Voltas - Hopeful EMP recovery priced in - Ambit

Deteriorating order pipeline in Middle East to restrict margin recovery

Post ~30% YoY revenue decline and -5% EBITDA margin in ME EMP FY14 revenues, ME EMP EBITDA margins would recover to 2% in FY15 and 3.5% in FY16 owing to higher operating leverage from Rs.11bn order inflow and 1.4x book-to-bill ratio in FY14 (0.9x in FY13). Whilst ME has a large CY13-18 project pipeline of US$820bn the project mix has deteriorated due to higher infrastructure spend compared to building construction over the last decade.

Increasing competition in sluggish domestic MEP industry

The entry of international payers such as Drake & Scull and Al Zamil would further increase competition intensity in the domestic MEP industry. We believe a sharp recovery in commercial real estate looks unlikely, given high vacancy rates (20-30%) in key markets such as NCR and Mumbai. Infrastructure capex could revive Indian capex cycle but the MEP spend as a percentage of total investment is low in infrastructure: airports (2.7%) and metro rail (0.6%).

UCP an unmatched franchise but 10% EBIT margin unsustainable

Voltas has built an unmatched room AC franchise (20.4% market share) through: (a) a 'value for money brand' (b) flexi-sourcing model, and (c) strong dealer network. However, Voltas would not be able to achieve management guidance of 10% EBIT margin in the UCP segment owing to higher advertising costs in a high competition industry. Further, its UCP RoCE's could decline if Voltas were to set-up room AC manufacturing plant.

Voltas would not rerate to FY05-07 multiples due to lower RoCE/RoE

Assuming mid-teen revenue growth from FY16 onwards, our DCF-based SOTP valuation of Rs.132/share (EMP-Rs.28; UCP-Rs.48, EPS-Rs.20; cash/ investments/rent- Rs.35), implies 14.5 FY15 eps of Rs.9.1. Voltas is trading at an expensive 20x oneyear forward P/E, a 24%/48% premium to its 8-yr/4-yr average. Lower FY15/16 RoE/RoCE of 17%/13% vs 34%/24% in FY06-08 would limit P/E multiple expansion to ME order-driven highs of 25x in FY08.

Source : Equity Bulls

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