Havells India - Tripped! - Nirmal Bang

Reversal in the turnaround story of Sylvania, higher bill discounting leading to weak free cash flow and likely lower growth in domestic operations make us worried on the prospects of Havells India (HIL). Its stock trades at 16.9x/11.5x FY14E P/E and EV/EBITDA, above the eight-year median of 13.8x/9.6x, respectively. With the likely poor free cash flows of Rs782mn/Rs901mn in FY14E/FY15E, respectively, from standalone operations, HIL would not be in a position to command the multiples enjoyed by fast moving consumer goods (FMCG) companies. Our PAT estimates are 13.0%/12.4% below Bloomberg consensus estimates for FY14E/FY15E, respectively. Considering the fact that EBITDA/PAT CAGRs would moderate to 9.3%/12.3% over FY12-FY15E compared to 31.6%/112.7% over FY09-FY12, respectively, the valuation looks expensive. With a lower growth momentum, declining returns on incremental capital and a weak free cash flow, we expect a de-rating of HIL. Using SOTP-based valuation, we have assigned a Sell rating to HIL with a target price of Rs507, translating into FY15E P/E and EV/EBITDA of 12.1x/8.6x, respectively.

Subdued free cash flow/return ratios to cap valuation: Including bills discounted, an off-balance sheet item in short-term debt and debtors, the working capital days for standalone/consolidated HIL are at 75/93, 2.8x/1.4x higher than the reported 27/66, respectively, for FY12. We believe this is a major reason for the bloated balance sheet of HIL. Standalone receivables/inventory days also increased from 46/37 in FY09 to 63/74, respectively, in FY12, generating subdued operating cash flow of Rs1,132mn. With a further deterioration in receivables, we expect free cash flow to remain muted at Rs782mn/Rs901mn on standalone basis and Rs629mn/Rs764mn on consolidated basis for FY14E/FY15E, respectively, while RoCE is likely to slip from 20.2% in FY12 to 17.0% in FY15E. With a poor free cash flow, we don't think HIL should command a premium valuation in line with other FMCG players.

Usage of short-term funds for long-term liabilities: We believe HIL is adopting a risky strategy of utilising short-term resources to fund long-term liabilities. After a closer look at its financials, we believe HIL over-stretched its short-term funds limit by ~Rs3,908mn which needs to be refinanced with long-term funds in FY13. We believe bills discounted exerted pressure on liquidity and expect it to reflect on the valuation.

Sylvania restructuring showing signs of fatigue: The benefits of restructuring turned out to short-lived with EBITDA margin at Sylvania falling to 4.4% in the 9MFY13 period from 8.4% in FY12. Slowdown in Europe and poor penetration in Latin America are matters of grave concern, as all this exerts pressure on volume as well as margins of its European/Latin America operations. We feel the turnaround would take a longer time to materialise than what the management and the street have factored in. We have valued Sylvania at Rs22/share against the street's valuation of Rs50-Rs100/share. HIL has not amortised goodwill of Rs3,625mn, 13% of its networth in FY12. If goodwill is amortised over seven years, our FY14E/FY15E PAT estimates decline 11.7%/9.9%, respectively.

Source : Equity Bulls

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