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.