Crompton Greaves shares: No bad news is good news, says JP Morgan

Written by JP Morgan | Updated: Aug 12 2013, 20:11pm hrs
After a series of large disappointments in quarterly numbers over the last two years, expectations were running low for Crompton Greaves (CG). A sequential improvement in revenue growth, segment-wise margin performance and an adverse one-off free quarter came as a slight relief; the stock outperformed the Sensex by 5.3% as a result that day.

Results summary: Crompton Greaves Ltd shares reported consolidated sales growth of 12.3% year-on-year, slightly better than expected. Top line was led by overseas power, up 16%, and consumer, up a healthy 20.6%. Domestic power revenue declined by 5.1% in the June quarter, however, the management clarified that sales from Kanjur Marg plant were set back by R700m owing to disruption by fire. Consolidated Ebitda (earnings before interest and taxes) margin of 4.6% (down 130bps y-o-y) was below our estimate of 5.5% but nevertheless a sequential quarter-on-quarter improvement from 2.3% in Q4FY13.

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Higher other income (R353m, +84% y-o-y), led to PBT (profit before tax) of R1.07 bn (down 17% y-o-y), which was just 2.8% below estimate. A high tax rate of 43.3% pulled down the June quarter PAT to R601m (down 30% y-o-y). Consolidated order inflows of R24 bn were down 10% y-o-y, but domestic inflows of R14.4 bn, were up 20% (consolidated OBorder bookof R98 bn is up 7% q-o-q).

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Segment-wise margin performance: Overseas power Ebit margin was -1.5% in Q1. As per management, both Belgium and Hungary were Ebit positive in the June quarter, comforting given it follows a round of restructuring in FY13. The overseas segment loss flows from their Canada (executing legacy orders, new management in place) and US (unit underutilised, low margin system orders) operations. The management remained non-committal about a decisive recovery in FY14, given the year will see a clean up of existing overseas backlog and there is still a lot of uncertainty regarding delivery of legacy power transformer orders. Margin disappointment was mainly led by industrial segment (8.5%, -275bps q-o-q).

Should we call this a turnaround Overseas margin performance remains a key risk in FY14 and June quarter performance alone remains inconclusive. We believe the ongoing buyback in CG is likely to provide support to near-term stock performance. We remain Neutral on CG and believe growth catalysts are in store for long-term investors; within the space on a relative basis we have been UW (underweight) on Bhel, Siemens and ABB.

Price target and valuation analysis: We maintain our Mar-14 DCF(discounted cash flow)-based PT (price target) of R85 implies 12.3x(times) FY14e EPS (earnings per share) and 10x FY15e EPS.

The stock has held up post weak results on subsequent management assurances regarding recovery from FY13 trough margins. Proof of performance would make us incrementally positive on the stock.

Maintain Neutral rating: Profitability remains a weak link especially in overseas subsidiaries, but with scope for sharp improvement from current lows. Signals to the contrary are a key downside risk. The key upside risk is waning of RM (raw material) cost pressures due to easing commodity prices and higher-than-expected improvement in profitability in FY14.

JP Morgan