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ICICIDirect - Pick of the Week - Havells India Ltd.

Havell’s India is likely to sustain its growth momentum on the back of booming user industries such as construction, engineering and power. The commissioning of new plants for electrical consumer durables – fans, CFL, etc, and switchgears in the excise- free zone of Uttaranchal and Himachal Pradesh would help it to expand its market share and improve margins.

Company Background

Havells India is one of the leading electrical and power distribution equipment companies in the country, manufacturing products ranging from building circuit protection, industrial & domestic switchgear, cables & wires, energy meters, fans, CFLs, luminaries, bath fittings and modular switches. Promoted by Qimat Rai Gupta and S K Gupta, Havell's India was incorporated in August 1983. It started by producing miniature circuit breakers and distribution boards in 1984. It entered into a technical collaboration with Christian Geyer, Germany, to manufacture miniature circuit breakers in India. In 1991, it was amalgamated with Elymer Havell’s, which had facilities to manufacture HRC fuses. The company has set up a new manufacturing facility for MCB's and other switchgear products at Baddi, Himachal Pradesh and an integrated ceiling fans manufacturing unit at Haridwar in Uttaranchal.

Investment rationale

Boom in user industries
Havell’s India is likely to sustain the growth momentum on the back of the boom in the user industries such as construction, engineering and power. Its top line has grown at a CAGR of over 45% during the past 5 years from Rs 171.08 crore in FY01 to Rs 1108.25 crore in FY06. During this period the bottom line grew at a CAGR of over 59% from Rs 6.21 crore to Rs 63.21 crore. Domestic & industrial switch gears, cables and consumer electrical equipment contribute an equal 25% to its revenues while the balance rest 18% and 7% is contributed by wires and the newly acquired Crabtree revenue (cater to premium segment of modular switches and bath fittings) respectively.

The company is in a sweet spot as all its divisions are likely to sustain growth momentum given the ongoing boom in user industries such as construction, engineering and power.

(a) Switchgear Division

Havell’s is the largest manufacturers of MCBs, RCCBs, and distribution boards in India with the market share of around 25% in the market for MCBs. In FY06, switchgear contributed 30% at Rs 329.85 crore to its overall revenue. This segment is the most profitable one with operating margins to the tune of 31.17% in the H1FY07. The company currently exports MCBs to over 45 countries, including the quality conscious European countries. In order to accelerate its growth further, the company is in the process of setting up a 100% export-oriented unit (EOU) at Baddi, which would augment its capacities to 30 million poles of MCBs and would it in the top 10 league of manufacturers in the world.

(b) Cable & Wire Division

The cable & wire segment generated Rs 344.34 crore in the H1FY07 with operating margins of 13.30% at Rs 46.02 crore. In FY06, the cable division grew at 52% YoY to Rs 465.16 crore. The company is recognized as quality manufacturers of cable & wires and offers a complete range of low and high voltage PVC and XLPE cables, besides, domestic FR/FRLS wires, Co-Axial TV and telephone cables. During the FY06, the company had almost doubled its capacity.

(c) Electrical Consumer Durables Division

During FY06, the turnover of the division grew at 109% y-o-y to Rs 274.41 crore while in the first half of FY07, the revenue from the division increased by around 61% y-o-y to Rs 193.87 crore. The company generated operating profit of Rs 24.50 crore with 12.63% margin. In this division, the company expanded its CFL capacity to become the largest CFL manufacturer in the country. The company currently exports CFL to the neighboring countries of Sri Lanka, Bangladesh besides Middle East and African countries. The company has initiated marketing of this energy saving product in the smaller towns and rural areas, which is likely to push the demand and growth of the product.

The electrical consumer business is the fastest growing segment wherein company enjoys market leadership position in compact fluorescent lamps (CFL) segment, which is growing at 40% per annum.

Expansion to sustain growth momentum

The company is undertaking expansion in existing as well as new product categories to widen its offerings and reap the opportunities emerging in user industries. The company is entering into two new segments, electrical motors and power capacitors at a capex of Rs 100 crore which would be funded entirely through internal accruals. Initially the company would manufacture motors up to 100 HP and gradually ramp up to 300 HP in due course. The company also plans to set up a power capacitor unit in Haridwar with an initial capacity of 3,00,000 KVRs. The company hopes to generate revenues of about Rs 36 crore from capacitors and Rs 240 crore from motor business in its first year of operation.

Tax incentives from new plants to expand market share

It has commissioned new plants for electrical consumer durables – fans, CFL, etc. in the tax-free zone of Uttaranchal and Himachal Pradesh. The production in these zones would enable the company to expand market share along with margins. The company hopes to capture a bigger slice of the Rs 1,600 crore electric fan segment from the unorganized sector on the back of tax incentives which would help it to bridge the price differential. Besides pricing power, the company hopes to generate volumes from this segment that is likely to grow at 16% per annum through its innovative product, which consume 33% less power.

Risks & Concerns

1. The company’s principal inputs are aluminium and copper. Copper constitutes almost 40% of the total cost of production of electric equipment. The prices of these metals are currently on an upturn, which may put pressure on the margins. However, the company is able to pass on the incremental cost though with a time lag.

2. The domestic market for consumer electric products is highly competitive with presence of unorganized sector. As the unorganized sector does not pay excise, the company has set up plant in Baddi, where it would have excise benefit through which it would be able to take on the unorganized sector more efficiently.

The company’s top line has grown at a CAGR of over 45% during last 5 years from Rs 171.08 crore in FY01 to Rs 1108.25 crore in FY06. Bottom line grew at faster pace with a CAGR of over 59% from Rs 6.21 crore to Rs 63.21 crore during the same period. For the first half of FY07, the company reported a net profit of Rs 46.90 crore on sales of Rs 786.49 crore. We expect the company to sustain its growth momentum in the current financial year though the growth rate may moderate later due to high base effect. The company is likely to post a net profit of over Rs 95 crore in FY07E on a turnover of over Rs 1600 crore on a conservative basis though the company is targeting it to be Rs 2000 crore.

Valuation

Havell’s India is likely to sustain its growth momentum on the back of the boom in the user industries such as construction, engineering and power. Commissioning of new plants for electrical consumer durables viz. fan, CFL, etc. in excise free zones would also lead to margin expansion. The company is currently trading at Rs 315, 18x the FY07E EPS of Rs 17.45. The company has an impressive return on equity of more than 45%, which along with margins expansion may trigger into further re-rating of stock. We expect the company to generate returns to the tune of 20% over 3-6 months with a target price of Rs 380.

Technical Outlook

The stock is currently trading above its 200 day moving average, which is around Rs 273. The stock has a strong support at Rs 302 level. It made a double bottom at these levels and bounced back to Rs 314 level. On the upper side, if it closes above Rs 324 with good volume, we expect a strong breakout and it could rise to Rs 351 – Rs 380 levels.

Stocks you can pick up this week

Reliance Industries
Research: Enam Securities
Recommendation: Outperformer
CMP: Rs 1,286.25 (Face Value Rs 10)
12-Month Price Target: Rs 1,400

Reliance Industries (RIL) has filed a revised development plan with the Director General of Hydrocarbon (DGH) for the key KG-D6 block. In the amended plan, RIL has sought approval for 80mmscmd of gas production and has proposed proportionate increase in the capex.

Based on independent assessment, RIL expects the P2 (proved + probable) reserves at 11.3 TCF. This represents an almost 100% increase over earlier estimates. The management has not indicated the quantum of P1 reserves as of now, but it is expected to be around 6TCF (as per the filings of Niko Resources- RIL’s JV partner).

The management is likely to share details once the revised plan is approved by DGH. Enam believes the filing of revised development plan for KG-D6 is a significant event and strengthens the outlook on RIL’s new business initiative. Going ahead, improving policy outlook on gas pricing and achievement of project milestones will align RIL’s E&P valuation multiples to its regional peers.

Mangalam Cement
Research: India Infoline
Recommendation: Buy
CMP: Rs 204 (Face Value Rs 10)
12-Month Price Target: Rs 297

Mangalam Cement (MCL) has performed strongly, wiping out its accumulated losses in FY06. The strong demand for cement in the domestic market coupled with firm cement prices is expected to bring rich rewards for the company in the next 18 months. MCL is putting up a 17.5-mw captive power plant, which is expected to go on steam by June ’07.

MCL is also adding 0.5 million tonnes of new cement capacity to take its total production capacity to 2 mt by September ’07. The stock is trading at EV/tonne of $70 of its FY08 capacity of 2 mt. On EV/EBIDTA basis, it is quoting at 3.9 times, while on an EPS basis, it is trading at 5.6 times.

With improvement in the balance sheet and operational efficiencies, India Infoline feels the stock is undervalued and recommends a ‘buy’, with a target of Rs 297 within a year. The target price discounts estimated FY08 earnings by 8.0x and EV/EBIDTA by 5.5x.

KEI Industries
Research: ULJK Securities
Recommendation: Buy
CMP: Rs 361 (Face Value Rs 10)
12-Month Price Target: Rs 403

Kei’s revenue growth is strong for FY07, with an overall sales growth of 85%. Cables sales are expected to grow by 90%, stainless steel wire by 48%, winding flexible and house wire by 80% and others by 25%. Last year, KEI generated revenues worth Rs 23.5 crore through exports, of which Rs 10 crore accrued from the Gulf region.

The company is in the process of integrating backwards by setting up an aluminum properzi and PVC compounding plant, which is likely to be operational in six months at a capex of Rs 7-10 crore. This will strengthen the operating margins by reducing the cost of the company by Rs. 4-5 crore.

KEI plans to undertake a greenfield expansion with capex of Rs 180 crore in Uttaranchal in FY08. With the management’s above plan for capacity expansion and backward integration, KEI is set to enter higher growth orbit. ULJK estimates the fair value of the company at Rs 403 and expects the company will trade at a P/E of 7.9 times within 12 months.

KRBL
Research: BRICS PCG
Recommendation: Buy
CMP: Rs 143 (Face Value Rs 10)
12-Month Price Target: Rs 267

KRBL has posted a revenue growth of 28.4% y-o-y to Rs 230 crore during Q2 FY07 due to better volumes and higher realisations on both domestic and export sales. Higher sales led a 52.5% y-o-y rise in operating profit to Rs 31.46 crore, which expanded the operating margin to 13.8% compared to 11.6% in Q2 FY06.

Net profit stood at Rs 15.12 crore, registering 88% growth. The company plans to launch its own brand of rice bran oil in consumer packs by December ’07. It commissioned a 12.5-mw wind farm in August ‘06 at Dhulia, Maharashtra, and is planning a 3.5-mw power plant in Ghaziabad for captive consumption.

This will lead to power cost savings of around Rs 5 crore each year. BRICS maintains a ‘buy’ call on the scrip, but lowers its target price to Rs 267 from Rs 301 earlier, considering that the company’s integrated milling plant in Dhuri, Punjab commenced operations only in October ’06.

Taj GVK
Research: Pioneer Intermediaries
Recommendation: Buy
CMP: Rs 241 (Face Value Rs 2)
12-Month Price Target: Rs 325

Taj GVK Hotels & Resorts (TAJGVK) reported a jump of 38% in revenues to Rs 57.9 crore in Q2 FY07, on the back of higher average room realisations (ARR) and steady occupancy rates (OR) in Hyderabad. The average ARR across the three hotels of the group in Hyderabad at Rs 7,635 was higher by 41% y-o-y, while ARR in Chandigarh was ~Rs 6,000.

TAJGVK’s capital charges in Q2 FY07 remained stable y-o-y. While the interest burden stood at Rs 1crore in the quarter, against Rs 90 lakh last year, depreciation was static at Rs 3.2 crore. Net profit for the quarter rose to Rs 15.2 crore from Rs 9.4 crore in Q2 FY06 (+62% y-o-y). TAJGVK has commenced work on its 200-room, greenfield property in Begumpet in Hyderabad and is set to commission its 215-room property in Chennai by June ’07.

At the current market price, the stock is trading at a P/E of 19.1x its FY08 EPS of Rs 12.7. Pioneer Intermediaries makes its case for investment on the back of stability and visibility in the company’s earnings over the next 18-24 months, due to absence of significant room addition in Hyderabad and on account of potential upside in revenues from the Chandigarh property.

Spanco Telesystems
Research: Emkay Share
Recommendation: Buy
CMP: Rs 171 (Face Value Rs 10)
12-Month Price Target: Rs 217

Spanco Telesystems announced a robust set of independent results after the demerger of Sparsh — its domestic call centre business. The results are not comparable as Sparsh was not part of company in Q207. The total revenues of the company in Q207 were Rs 121.7 crore.

Telecom network integration business has surprised with total revenue of Rs 113.1 crore in Q207 compared to Rs 20.5 crore in Q206. EBIDTA for the quarter stood at Rs 16.6 crore, up 85% over the preceding quarter and PAT stood at Rs 9 crore. EPS for Q207 and H107 stands at Rs 5.7 and Rs 8.6, respectively.

Emkay Share expects the company’s PAT to be Rs 37.4 crore for FY07 and Rs 66.7 crore for FY08. Emkay values the listed entity at 9x FY07E EPS of Rs 24 or 5.2x FY08E EPS of Rs 42 and put target of Rs 217. Sparsh will be listed in due course with an expected target of Rs 47 (12x FY07E EPS of Rs 4).

Bhagiradha Chemicals & Industries Ltd. (BHAC)

Bhagiradha Chemicals & Industries is one of India’s largest manufacturers of the best-selling insecticide, Chlorpyriphos. The company is reorienting its strategy and focusing on R&D to drive growth. It is foraying into contract manufacturing of high-value agrochemicals. We expect sales to grow at a CAGR of 22.50% from Rs 77.52 crore in FY06 to Rs 116.3 crore in FY08E, resulting in EPS growing at a CAGR of 44.20% from Rs 17.5 in FY06 to Rs 36.4 in FY08E. We rate the stock an OUTPERFORMER with a 3 to 6-month price target of Rs 189.

Background

Bhagiradha Chemicals & Industries was incorporated in 1994 to manufacture Chlorpyriphos, a new generation insecticide at that time. Chlorpyriphos is an insecticide used on a wide variety of crops such as cotton, chilly, rice, sorghun, soyabean, sugarcane, groundnut, vegetables, ornamentals and flowers. It is used for commercially important plantation crops like citrus, mango and grapevive. Chlorpyriphos also finds application in the preservation of wood and timber.

The promoters, Koteswara Rao and D Sadasividu were previously working at Indian Institute of Chemical Technology (IICT), which has developed several innovative technologies for chemical products (including Chlorpyriphos). The initial capacity of the plant was 300 tonnes per annum (tpa) and this was expanded to 2,000 tpa as on March 2006. The company diversified into producing herbicides in 2004, and has been launching a new product every year. It also has a facility to make bulk formulations of Chlorpyriphos. Its current product portfolio comprises of two insecticides – Chlorpyriphos and Imidacloprid – and two herbicides (Triclopyr and Fluroxypyr).

Investment Rationale

Differentiated business model
Selling agrochemicals in regulated markets requires huge sums for generating the data package required for product registration. Alternatively, the data can be purchased from the original inventor. However, inventor companies demand hefty amounts, making the business unviable. Most Indian companies have thus focused on the domestic market and developing nations where it is easy and cheap to register their products. But the consequence has been too players competing in the same markets. Apart from drastic price erosions, there is also lack of stability in the business since customers can easily switch suppliers. Overcapacity in the agrochemical sector in China has further exacerbated the situation.

In order to overcome these hurdles, Bhagiradha is now reorienting its strategy and focusing on R&D to drive growth. The promoters of Bhagiradha are technocrats who have strong R&D experience. The company has a state-of-the-art R&D center at Hyderabad, which employs 30 scientists and its expenditure on R&D is on the rise with Rs 45 lakh being spent on R&D in FY06 (55% Y-o-Y growth).

Manufacturing pact with Dow AgroSciences
Bhagiradha recently signed a contract manufacturing agreement with Dow AgroSciences for the herbicide Fluroxypyr. Bhagiradha is to supply minimum 250 tonnes of Fluroxypyr per year for the next 4 years. Dow AgroSciences is the original inventor of Fluroxypyr and was its sole producer till now. The global demand for Fluroxypyr is about 1,500 tpa. It is a high-value product and is mainly used in the developed markets. This deal is an important milestone for Bhagiradha since Dow AgroSciences chose it as its partner despite the fact that the two are competitors in the Triclopyr and Chlorpyriphos market. It also vindicates Bhagiradha’s new business strategy of R&D-driven growth since many other Indian companies were also in the race to be the first to develop a generic version of this product.

With an increasing trend of MNCs to outsource molecules that have gone off patent, Bhagiradha will now be the preferred option for Dow AgroSciences in case it decides to outsource more of its Fluroxypyr requirement in the future.

For FY07E, Fluroxypyr volumes are expected to be 250 tonnes, translating into revenues of Rs 35 crore. We expect Dow AgroSciences to increase the quantity to 370 tonnes in FY08E, and revenues rising to Rs 50 crore. Bhagiradha’s bottom line is expected to get a significant boost since contribution level in this product is about 50%. The total investment in the Fluroxypyr plant was only Rs 8.5 crore.

Broad-based product portfolio
For the first 10 years since its inception, Bhagiradha was only manufacturing Chlorpyriphos. In 2004, it decided to diversify into other products to mitigate the risks associated with a one-product. It launched Triclopyr (a herbicide) in 2004, Imidacloprid (an insecticide) in 2005 and Fluroxypyr (herbicide) in 2006.

Revenues from new products now constitute 30% of its total sales. They expected to rise to 61 % by FY08E. Since these are high-margin products, its NPM has also increased to 11.5% in FY06 from 9.5% in FY05.

Product Profile

Chlorpyriphos: This insecticide was launched in 1994 in the Indian market. Initially many companies set up plants for this product based on a breakthrough technology developed by IICT. Chlorpyriphos volumes have grown exponentially since then but its price has crashed from more than Rs 500/kg in 1994 to current price of Rs 260/kg due to intense competition. This led to many smaller companies stopping production. Currently, there are only a few companies still left in the field. They include Bhagiradha, Excel industries, Dow AgroSciences, Gharda Chemicals and Mitsu. Considering the low-margins, Bhagiradha plans to maintain current capacity of 2,000 tpa and use it as a cash cow. It will funnel fresh investments into facilities for new high-value products only.

Triclopyr: This herbicide accounts for 9% of Bhagiradha’s turnover and the entire production is exported. Dow AgroSciences originally developed this product and Bhagiradha, Aimco Pesticides and Punjab Chemicals & Crop Protection Ltd now produce its generic versions. Global demand is approximately 1,500 tonnes and major export destinations are Australia, New Zealand and South East Asia. Triclopyr sales are expected to reach Rs 11 crore in 2007 and Rs 12.9 crore in 2008.

Financials:

The full benefits of the Fluroxypyr deal will be visible from the current year onwards with sales expected to grow by 50% from Rs 77.52 crore in FY06 to Rs 116.3 crore in FY08E. However, net profit would soar by more than 100% from Rs 8.9 crore in FY06 to Rs 18.5 crore in FY08E. The shift towards high-value products will see NPM expand from 11.5% in FY06 to 15.9% in FY08E. RoCE, which was respectable 31.8% in FY06, is also set to reach impressive levels of 39.5% in FY08E. The free cash flow generated would be used to reduce debt through bullet repayments. Debt/Equity ratio is expected to fall from 1.1 in FY06 to 0.3 in FY08E, thus considerably de-leveraging the balance sheet.

Risks & Concerns

MNCs have an option to outsource products from their subsidiaries in developing nations. Syngenta has already done this by making its Indian arm a global sourcing base for the insecticide Thiamethoxam. Unless the patent holder considers Bhagiradha a serious threat, it may not be the preferred partner for its outsourcing deals.

Valuation

The company is currently trading at one of the lowest P/E ratios in the industry. We expect sales to grow at a CAGR of 22.50% from Rs 77.52 crore in FY06 to Rs 116.3 crore in FY08E and EPS to grow at a CAGR of 44.20% from Rs 17.5 in FY06 to Rs 36.4 in FY08E. At the current price of Rs 157, the stock trades at 8.97x its FY06 EPS of Rs 17.5 and 4.31x its FY08E EPS of Rs 36.4. The stock is available at an EV/EBIDTA of 6.39x FY06 earnings and 3.10x FY08E earnings. We rate the stock an OUTPERFORMER with a price target of Rs 189 with a 3 to 6- month timeframe.

Technical Outlook

The stock has formed a good support at the Rs 120 levels and has been in an accumulation mode since then. Stochastic has turned positive and the RSI indicator also signals a BUY. It faces a minor resistance at Rs 160 levels. Volumes have been picking up recently.