On the block 'Underperform' for Crompton Greaves shares: Jefferies

Updated: May 19 2014, 12:38pm hrs
Clearly, markets are on a data holiday, with elections being the focal point. As data and fundamentals make a gradual comeback to justify bumped up valuations we take a look at what is priced in. However, Crompton has an additional takeover candidate angle as per media reports, but denied by the management. On fundamentals, for Crompton Greaves (CRG), we believe power systems Ebit (earnings before interest and taxes) margins is the key.

Valuation: Given subdued margin profile and ROEs (return on equity) in the medium-term, we maintain Underperform with a target price of R100, valuing the stock at 10x PE FY16e (steep discount to 15-year mean of 20x) and R9/ share for its holding in Avantha Power).

Power systems Ebit margins, the key variable: Crompton Greaves earnings have declined 90% over FY11-13. Ebit margins in power systems has gone negative from 12.4% to -1.4% over FY11-13 due to increasing competitive pressure in a difficult global backdrop. The management has made concerted efforts to reduce costs by revamping its facilities in Belgium (16% of sales). Our FY16e margins assume 170 bps improvement over FY14e margins of 2.5% (-1.5% loss in FY13). This is a best case factoring in all potential cost benefits from Belgium restructuring. Our target price of R100 factors in 4.1% margins, while current price levels suggest 200 bps higher. Every 100 bps change in Power systems margins is 15% delta on EPS. Given the sharp volatility in this from -1.4% to 12% over the last decade, it holds a key for stock.

Takeover candidate not surprising: Recent media articles suggest that CRG is a potential takeover candidate with value of $2.5 bn (implying R224 per share, about 28% premium to market price and 1.2x EV/Sales FY13).

The management denied it, but it would not surprise us given promoters competitive and technical edge is an issue. In the T&D space, Toshiba acquired Vijai Electricals in India for $200m in January 2014 at 0.8x EV/sales. At 0.8x FY13 sales, implied price for CRG is R139.