Meeting with management reveals “consumer pull” model is firmly on track. Growth would be driven by multiple SKU launches, with a youthful bias, from FY17, backed by surge in R&D and A&M. High-growth premium range will remain unscathed as deal with Morphy Richards is up for renewal in FY17 on new royalty terms (revenue-linked). Inventory rationalisation with Theory of Constraint (TOC) rollout drove sharp turnaround in Lighting (21% revenue CAGR & 280bps margin boost; 9MFY16) and spells end to E&P losses (legacy receivables tapering); margins of these segments should now sustain at 5%-6%. TOC rollout under way in Consumer Durables (CD) will not dent growth as inventory rationalisation has kicked in pan-India. Another key concern, management attrition in 1HFY16 due to TOC rollout, is now behind the company. E&P will not be demerged given synergies with Lighting and ROCE of ~18%.
Focus on product development; ad spend to increase
With the change in the business model from “channel push” to “consumer pull”, management is looking to revamp Bajaj Electrical’s (BJE’s) product portfolio. The focus will be on increasing the share of premium products (currently 10-15% of revenues) and stepping up R&D. BJE is scouting for an R&D product head who will help BJE in coming up with new designs across the product portfolio to appeal to the youth.
Advertisement spend is likely to increase by 59% in FY16 (YTD BJE has already spent R610m, vs R565m in FY15) and likely to remain at around 3% of revenues. Ad campaigns will be targeted towards youth to change the perception of ‘Bajaj’ being more for the elderly given it is a 77-year-old brand.
Morphy agreement should get renewed
Management allayed fears over the agreement with Morphy Richards (Morphy) not getting renewed as the royalty terms are being re-negotiated to become linked to revenues from a fixed rate currently. Morphy products comprise BJE’s premium product range and contribute 11%/5% of CD/overall revenues. Moreover, the revenue CAGR is an impressive 26% over FY09-15 vs 18%/16% for CD/overall revenues. In the event of the agreement not getting renewed and Morphy deciding to tie up with another player (e.g. TTK Prestige) it will be big loss to BJE as TTK may use the Morphy brand to become aggressive in electrical appliances .
TOC fully implemented in E&P; losses now history
Theory of Constraints (TOC) has now been fully implemented in E&P; hence, losses in the business may not recur. Moreover, in E&P, receivables pertaining to the legacy projects in each segment are now less than R100m each (vs cumulative R4 bn a year ago); Q3FY16 actually saw a write-back of R50m, which implies BJE historically made higher provisions for receivables pertaining to legacy projects. Also, no portion of the order backlog has legacy projects. Note that historical losses in E&P were primarily on account of under-recovery of receivables on the legacy projects.
The processes relating to taking up of new projects have been significantly tightened after the rollout of TOC. Consequently, the conversion ratio (defined as a percentage of orders won of tenders bid for) has been very low, at 15%-18%, for power distribution and 8%-12% for transmission line towers and order inflow has declined by 39% year-on-year in E&P. BJE has also become very selective in bidding and is currently bidding only in a few states like West Bengal, Odisha, Madhya Pradesh, Jharkhand, Chhattisgarh and Bihar given fewer issues pertaining to right of way (ROW) in these states. On the execution side, the project monitoring team has been beefed up and monitoring is now on a weekly basis; BJE is ahead of schedule in 26% of its total backlog.
The risk in E&P is management’s inclination to go overseas. Geographies BJE is trying to bid for are Africa, the Middle-East, LatAM and South-East Asia. Given the decline in oil and commodity prices, the risk to doing business in these areas pertains to execution slowdown. We view this as a negative given that very seldom have Indian companies succeeded in E&P business overseas.
Lighting business turnaround due to TOC
The lighting business has clocked an impressive 21% revenue CAGR in 9MFY16 and 280bps margin improvement y-o-y, led by successful rollout of TOC (theory of constraints). Unlike in consumer durables where a rollout is difficult given prevalence of schemes and dominance of wholesalers, in lighting it is not difficult as discounting is not prevalent and business has retail focus. Revenue growth has also been aided by ramp-up of the LED portfolio, both in lamps and luminaires. EESL orders also helped the surge in revenue growth.
CD to post revenue growth in FY17 despite TOC rollout
YTDFY16 has been a weak period for consumer durables given a 1% y-o-y decline in revenue and 180bps y-o-y decline in Ebit margin. The decline in revenue is despite ~10% y-o-y growth in secondary sales YTD. Rollout of TOC in 19 cities and discontinuation of discounting on a pan-India basis has impacted sales. In FY17, the plan is to rollout TOC in 80% of the sales area.
However, revenue growth should recover in FY17. This would be led by: (i) strong growth in areas where TOC has been implemented (led by rising reach, range and replenishment) and (ii) lower revenue decline in areas where TOC will be rolled out in FY17 as inventory rationalisation has already started in non-TOC areas with price discounting having been stopped across India.
Attractive valuation: Consumer business trading at 17.1x FY17e P/E
Based on our FY17e EPS, BJE is trading at an attractive valuation of 13.3x P/E. If we assume that the E&P business is valued fairly at R45/share (7.1x FY17 P/E), the consumer business is trading at an attractive valuation of 17.1x. This is despite 23.6% EPS CAGR over FY16-FY18 and 45% adjusted RoCE (adjusted for unallocated capital employed) over FY17-FY18. We do believe BJE’s franchise is weaker than those of Havells and V-Guard given the presence in the E&P segment, lack of product diversification (franchise strong primarily in domestic appliances), and high attrition in senior management. However, we don’t think BJE’s consumer business should trade at a 18%/41% discount to Havells/ VGuard based on FY17e P/E given BJE’s strong RoCE of 45% over FY17-FY18 vs 19%/24% for Havells/V-Guard.
Key risks to our thesis is (i) continuation of management
attrition despite majority of management now on board with TOC implementation, (ii) delays in TOC rollout in the CD segment and (iii) recurrence of losses in the E&P segment.