03-08, it has decelerated to 15% and 22% over FY08-14 respectively and...


…Havells’ revenue and PAT growth is likely to Exhibit 39:be slower than its peers

Source: Company, Ambit Capital research; Note: We have taken V-Guard, Bajaj Electricals (non-E&P), Finolex Cables and TTK Prestige as peers

Can Havells P/E get re-rated to where the paint companies are trading? Several investors ask us if Havells’ P/E can get re-rated to where the paint companies are trading. Currently, Asian Paints, which is a leader, is trading at 36x FY16E P/E, an 18% premium to Havells’ standalone franchise. We do not believe companies in the light electricals segment deserve to trade at multiples assigned to paint companies because the paints sector is: (a) a large unfragmented market unlike light electricals; (b) has large sustainable competitive advantage (market leadership by the top-4 players for ~30 years, which is unheard of in light electricals); (c) a single large category unlike light electricals which is a combination of several sub categories; and (d) has strong brand recall with intermediaries relative to light electricals. Please refer to page 13 for a detailed discussion on this.

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Havells India


DCF valuation at `270/share We valued Havells India through a free cash flow (FCFF) model for the standalone business and Sylvania separately.

Havells (standalone):

Our FCFF metric is ’cash profit – increase in working capital – capex’. Our FCFF model has three distinct phases:

FY15-19: We have modelled revenue CAGR of 16% over FY15-19E and expect a 70bps improvement in EBITDA margin to 13.9% over FY15-19E vs 13.2% in FY14. Note that we have assumed a 150bps YoY improvement in margin in FY17 due to discontinuance of the royalty payment to the promoter from FY17 onwards, which will result in a 100bps saving in cost.

FY19-30: We have modeled a 50bps decline in revenue growth per annum until FY30. We have modelled revenue CAGR of 12% over FY19-30E. We expect EBITDA margin to decline by 20bps every year over FY19-22E to 14.0% in FY22E and then we assume gradual decline to 13.5% by FY30E.

FY30 onwards: We have assumed a terminal growth rate of 5%.

We have assumed weighted average cost of capital of 11.8% for Havells standalone. We value Havells standalone at `260/share which implies FY17 P/E of 23.1x.

DCF value of Havells standalone is `260/share Exhibit 40:

Particulars ` mn

Net PV of free cash flows for Havells 82,840

Terminal value 75,053

Total 157, 893

Less: Net debt/ (cash) -4,291

Value of Havells standalone entity 162,184

Total no. of shares (in mn) 624

Value per share (`/share) of Havells standalone entity 260


FCF profile of Havells standalone Exhibit 41:


Revenue and margin evolution of Havells Exhibit 42:standalone


Sylvania:

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

FY1

5E

FY1

7E

FY1

9E

FY2

1E

FY2

3E

FY2

5E

FY2

7E

FY2

9E

FCFF (Rsmn) on LHS WACC (%) ROCE (%)

12.0%

12.5%

13.0%

13.5%

14.0%

0

50,000

100,000

150,000

200,000

250,000

300,000

350,000

FY1

6EFY

17E

FY1

8EFY

19E

FY2

0EFY

21E

FY2

2EFY

23E

FY2

4EFY

25E

FY2

6EFY

27E

FY2

8EFY

29E

FY3

0E

Revenue (Rsmn) EBIT margin (%) on RHS

We have assumed WACC of 11.8% and terminal growth rate of 5% for Havells standalone

Particulars %

Cost of equity 14.5%

Cost of debt 10.0%

Debt/Equity 35.0%

Corporate tax rate 33.0%

WACC 11.8%

Terminal growth rate 5.0%


Havells India


Our FCFF metric is ’cash profit – increase in working capital – capex’. Our FCFF model has three distinct phases:

FY15-18: We model revenue CAGR of 3% over FY15-18E and expect 420bps improvement in EBITDA margin to 7.2% by FY18E led by: (a) lower base effect as EBITDA margin declined by 230bps YoY in FY14; and (b) operating leverage.

FY19-30: We model constant revenue growth of 3% and EBITDA margin of 7.2% over FY19-30E.

FY30 onwards: We have assumed a terminal growth rate of 2%.

We have assumed weighted average cost of capital of 15% for Sylvania vs 13% for Havells standalone given the challenging business environment in Europe. We value Sylvania at `10/share, which implies FY16 P/E of 8.8x.

DCF value of Sylvania is `10/share Exhibit 43:

Particulars ` mn

Net PV of free cash flows for Havells 8,072


Total 10,013

Less: Net debt/ (cash) 4,056

Value of Sylvania 5,956


Value per share (`/share) for Sylvania 10


FCF profile of Sylvania Exhibit 44:


Revenue and margin evolution of Sylvania Exhibit 45:


Sensitivity analysis of our Havells’ fair value Exhibit 46:

Rs/share Standalone revenue CAGR over FY14-17 (%)

10.3% 12.3% 14.3% 16.3% 18.3% 20.3% 22.3%

Sta

nd

alo

ne E

BIT

DA

m

arg

in o

ver

FY1

4-1

7 (

%)

11.9% 189 204 220 230 249 265 280

12.4% 199 215 231 237 262 278 293

12.9% 210 226 240 247 274 291 297

13.4% 220 237 252 270 287 304 321

13.9% 230 247 263 282 299 318 335

14.4% 240 258 274 294 312 331 348

14.9% 251 269 286 306 324 344 362

Source: Ambit Capital research, Note – fair value includes Sylvania’s fair value of Rs10/share; highlighted case implies our base case

5.0%

7.0%

9.0%

11.0%

13.0%

15.0%

17.0%

0

200

400

600

800

1,000

1,200

FY1

6FY

17

FY1

8FY

19

FY2

0FY

21

FY2

2FY

23

FY2

4FY

25

FY2

6FY

27

FY2

8FY

29

FY3

0

FCFF (Rsmn) on LHS WACC (%) ROCE (%)

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

0

10,000

20,000

30,000

40,000

50,000

60,000

FY1

5FY

16

FY1

7FY

18

FY1

9FY

20

FY2

1FY

22

FY2

3FY

24

FY2

5FY

26

FY2

7

Revenue (Rsmn) EBIT margin (%) on RHS

Havells India


Catalysts

We expect the following negative catalysts to result in a share price fall in the future:

Decline in EBIT margins for switchgears and fans over FY15-17 of more than 200bps (YoY) will lead to consensus downgrades in EBITDA margin. This is likely given the increase in competition in both these segments.

Lower growth in domestic appliances over FY16-18 can lead to consensus downgrades in standalone revenue growth, as this is the only category amidst the new categories launched since FY11 which is doing well. The 16% standalone revenue CAGR over FY10-14 is led by 24% revenue CAGR in electric consumer durables (includes domestic appliances).

Deterioration in Sylvania’s EBITDA margin: Whilst the management is guiding for improvement in Sylvania’s profitability in FY15, with EBITDA margin improving from 3% in FY14 to 5-6% in FY15, we believe the fall in bond yields (to result in increase in pension liability) coupled with the adverse currency movement would result in Sylvania missing the management guidance (we expect EBITDA margin of 3.3% in FY15). Moreover, with deterioration of the demand environment in Europe (share in Sylvania revenue is at 57%), Sylvania’s volumes could be impacted.

Inorganic acquisitions for portfolio expansion: Havells has been consistently eyeing inorganic opportunities given that it wants to further consolidate its positioning across categories. If any such acquisition materialises then it can be value-accretive for Havells. We believe Havells may be eyeing acquiring companies with strong brand recall in tier-III and tier-IV cities given the next leg of growth is likely to come from these cities.

Portfolio expansion: Whilst Havells has the most diversified portfolio, there are still gaps like inverters, coolers, building management systems or security systems which Havells may want to add. Whilst the probability of this is lower for coolers and inverters given the smaller market size, for building management and security systems also we believe the probability would be lower given that it’s a B2B segment (where brand pull is the least).

Risks to our SELL stance

Reduction in competitive intensity: We expect a broader recovery in the light electricals sector led by improving consumer sentiment over the next 3-6 months; however, our forecast for lower standalone revenue growth for Havells’ relative to peers is based on the rising competitive intensity and low price points from other regional players that have now started commanding a pan-India presence from being a regional player earlier. However, a reduction in competitive intensity in the future might result in a revival in standalone revenue growth for Havells, which in turn might aid in the earnings growth for the firm.

Sustained growth in domestic appliances: If Havells is able to sustain its strong growth in domestic appliances over the next 2-3 years, it can lead to upgrades in standalone revenue growth which in turn will lead to earnings upgrades.

Stake sale in Sylvania: Investment in Sylvania has been a big drag on Havells’ standalone RoE. If Havells is able to divest its stake in Sylvania, it will aid in RoE improvement. We value Sylvania at `6.3bn (implies 0.18x FY14 revenues) and peers trade at 0.5x sales and if a divesture was to take place at `6.3bn or above then it will be a positive.

Explanation for our flags on the cover page Exhibit 47:

Segment Score Comments

Accounting RED In our accounting analysis of light electrical companies, Havells scores low due to high contingent liability consequent to channel financing, high related party transaction, large volatility in the inventory days and high non-operating expense as a percentage of revenue.

Predictability AMBER In the past two quarters, the results showed an EPS surprise to consensus estimates by 8 to 14%.

Earnings Momentum RED In the past three months, the management has downgraded its FY15 revenue growth estimate from 17-20% earlier to 12-14% and consensus has downgraded Havells’ consolidated FY16 EPS estimate by 3%.


Havells India


Balance sheet

Year to March (` mn) FY13 FY14 FY15E FY16E FY17E

Cash 4,736 8,819 12,424 14,513 15,582

Debtors 8,623 10,005 11,828 12,421 13,062

Inventory 13,184 14,934 16,087 17,716 18,933

Loans & advances 2,661 2,920 3,119 3,407 3,730

Miscellaneous/Other Current Assets 131 198 225 265 311

Investments - - - - -

Fixed assets 15,245 16,447 17,226 18,276 19,515

Total assets 44,579 53,324 60,909 66,598 71,132

Current liabilities & provisions 21,336 27,957 29,722 32,045 34,921

Debt 8,342 8,240 10,635 9,595 5,242

Other liabilities - Deferred Tax Liability 481 467 467 467 467

Total liabilities 30,159 36,664 40,825 42,107 40,630

Share Capital 624 624 624 624 624

Reserves & surpluses 13,797 16,036 19,460 23,867 29,879

Total networth 14,420 16,660 20,084 24,491 30,503

Net working capital 3,132 (97) 1,311 1,499 804

Net debt (cash) 3,606 (580) (1,788) (4,918) (10,340)


Income statement


Operating income 72,479 81,858 89,145 99,712 111,626

% growth 11.2 12.9 8.9 11.9 11.9

Operating expenditure 65,735 74,433 81,049 89,559 98,458

EBITDA 6,744 7,425 8,096 10,153 13,168

% growth 2.6 10.1 9.0 25.4 29.7

Depreciation 1,097 1,155 1,346 1,402 1,472

EBIT 5,647 6,270 6,750 8,751 11,696

Interest expenditure 1,232 741 685 715 553

Non-operational income / Exceptional items 279 413 418 457 432

PBT 4,694 5,941 6,484 8,492 11,574

Tax 824 1,478 1,825 2,488 3,458

PAT 3,870 4,463 4,659 6,004 8,116

% growth 4.6 15.3 4.4 28.9 35.2


Havells India


Cash flow statement


PBT 6,638 5,941 6,484 8,492 11,574

Depreciation 1,097 1,155 1,346 1,402 1,472

Interest 1,133 572 685 715 553

Tax (1,225) (1,336) (1,825) (2,488) (3,458)

(Incr) / decr in net working capital (1,392) 1,719 (1,437) (228) 650

Others 127 629 - - -

Cash flow from operating activities 6,377 8,681 5,253 7,894 10,792

(Incr) / decr in capital expenditure (1,473) (1,725) (2,125) (2,452) (2,711)

(Incr) / decr in investments 26 (2,247) - - -

Others 13 210 - - -

Cash flow from investing activities (1,433) (3,762) (2,125) (2,452) (2,711)

Issuance of equity - 0 0 - -

Incr / (decr) in borrowings (422) (748) 2,396 (1,040) (4,354)

Others (2,099) (2,349) (1,920) (2,312) (2,658)

Cash flow from financing activities (2,521) (3,097) 476 (3,352) (7,011)

Net change in cash 2,423 1,822 3,604 2,089 1,069


Ratio Analysis

Year to March (%) FY13 FY14 FY15E FY16E FY17E

EBITDA margin 9.3 9.1 9.1 10.2 11.8

Net profit margin 5.3 5.5 5.2 6.0 7.3

Return on capital employed 24.1 19.8 17.4 19.1 23.5

Return on equity 32.3 28.7 25.4 26.9 29.5

Current ratio (x) 1.4 1.3 1.5 1.5 1.5


Valuation parameter

Year to March FY13 FY14 FY15E FY16E FY17E

EPS (`) 6.2 7.2 7.5 9.5 12.9

Book value per share (`) 23.1 26.7 32.2 38.9 48.5

P/E (x) 45.0 39.0 37.4 29.2 21.6

P/BV (x) 12.1 10.4 8.7 7.2 5.8

EV/EBITDA (x) 25.7 23.4 21.4 17.1 13.2

EV/Sales (x) 2.4 2.1 1.9 1.7 1.6

EV/EBIT (x) 30.7 27.7 25.7 19.8 14.8


Havells India


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Key financials Year to March FY13 FY14 FY15E FY16E FY17E Net Revenues (Rs mn) 13,602 15,176 18,342 22,194 26,685 Operating Profits (Rs mn) 8.1 8.1 9.0 9.5 9.9 Net Profits (Rs mn) 629 702 983 1,308 1,735 EPS (Rs) 21.1 23.6 33.0 43.9 58.2 RoE (%) 26.7 24.3 27.8 29.6 31.4 P/E (x) 53.6 48.0 34.3 25.8 19.4 P/B (x) 12.9 10.7 8.6 6.9 5.5 Source: Company, Ambit Capital research

Emerging as a pan-India player

V-Guard is fast emerging as a pan-India player through senior talent hiring and product portfolio expansion. We expect EBITDA margin improvement of 180bps over FY14-17E led by rising share of non-south revenue to 50% by FY17 vs 30% in FY14. This revenue increase would likely be led by expansion of distribution network in non-south (by leveraging relationships of senior recruits) and introduction of new products (appliances and fans). We upgrade our long-term revenue CAGR (12.4% over FY16-30E vs 9.9% earlier) and our TP to Rs1,310 (vs Rs1,009 earlier), implying 22.5x FY17 P/E vs 23.9x for Havells standalone. Strong franchise and untapped opportunity portend faster-than-industry growth and hence industry-leading multiples.

Competitive position: MODERATE Changes to this position: POSITIVE Fast emerging as a pan-India player V-Guard is fast emerging as a pan-India franchise due to its: (a) strong brand building (ad spend increased 29% over FY11-14), (b) distribution network expansion (60% channel partners in non-south), and (c) new product introduction (water heaters and appliances). Over the last five years, share of non-south has increased from 15% of FY10 revenues to 30% of FY14 revenues (61% CAGR over FY10-14), with north India being the strongest geography. Growth in non-south is EBITDA margin accretive V-Guard’s non-south EBITDA margin improved from -1.3% in FY12 to 1.5% in FY14 led by 30% revenue CAGR over FY12-14. This was led by favourable operating leverage as the share of advertisement spends in non-south declined from ~5.5% of FY12 revenues to 5% of FY14 revenues. We expect overall EBITDA margin to improve by 180bps to 9.9% by FY17 as we expect the share of non-south revenues to further improve to 50% of overall revenues by FY17. Upgrade EBITDA margin and long-term revenue growth estimates We upgrade our FY16-19 and FY20-30 revenue growth assumption by 380bps and 210bps to 19.1% and 10.5% respectively led by: (a) improvement in market share in non-south market, and (b) launch of additional products in non-south market by FY17. Higher EBITDA margin in non-south due to improvement in gross margin and favourable impact of operating leverage should lead to 180bps improvement in EBITDA margin over FY14-17E. Target price upgraded to Rs1,310/share We upgrade our DCF-based valuation by 30% to Rs1,310 driven by upgrades to our FY16-30 estimates: (a) increase in revenue CAGR to 12% vs 10% earlier and (b) higher EBITDA margin to 10.0% vs 9.9% earlier. Our TP implies 22.5x FY17 P/E (6% discount to Havells standalone). We expect the discount to narrow given higher FY14-17E EPS CAGR of 35% vs Havells’ standalone 14% and higher FY17E RoE of 31.4% vs Havells’ 22.8%. We believe a ‘growth company’ like V-Guard deserves to trade closer to ‘market leader’ like Havells. Risks: Redundancy of the core product; non-south scale-up.

COMPANY INSIGHT VGRD IN EQUITY January 06, 2015

V-GuardBUY

Capital Goods

Recommendation Mcap (bn): `34/US$0.5 6M ADV (mn): `56/US$0.9 CMP: `1, 138 TP (12 mths): `1,310 Upside (%): 15

Flags Accounting: AMBER Predictability: GREEN Earnings Momentum: GREEN

Catalysts

Improvement in revenue share of non-south to 50% by FY17

Launch of additional products in non-south market over FY15-17

Performance


16,000

22,000

28,000

34,000

350

700

1,050

1,400

Dec

-13

Feb-

14

Apr

-14

Jun-

14

Au

g-1

4

Oct

-14

Dec

-14

V-Guard Sensex on RHS

Analyst Details Bhargav Buddhadev +91 3043 3252 [email protected]

Deepesh Agarwal +91 3043 3275 [email protected]

V-Guard Industries


Fast emerging as a pan-India franchise Share of non-south doubled to 30% in the past four years; growth led by wires and stabilisers Despite the dominant position of Havells, Bajaj and Polycab in the non-south market, V-Guard has been successfully growing its non-south franchise (share of non-south revenue increased from 15% in FY10 to 30% in FY14). Whilst V-Guard is gaining market share from Havells and Polycab in housing wires, it is gaining market share from AO Smith, Racold and Havells in water heaters; V-Guard is already a pan-India market leader in stabilisers, with a market share of 25%. In the last two years, V-Guard reported strong revenue CAGR of 49% in non-south led by strong revenue CAGR of 50% in housing wires, 38% in stabilisers and 74% in digital UPS over FY12-14.

Exhibit 1: V-Guard is fast graduating into a pan-India franchise led by strong growth in non-south


Exhibit 2: Growth in non-south was led by strong 50% and 38% revenue CAGR over FY12-14 in housing wires and stabilisers

Source: Company, Ambit Capital research, Note – DUPS represents digital UPS

Despite market slowdown, FY15 to be a better year for V-Guard… We expect V-Guard to report revenue growth of 21% YoY in FY15 (vs 12% in FY14) led by revenue growth of 35% (vs 34% in FY14) in non-south and 10% (vs 4% in FY14) in south. After a bad festive season in FY14 (3QFY14 was a weak quarter for V-Guard, as seen in Exhibit 4), the start to the festive season in FY15 has been better. After a successful Onam season, sales until Diwali were robust. However, subsequently, the market turned weak due to weakening consumer sentiments coupled with decline in power outages across India. Despite this V-Guard continues to grow more than 30% in non-south and 10% in south, as per our recent channel checks.

95% 91% 85% 78% 79% 75% 70%

5% 9% 15% 22% 21% 25% 30%

0%

20%

40%

60%

80%

100%

FY0

8

FY0

9

FY1

0

FY1

1

FY1

2

FY1

3

FY1

4

South Non South

-

200

400

600

800

1,000

1,200

1,400

Stabiliser DomesticPump

WaterHeater

PVCwires

DUPS

FY12 FY13 FY14

Whilst V-Guard is gaining market share from Havells and Polycab in housing wires, it is gaining market share from AO Smith, Racold and Havells in water heaters

Despite the demand deceleration in the industry, V-Guard continues to grow more than 30% in non-south and 10% in south, as per our recent channel checks

V-Guard Industries


Exhibit 3: Key takeaways from our discussions with non-south channel partners

Region Channel comments on V-Guard

North

Delhi Whilst V-Guard is gaining market share from Havells in wires, it is gaining from AO Smith in water heaters.

Noida Water heaters are showing strong growth for V-Guard. V-Guard's Pebble series is competing well with Havells' premium water heaters.

Lucknow V-Guard has strong brand recall in stabilisers. It is emerging as the biggest beneficiary of the shift in the stabiliser market from unorganised to organised.

East

Kolkata Despite the weakness in demand environment on a YoY basis, V-Guard continues to grow at more than 30%.

West

Mumbai Whilst the presence of V-Guard in metro cities such as Mumbai remains very weak, it has improved its market share in tier-II and tier-III cities of Maharashtra.

Jaipur Quality product coupled with strong brand promotion is helping V-Guard gain market share.


Exhibit 4: 3QFY14 was one of the weakest quarters for V-Guard


-

10

20

30

40

50

60

1Q

FY1

2

2Q

FY1

2

3Q

FY1

2

4Q

FY1

2

1Q

FY1

3

2Q

FY1

3

3Q

FY1

3

4Q

FY1

3

1Q

FY1

4

2Q

FY1

4

3Q

FY1

4

4Q

FY1

4

1Q

FY1

5

2Q

FY1

5

Revenue growth YoY (%)

V-Guard Industries


Growth in non-south is EBITDA margin accretive Higher growth in non-south led to successful turnaround of the non-south market Increase in revenue share of non-south from 21% in FY12 to 30% in FY14 led to 280bps improvement in non-south EBITDA margin from -1.3% in FY12 to 1.5% in FY14. This was led by the favourable impact of operating leverage, as the share of fixed cost as a percentage of revenues declined from 24.2% in FY12 to 19.4% in FY14. However, during this period, gross margin contracted from 22.9% in FY12 to 20.9% in FY14 due to launch of new product categories.

Exhibit 5: V-Guard’s EBITDA margin in non-south improved by 280bps over FY12-14…

Particulars South Non-South

FY12 FY13 FY14 FY12 FY13 FY14

Gross margin (%) 9.2% 23.9% 23.1% 22.9% 21.4% 20.9%

EBITDA margin (%) 8.7% 10.9% 11.3% -1.5% 0.4% 1.3%

PBT margin (%) 10.3% 8.7% 9.2% -0.9% -2.2% -5.1%


Exhibit 6: …led by the favourable impact of the operating leverage

FY12 FY13 FY14

YoY Change in gross margin (%) 1.4 -1.5 -0.5

YoY Change in EBITDA margin (%) -4.1 1.7 1.1

Impact of operating leverage YoY (%) -5.5 3.1 1.6


Our discussions with channel partners suggest more scope for margin expansion in non-south led by gross margin expansion and favourable operating leverage. Gross margin in non-south is at a significant discount of 210bps vs south. This gap will reduce as V-Guard starts achieving scale in non-south; scale will allow the dealer to work for lower commissions, as the revenue loss (due to lower commissions) will be more than offset by rising turnover.

Moreover, the share of advertisement spend in non-south is disproportionately high at 5.0% of FY14 revenues vs 3.9% of FY14 overall revenues. This will reduce as V-Guard starts achieving scale in non-south; the share of advertisement spend in non-south has already declined from 5.4% of FY13 revenues to 5.0% of FY14 revenues. We expect this to stabilise at 4.0% of non-south revenues by FY17, 50bps higher than 3.5% advertisement spend incurred in south.

Exhibit 7: Whilst the gap between south and non-south gross margin has reduced materially, there still remains scope for improvement

FY11 FY12 FY13 FY14

South's gross margin (%) 28.0 28.5 23.9 23.1

Non-South’s gross margin (%) 21.5 22.9 21.4 20.9

Difference (bps) 650bps 570bps 250bps 210bps


Exhibit 8: Share of advertisement spend in non-south though declined materially, is still much higher compared to south

Share of ad spend to revenue (%) FY13 FY14

V-Guard total 4.3% 3.9%

South 3.9% 3.5%

Non-south 5.4% 5.0%

Difference between non-south and south 1.5% 1.6%


For V-Guard, the share of advertisement spend in non-south is disproportionately high at 5.0% of FY14 revenues vs 3.9% of FY14 overall revenues

V-Guard Industries


Well placed to gain further market share in non-south V-Guard is well placed to gain market share from the leaders in the non-south market, due to: (a) improving brand recognition in non-south aided by strong advertisement spend, superior product quality (recent Pebble series has been a big success after strong brand recall for stabilisers, wires and pumps); (b) leveraging dealer contacts of the recently joined senior marketing staff who have strong relationships with the light electrical dealers since more than a decade; and (c) ethical practices adopted for distributors/dealers (for example dis-empanelling distributors who sell goods outside of their demarcated geographies) which is leading to strong push selling from their side; and (d) V-Guard’s market share in the non-south market still remains low, as the size of the non-south market is 4.0x the size of the south market. Note that the share of pan-India players in non-south at ~70% is significantly higher than V-Guard’s 30%.

Our discussions with industry participants suggest that the recently joined senior marketing staff hires have helped V-Guard in improving the quality of sales in addition to growing revenues. This is corroborated from the consistent reduction in debtor days from 62 days in FY09 to 51 days in FY14 (lowest since FY08) despite revenue CAGR of 36% over FY09-14 vs 20% over FY04-09. Also, such senior hires who know the channel very well prevent dumping of inventory across regions, which is extremely critical in protecting the company’s margins.

Recently joined senior marketing staff hires have helped V-Guard in improving the quality of sales in addition to growing revenues

V-Guard Industries


Upgrading EBITDA margin estimates from FY17 onwards Consequent to the strong momentum for V-Guard in the non-south market and the consequent margin improvement in the non-south market, we upgrade our long-term revenue growth and EBITDA margin assumption for V-Guard. We upgrade our revenue CAGR assumption from 15.3% to 19.1% over FY16-19 and from 8.5% to 10.6% over FY20-30. We also upgrade our EBITDA margin assumption by 20bps over FY16-19 and 10bps over FY20-30. We have modeled an average EBITDA margin of 10% over FY16-30. Consequently, our TP is upgraded by 29.8% to Rs1,310/share (implied FY17 P/E of 22.5x, a 6% discount to Havells standalone’s implied target multiple of 23.1x).

Exhibit 9: Change in estimates

New Old Change

FY15 FY16 FY17 FY15 FY16 FY17 FY15 FY16 FY17 Comments

Recommendation BUY

UR

Target Price (Rs) 1,310

1,009

29.8%

Upgrade led by the increase in the long term revenue growth and EBITDA margin assumptions

Revenues (Rs mn) 18,342 22,194 26,685 18,342 22,194 25,967 0% 0% 3%

We upgrade our FY17 revenue assumption by 3%, as V-Guard is seeing strong growth in the non-south market led by the gain in market share

Gross Profit (Rs mn) 4,769 5,881 7,178 4,769 5,881 6,946 0% 0% 3%

Trickle-down impact of higher revenues

Gross Margin (%) 26.0% 26.5% 26.9% 26.0% 26.5% 26.8% 0bps 0bps 10bps

EBITDA (Rs mn) 1,651 2,108 2,642 1,651 2,108 2,532 0% 0% 4%

EBITDA margin (%) 9.0% 9.5% 9.9% 9.0% 9.5% 9.8% 0bps 0bps 10bps

EBIT (Rs mn) 1,482 1,915 2,426 1,482 1,915 2,315 0% 0% 5%

EBIT Margin (%) 8.1% 8.6% 9.1% 8.1% 8.6% 8.9% 0% 0% 2%

PBT (Rs mn) 1,366 1,869 2,479 1,366 1,869 2,368 0% 0% 5%

PAT (Rs mn) 983 1,308 1,735 983 1,308 1,657 0% 0% 5%

Change in WC (Rs mn) (509) (278) (311) (509) (278) (212) 0% 0% 46%

CFO (Rs mn) 797 1,311 1,641 797 1,311 1,661 0% 0% -1%

FCF (Rs mn) 497 861 1,266 497 861 1,286 0% 0% -2%


Exhibit 10: Change in long-term estimates

New Old Change Comment

FY-16-19 FY20-30 FY-16-19 FY20-30 FY-16-19 FY20-30

Revenue CAGR 19.1% 10.6% 15.3% 8.5% 380bps 210bps Consequent to our revised expectation of higher market share gain for V-Guard in the non-south market

Average EBITDA margin (%) 10.0% 10.0% 9.8% 9.9% 20bps 10bps Upgrade in long-term growth assumption consequent to favourable leverage and improvement in gross margin

CFO CAGR 23.8% 11.3% 21.1% 8.6% 270bps 270bps Trickle-down impact of revenue and EBITDA margin upgrade EPS CAGR 24.6% 11.2% 19.2% 9.2% 540bps 200bps


V-Guard Industries


Key assumptions Exhibit 11: V-Guard – key assumptions Rs mn unless specified

FY13 FY14 FY15E FY16E FY17E Comments

Key assumptions

Electronics segment

Growth over FY14-17 is led by higher sales of stabiliser (+20%), digital UPS (+18%) and UPS (+19%) due to: (a) improvement in market share in non-south market and (b) increase in power outages in south given the likely pick-up in the power demand in FY16.

Net Revenues 4,594 4,504 5,418 6,629 7,822

% YoY growth 46% -2% 20% 22% 18%

Electro-mechanical segment

Growth over FY14-17 is led by higher sales of: (a) pumps (+18%) given the pickup in real estate demand; (b) water heaters (+30%) due to launch of new range of products; (c) fans (+22%) due to improvement in market share; and (d) LT wires and cables (+15%) due to pick-up in real estate demand.

Net Revenues 8,684 10,278 12,590 15,165 18,383

% YoY growth 36% 18% 22% 20% 21%

Others

Growth over FY14-17 is led by: (a) success in new products such as switchgears, induction cooktops and mixer grinder, and (b) higher growth in solar heaters due to benefit of subsidy under MNRE scheme.

Net Revenues 324 394 335 402 482

% YoY growth -1% 22% -15% 20% 20%

Key estimates

Sales 13,602 15,176 18,342 22,194 26,685 Revenue CAGR of 21% over FY14-17 is lower than revenue CAGR of 37% over FY11-13. Sales (YoY growth) (%) 37% 12% 21% 21% 20%

EBITDA 1,099 1,226 1,651 2,108 2,642 Expect 180bps increase in EBITDA margin over FY14-17 due to expansion of scale in non-south market and improvement in the margins of newly launched products.

EBITDA margin (%) 8.1% 8.1% 9.0% 9.5% 9.9%


-10% 11% 35% 28% 25%

Interest expense 200 211 154 88 0 Expect debt repayment of Rs300mn each in FY15 and FY16 and consequently assume decline in interest expenses.

PBT 822 943 1,366 1,869 2,479 PBT to register CAGR of 38% over FY14-17.

Tax rate (%) 23% 25% 28% 30% 30%

Assumed tax rate to increase from FY15, as Kashipur and Kala Amb are in their sixth year of tax exemption; consequently they are eligible for only 30% tax deduction vs 100% earlier. 30% tax exemption is available till FY19.

PAT 629 702 983 1308 1735 PBT to register CAGR of 35% over FY14-17.

PAT (YoY growth) (%) -21% 12% 40% 33% 33%

CFO 105 1,108 797 1,311 1,641

Improvement in CFO on the back of improvement in cash conversion cycle. We assume cash conversion cycle to remain flat in FY15 at 61 days assume improvement by 6 days in FY16 and 5 days in FY17.

Capex - 253 - 324 - 300 - 450 - 375 V-Guard is likely to incur only the maintenance capex.

Free cash flow - 149 784 497 861 1,266 Trickle-down impact of strong CFO.


Ambit vs consensus

Ambit Consensus Variation (%) Comment

Revenue (Rs mn)

- FY15 18,342 18,281 0%

Marginally ahead of consensus - FY16 22,194 21,913 1%

- FY17 26,685 26,290 2%

EBITDA (Rs mn)

- FY15 1,651 1,585 4% Higher than consensus estimate, as we expect a 170bps improvement in EBITDA margin over FY14-17, led by gross margin improvement and favourable operating leverage vs consensus expectation of only 110bps improvement in margins

- FY16 2,108 1,957 8%

- FY17 2,642 2,482 6%

EPS (Rs/share)

- FY15 33.0 31.0 6% Trickle-down impact of higher EBITDA estimate

- FY16 42.5 39.4 8%

- FY17 56.3 52.4 7%


V-Guard Industries


Premium valuation justified At CMP of 1,138/share, V-Guard is trading at a one-year forward P/E multiple of 27.6x, a 106% premium over its five-year average forward P/E multiple of 13.4x. The premium is justified and likely to widen further, as the company improves its EBITDA margin through sustained growth in the non-south market; over FY14-17, we expect improvement in EBITDA margin of 180bps and RoE of 700bps.

Moreover, V-Guard is trading at 19.4x FY17 P/E, a 19% discount to Havells standalone despite higher FY14-17E EPS CAGR of 35% vs Havells’ 13% and higher FY17E RoE of 31.4% vs Havells’ 22.8%. We believe a ‘growth company’ like V-Guard deserves to trade closer to the price multiple of a ‘market leader’ like Havells. We value V-Guard at `1,310/share, implying FY17 P/E of 22.5x (a 6% discount to Havells standalone).

DCF-based TP of `1,310/share We have valued V-Guard using a free cash flow (FCFF) model. Our FCFF metric is ’cash profit – increase in working capital – capex’. Our FCFF model has four distinct phases:

FY15-19: We model each year in detail and assume: (i) 20% revenue CAGR (vs 33% revenue CAGR over FY08-14) and (ii) EBIT margin of ~9.4% by FY19 (from 7.6% in FY14).

FY20-24: We model a decline in revenue growth of 2% every year. Consequently, our revenue CAGR over FY20-24 is 13% vs 20% over FY15-19. On EBIT margin, we assume average EBIT margin of 9.5%, which is 10bps higher than FY15-19.

FY25-30: We have modelled a constant revenue growth of 9% per annum and an average EBIT margin of 9.6%.

From FY31: We have assumed a terminal growth rate of 5%.

We expect V-Guard’s RoCE to improve from 20% in FY14 and to gradually reach a peak of 28% by FY17 and reduce thereon to 20% in FY27 on the back of our assumption of a gradual fall in operating margins from FY18 onwards. Based on these assumptions and assuming a WACC of 13.1%, our FCFF model values V-Guard at `1,310/share (implying FY17 P/E of 22.5x; a 6% discount to Havells’ current multiple) and 15% upside.

Exhibit 12: DCF-based TP of `1,310/share

`mn

Net PV of free cash flows for V-Guard 22,241


Total 40,051

Less: Net debt 964

Value of V-Guard 39,086


Value per share (`/share) 1,310


Exhibit 13: FCFF profile of V-Guard


5%

10%

15%

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30%

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500

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1,500

2,000

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6EFY

17E

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25E

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29E

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PV of FCF (Rsbn on LHS)RoCE (%)WACC (%)

We have assumed WACC of 13.1% and terminal growth rate of 5.0%

Particulars (%)

Cost of equity 15.0%

Cost of debt 12.2%

Debt/Equity 30.0%

Corporate tax rate 30%

WACC 13.1%

Terminal growth 5.0%


V-Guard Industries


Relative valuation: Discount to Havells unjustified given higher RoEs and higher EPS growth

At CMP, the stock is trading at 19.4x FY17 P/E, a 41% premium to its peers and 106% premium to its five-year average. On comparison with Havells (standalone), it is trading at an 18% discount on FY17E P/E despite higher FY14-17E EPS CAGR of 35% vs Havells’ 14%. Note that V-Guard’s FY17E RoE of 31% is 860bps higher than Havells’ standalone RoE of 22.8% in FY17E. V-Guard’s discount to Havells (consolidated) is 13% on FY17E P/E.

Havells is the closest peer to V-Guard, as both these companies have a diversified range of products in light electricals, as both are very strong spenders on brand building, with ad spends of 3.5-4% of revenues, and as both are consistently investing in strengthening their distribution network. Finolex, on the other hand, is a single product-line company, with electrical wires accounting for a revenue share of 87%; Bajaj is not a complete light electricals company, with its E&P business accounting for a revenue share of 28% in FY14. The only segment where V-Guard’s and TTK Prestige’s product portfolio overlaps is induction cooktop, which accounts for less than 2% of V-Guard’s revenues.

We may upgrade V-Guard’s RoEs further, as the margin gap between the south and non-south starts reducing further. This is possible as V-Guard builds scale in non-south. Currently, the average revenue per distributor in non-south at Rs38mn is only 39% of the average revenue per distributor in south. As V-Guard build scale and the average revenue per distributor in non-south increases, V-Guard’s gross margin should improve, as the distributor is now prepared to work at lower commissions (currently commissions in north India are higher by around 200bps as compared to commissions in south India). Also, capital employed turnover in non-south should improve, as the distributor is prepared to stock inventory on behalf of the company. This should help in improving RoEs further.

Exhibit 14: V-Guard is trading at an 19% discount to Havells (standalone) on FY17 P/E

CMP Mcap P/E (x) P/B (x) EV/EBITDA (x) RoE (%) CAGR

(FY14-17)

Company INR US$mn FY15 FY16 FY17 FY15 FY16 FY17 FY15 FY16 FY17 FY14 FY15 FY16 FY17 Revenue EPS


Havells (standalone) 279 2,748 36.7 31.5 23.9 6.8 5.9 5 24.1 20.8 15.9 23.9 19.9 20.1 22.8 16.3 13.6

Finolex Cables 269 649 18 13.7 12.2 3.3 2.8 2.5 13.7 10.6 9 20.5 19.4 22.1 21.6 21.2 19.5

Bajaj 246 398 41.2 18.1 13.9 3.3 2.9 2.5 16.1 10 8.2 -0.7 8.4 17.2 19.5 15.4 NA

TTK Prestige 3,513 629 30 22.4 17.6 6.7 6.3 5.7 19.3 14.7 11.7 22.8 29 34.2 38.3 19.8 30.4

V-Guard 1,138 533 34.3 25.8 19.4 8.6 6.9 5.5 21 16.5 13.1 24.3 27.8 29.6 31.4 20.7 35.2

Average (excl. V-Guard and Havells consol)

31.5 21.4 16.9 5 4.5 3.9 18.3 14 11.2 16.6 19.2 23.4 25.5 18.2 21.1

Divergence 17% 47% 41% 36% 31% 28% 32% 48% 42% 770bps 870bps 620bps 580bps 250bps 1,410bps

Source: Bloomberg, Ambit Capital research, Note – valuation as on 05 January 2015, We have calculated standalone P/E, P/B and EV/EBITDA for Havells by deducting Ambit’s fair value of Sylvania of Rs10/share from CMP

At CMP, V-Guard is trading at 19.4x FY17 P/E, a 41% premium to its peers and 106% premium to its five-year average

Currently, V-Guard’s average revenue per distributor in non-south at Rs38mn is only 39% of the average revenue per distributor in south

V-Guard Industries


Cross-cycle valuations – 106% premium to historical average V-Guard’s share price is currently trading at a one-year forward P/E multiple of 27.6x, a 106% premium over its five-year average forward P/E multiple of 13.4x. We believe the premium valuation is justified and can further expand. The valuation over past five years was depressed, as V-Guard’s RoE declined from 27% in FY11 to 24% in FY14 due to expansion in the non-south market. We expect V-Guard to report peak RoEs of 31% in FY17 due to the favourable impact of operating leverage and improvement in gross margin, as the company achieves scale in the non-south markets. Currently, V-Guard’s EBITDA margin in non-south is 980bps lower than the margin in south. We expect this gap to narrow to 400bps, as revenue contribution from non-south reaches 50%. The management is guiding for this to happen by FY17. Exhibit 15: V-Guard is trading at a 106% premium to the historical five-year average one-year forward P/E

Source: Bloomberg, Company, Ambit Capital research

Exhibit 16: This is justified given the strong PAT CAGR of 35% over FY14-17E


Exhibit 17: The premium to the historical five-year average one-year forward P/B is also 112%

Source: Bloomberg, Company, Ambit Capital research

Exhibit 18: This is justified given the improvement in RoE by 700bps over FY14-17E


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200

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1.8x - 10 20 30 40 50 60 70

10 15 20 25 30 35 40 45

FY0

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0

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1

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6E

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RoE (%) Revenue growth YoY (%) on RHS

We expect gap between south and non-south margin to narrow from 980bps currently to 400bps in FY17, as revenue contribution from non-south reaches 50%

V-Guard Industries


Catalysts Launch of new products in the non-south market: Whilst V-Guard has more than 11 product categories in south, it has introduced only five products (stabiliser, housing wires, pumps, digital UPS and water heater) in the non-south market. With the success of the newer products such as fans, switchgear, and induction cooktops in south, we believe the company might launch these products in the non-south market by FY17. The launch of these products in the non-south market will not only solidify V-Guard’s presence in the non-south market but also help the company in improving its operating margin on the back of favourable operating leverage.

Consistent increase in share of non-south revenues: The share of non-south in V-Guard’s total revenue has improved from 5% in FY08 to 30% in FY14. If V-Guard achieves scale in non-south with further improvement of revenue share from non-south then its EBITDA margin would start inching upward. Note that the margin in the non-south market is 980bps lower than south’s margin due to lack of scale. Given that we expect non-south revenue share to improve to 50% by FY17, we have modelled EBITDA margin expansion of 180bps over FY14-17E and reduction in working capital days by 11 days over FY14-17E (from 61 days in FY14 to 50 days in FY17).

Margin surprise a potential upside risk?

EBITDA margin difference between non-south and south is currently high at 980bps (as on FY14). Whilst we are expecting improvement of 180bps in overall EBITDA margin over FY14-17, as we expect the share of non-south to improve from 30% in FY14 to 50% by FY17, any further improvement in EBITDA margin will act as a positive catalyst. In the event the EBITDA margin does not improve beyond our expectation of 180bps over FY14-17, we do not see any further scope for re-rating in V-Guard’s valuation multiples.

Risks Redundancy of core product: Stabilisers, with FY14 revenue share of 17.6% and EBITDA share of 41%, remains a core product for V-Guard. The underlying demand driver for stabilisers is the poor quality of power. About 65% of stabilisers are used with air conditioners and refrigerators to protect them from power fluctuations. As India improves its power supply over the years, the quality of poor is likely to improve, which will lead to a decline in the requirement for voltage stabilisers.

Still a small player in non-south market: The light electrical industry in India has strong regional brands: Havells dominates north India whilst Polycab and Bajaj Electricals dominate west India. Hence, V-Guard with 70% revenues from south would face a tall task in consistently delivering a strong performance in north and west India. Even in south, ~51% of revenues come from Kerala.

Lacks bargaining power with vendors: V-Guard lacks bargaining power, with vendors manufacturing stabilisers, as it cannot afford to delay payments given their 100% dependence on the company. Hence, the creditor days for V-Guard are the lowest amongst its peers.

Exhibit 19: Explanation for our flags on the cover page

Segment Score Comments

Accounting AMBER

In our accounting analysis of light electrical companies, V-Guard score low due to poor working capital cycle and low CFO/EBITDA. Expansion in non-south market has been the reason for V-Guard’s poor cash conversion. However, the working capital cycle of V-Guard has improved from 96 days in FY11 to 61 days in FY14.

Predictability GREEN In the past two quarters, the results were in line with consensus estimates.

Earnings Momentum GREEN In the past six months, consensus has upgraded V-Guard’s EPS estimates for FY15 by 6%.


V-Guard Industries


Balance Sheet

Year to March (Rs mn) FY13 FY14 FY15E FY16E FY17E

Cash 150 28 -150 19 381

Debtors 1,988 2,121 2,513 2,919 3,436

Inventory 2,486 2,525 3,216 3,770 4,387

Loans & advances 454 381 612 741 891

Other Current Assets 2 1 1 1 1

Investments - - - - -

Fixed assets 1,470 1,662 1,794 2,051 2,209

Miscellaneous - - - - -

Total assets 6,549 6,718 7,986 9,500 11,305

Current liabilities & provisions 2,282 2,473 3,278 4,088 5,062

Debt 1,574 992 700 400 -

Other liabilities - Deferred Tax Liability 79 95 95 95 95

Total liabilities 3,935 3,560 4,074 4,584 5,157

Shareholders' equity 298 298 298 298 298

Reserves & surpluses 2,315 2,859 3,614 4,618 5,849

Total networth 2,613 3,158 3,912 4,917 6,148

Net working capital 2,646 2,554 3,063 3,341 3,651

Net debt (cash) 1,425 964 850 381 -381


Income statement

Year to March (Rs mn) FY13 FY14 FY15E FY16E FY17

Operating income 13,602 15,176 18,342 22,194 26,685

% growth 36.9 11.6 20.9 21.0 20.2

Operating expenditure 12,503 13,950 16,691 20,086 24,044

EBITDA 1,099 1,226 1,651 2,108 2,642

% growth (10.3) 11.5 34.7 27.7 25.3

Depreciation 114 120 168 193 216

EBIT 985 1,106 1,482 1,915 2,426

Interest expenditure 200 211 154 88 -

Non-operational income / Exceptional items 36 48 37 42 54

PBT 822 943 1,366 1,869 2,479

Tax 193 241 382 561 744

Reported PAT 629 702 983 1,308 1,735

Adjustments - - - - -

Adjusted PAT 629 702 983 1,308 1,735

% growth (21.2) 11.6 40.1 33.1 32.6


V-Guard Industries


Cash flow statement

Year to March (Rs mn) FY13 FY14 FY15E FY16E FY17

PBT 822 943 1,366 1,869 2,479

Depreciation 114 120 168 193 216

Interest 180 191 154 88 -

Tax (255) (189) (382) (561) (744)

(Incr) / decr in net working capital (772) (23) (509) (278) (311)

Others 16 66 - - -

Cash flow from operating activities 105 1,108 797 1,311 1,641

(Incr) / decr in capital expenditure (253) (324) (300) (450) (375)

(Incr) / decr in investments - 25 - - -

Others - 19 - - -

Cash flow from investing activities (253) (280) (300) (450) (375)

Issuance of equity (2) - - - -

Incr / (decr) in borrowings 560 (567) (292) (300) (400)

Others (310) (359) (383) (392) (504)

Cash flow from financing activities 248 (926) (674) (692) (904)

Net change in cash 100 (98) (177) 169 362


Ratio analysis

Year to March (%) FY13 FY14 FY15E FY16E FY17E

EBITDA margin 8.1 8.1 9.0 9.5 9.9

EBIT margin 7.2 7.3 8.1 8.6 9.1

Net profit margin 4.6 4.6 5.4 5.9 6.5

Return on capital employed 20.6 19.9 24.4 27.0 29.6

Return on equity 26.7 24.3 27.8 29.6 31.4

Current ratio (x) 2.2 2.0 1.9 1.8 1.8


Ratio analysis

Year to March FY13 FY14 FY15E FY16E FY17E

EPS (Rs) 21.1 23.6 33.0 43.9 58.2

Book value per share (Rs) 87.7 106.0 131.3 165.0 206.3

P/E (x) 53.6 48.0 34.3 25.8 19.4

P/BV (x) 12.9 10.7 8.6 6.9 5.5

EV/EBITDA (x) 31.6 28.3 21.0 16.5 13.1

EV/Sales (x) 2.6 2.3 1.9 1.6 1.3

EV/EBIT (x) 35.2 31.4 23.4 18.1 14.3


V-Guard Industries


Institutional Equities Team

Saurabh Mukherjea, CFA CEO, Institutional Equities (022) 30433174 [email protected]

Research

Analysts Industry Sectors Desk-Phone E-mail

Nitin Bhasin - Head of Research E&C / Infra / Cement / Industrials (022) 30433241 [email protected]

Aadesh Mehta, CFA Banking / Financial Services (022) 30433239 [email protected]

Achint Bhagat Cement / Infrastructure (022) 30433178 [email protected]

Aditya Bagul Consumer (022) 30433264 [email protected]

Aditya Khemka Healthcare (022) 30433272 [email protected]

Ashvin Shetty, CFA Automobile (022) 30433285 [email protected]

Bhargav Buddhadev Power Utilities / Capital Goods (022) 30433252 [email protected]

Dayanand Mittal, CFA Oil & Gas / Metals & Mining (022) 30433202 [email protected]

Deepesh Agarwal Power Utilities / Capital Goods (022) 30433275 [email protected] Gaurav Mehta, CFA Strategy / Derivatives Research (022) 30433255 [email protected]

Karan Khanna Strategy (022) 30433251 [email protected]

Krishnan ASV Real Estate (022) 30433205 [email protected]

Pankaj Agarwal, CFA Banking / Financial Services (022) 30433206 [email protected]

Paresh Dave, CFA Healthcare (022) 30433212 [email protected]

Parita Ashar Metals & Mining / Oil & Gas (022) 30433223 [email protected]

Rakshit Ranjan, CFA Consumer / Retail (022) 30433201 [email protected]

Ravi Singh Banking / Financial Services (022) 30433181 [email protected]

Ritesh Gupta, CFA Midcaps – Chemical / Retail (022) 30433242 [email protected]

Ritesh Vaidya Consumer (022) 30433246 [email protected] Ritika Mankar Mukherjee, CFA Economy / Strategy (022) 30433175 [email protected]

Ritu Modi Automobile (022) 30433292 [email protected]

Sagar Rastogi Technology (022) 30433291 [email protected]

Sumit Shekhar Economy / Strategy (022) 30433229 [email protected]

Sandeep Gupta Media / Midcaps (022) 30433211 [email protected]

Tanuj Mukhija, CFA E&C / Infra / Industrials (022) 30433203 [email protected]

Utsav Mehta Technology (022) 30433209 [email protected]

Sales

Name Regions Desk-Phone E-mail

Sarojini Ramachandran - Head of Sales UK +44 (0) 20 7614 8374 [email protected]

Deepak Sawhney India / Asia (022) 30433295 [email protected]

Dharmen Shah India / Asia (022) 30433289 [email protected]

Dipti Mehta India / USA (022) 30433053 [email protected]

Hitakshi Mehra India (022) 30433204 [email protected]

Nityam Shah, CFA USA / Europe (022) 30433259 [email protected]

Parees Purohit, CFA UK / USA (022) 30433169 [email protected]

Praveena Pattabiraman India / Asia (022) 30433268 [email protected]

Production

Sajid Merchant Production (022) 30433247 [email protected]

Sharoz G Hussain Production (022) 30433183 [email protected]

Joel Pereira Editor (022) 30433284 [email protected]

Nikhil Pillai Database (022) 30433265 [email protected]

E&C = Engineering & Construction

V-Guard Industries


Stock price performance

Bajaj Electricals Ltd (BJE IN, SELL)


Havells India Ltd (HAVL IN, SELL)


V-Guard Industries Ltd (VGRD IN, BUY)


Finolex Cables Ltd (FNXC IN, BUY)


Exhibit 20: TTK Prestige Ltd (TTKPT IN, BUY)


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15BAJAJ ELECTRICALS LTD

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HAVELLS INDIA LTD

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V-GUARD INDUSTRIES LTD

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FINOLEX CABLES LTD

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TTK PRESTIGE LTD

V-Guard Industries


Explanation of Investment Rating

Investment Rating Expected return (over 12-month)

BUY >5%

SELL <5%

NO STANCE We have forward looking estimates for the stock but we refrain from assigning valuation and recommendation

UNDER REVIEW We will revisit our recommendation, valuation and estimates on the stock following recent events

NOT RATED We do not have any forward looking estimates, valuation or recommendation for the stock

Disclaimer This report or any portion hereof may not be reprinted, sold or redistributed without the written consent of Ambit Capital. AMBIT Capital Research is disseminated and available primarily electronically, and, in some cases, in printed form.

Additional information on recommended securities is available on request.

Disclaimer

1. AMBIT Capital Private Limited (“AMBIT Capital”) and its affiliates are a full service, integrated investment banking, investment advisory and brokerage group. AMBIT Capital is a Stock Broker, Portfolio Manager and Depository Participant registered with Securities and Exchange Board of India Limited (SEBI) and is regulated by SEBI

2. AMBIT Capital makes best endeavours to ensure that the research analyst(s) use current, reliable, comprehensive information and obtain such information from sources which the analyst(s) believes to be reliable. However, such information has not been independently verified by AMBIT Capital and/or the analyst(s) and no representation or warranty, express or implied, is made as to the accuracy or completeness of any information obtained from third parties. The information, opinions, views expressed in this Research Report are those of the research analyst as at the date of this Research Report which are subject to change and do not represent to be an authority on the subject. AMBIT Capital may or may not subscribe to any and/ or all the views expressed herein.

3. This Research Report should be read and relied upon at the sole discretion and risk of the recipient. If you are dissatisfied with the contents of this complimentary Research Report or with the terms of this Disclaimer, your sole and exclusive remedy is to stop using this Research Report and AMBIT Capital or its affiliates shall not be responsible and/ or liable for any direct/consequential loss howsoever directly or indirectly, from any use of this Research Report.

4. If this Research Report is received by any client of AMBIT Capital or its affiliate, the relationship of AMBIT Capital/its affiliate with such client will continue to be governed by the terms and conditions in place between AMBIT Capital/ such affiliate and the client.

5. This Research Report is issued for information only and the 'Buy', 'Sell', or ‘Other Recommendation’ made in this Research Report such should not be construed as an investment advice to any recipient to acquire, subscribe, purchase, sell, dispose of, retain any securities and should not be intended or treated as a substitute for necessary review or validation or any professional advice. Recipients should consider this Research Report as only a single factor in making any investment decisions. This Research Report is not an offer to sell or the solicitation of an offer to purchase or subscribe for any investment or as an official endorsement of any investment.

6. This Research Report is being supplied to you solely for your information and may not be reproduced, redistributed or passed on, directly or indirectly, to any other person or published, copied in whole or in part, for any purpose. Neither this Research Report nor any copy of it may be taken or transmitted or distributed, directly or indirectly within India or into any other country including United States (to US Persons), Canada or Japan or to any resident thereof. The distribution of this Research Report in other jurisdictions may be strictly restricted and/ or prohibited by law or contract, and persons into whose possession this Research Report comes should inform themselves about such restriction and/ or prohibition, and observe any such restrictions and/ or prohibition.

7. AMBIT Capital Private Limited plans to register itself as a Research Entity under the SEBI (Research Analysts) Regulations, 2014. Conflict of Interests

8. In the normal course of AMBIT Capital’s business circumstances may arise that could result in the interests of AMBIT Capital conflicting with the interests of clients or one client’s interests conflicting with the interest of another client. AMBIT Capital makes best efforts to ensure that conflicts are identified and managed and that clients’ interests are protected. AMBIT Capital has policies and procedures in place to control the flow and use of non-public, price sensitive information and employees’ personal account trading. Where appropriate and reasonably achievable, AMBIT Capital segregates the activities of staff working in areas where conflicts of interest may arise. However, clients/potential clients of AMBIT Capital should be aware of these possible conflicts of interests and should make informed decisions in relation to AMBIT Capital’s services.

9. AMBIT Capital and/or its affiliates may from time to time have or solicit investment banking, investment advisory and other business relationships with companies covered in this Research Report and may receive compensation for the same.

Additional Disclaimer for U.S. Persons

10. The research report is solely a product of AMBIT Capital 11. AMBIT Capital is the employer of the research analyst(s) who has prepared the research report 12. Any subsequent transactions in securities discussed in the research reports should be effected through Enclave Capital LLC. (“Enclave”). 13. Enclave does not accept or receive any compensation of any kind for the dissemination of the AMBIT Capital research reports. 14. The research analyst(s) preparing the email / Research Report/ attachment is resident outside the United States and is/are not associated persons of any U.S. regulated broker-dealer and that

therefore the analyst(s) is/are not subject to supervision by a U.S. broker-dealer, and is/are not required to satisfy the regulatory licensing requirements of FINRA or required to otherwise comply with U.S. rules or regulations regarding, among other things, communications with a subject company, public appearances and trading securities held by a research analyst account.

15. This report is prepared, approved, published and distributed by the Ambit Capital located outside of the United States (a non-US Group Company”). This report is distributed in the U.S.by Enclave Capital LLC, a U.S. registered broker dealer, on behalf of Ambit Capital only to major U.S. institutional investors (as defined in Rule 15a-6 under the U.S. Securities Exchange Act of 1934 (the “Exchange Act”)) pursuant to the exemption in Rule 15a-6 and any transaction effected by a U.S. customer in the securities described in this report must be effected through Enclave Capital LLC (19 West 44th Street, suite 1700, New York, NY 10036).

16. As of the publication of this report Enclave Capital LLC, does not make a market in the subject securities. 17. This document does not constitute an offer of, or an invitation by or on behalf of Ambit Capital or its affiliates or any other company to any person, to buy or sell any security. The information

contained herein has been obtained from published information and other sources, which Ambit Capital or its Affiliates consider to be reliable. None of Ambit Capital accepts any liability or responsibility whatsoever for the accuracy or completeness of any such information. All estimates, expressions of opinion and other subjective judgments contained herein are made as of the date of this document. Emerging securities markets may be subject to risks significantly higher than more established markets. In particular, the political and economic environment, company practices and market prices and volumes may be subject to significant variations. The ability to assess such risks may also be limited due to significantly lower information quantity and quality. By accepting this document, you agree to be bound by all the foregoing provisions.

Additional Disclaimer for Canadian Persons

18. AMBIT Capital is not registered in the Province of Ontario and /or Province of Québec to trade in securities and/or to provide advice with respect to securities. 19. AMBIT Capital's head office or principal place of business is located in India. 20. All or substantially all of AMBIT Capital's assets may be situated outside of Canada. 21. It may be difficult for enforcing legal rights against AMBIT Capital because of the above. 22. Name and address of AMBIT Capital's agent for service of process in the Province of Ontario is: Torys LLP, 79 Wellington St. W., 30th Floor, Box 270, TD South Tower, Toronto, Ontario M5K 1N2

Canada. 23. Name and address of AMBIT Capital's agent for service of process in the Province of Montréal is Torys Law Firm LLP, 1 Place Ville Marie, Suite 1919 Montréal, Québec H3B 2C3 Canada. Disclosure 24. Ambit and its associates have financial interests in Havells, Crompton Greaves and Asian Paints. Analyst Certification Each of the analysts identified in this report certifies, with respect to the companies or securities that the individual analyses, that (1) the views expressed in this report reflect his or her personal views about all of the subject companies and securities and (2) no part of his or her compensation was, is or will be directly or indirectly dependent on the specific recommendations or views expressed in this report. © Copyright 2015 AMBIT Capital Private Limited. All rights reserved.

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