Despite a disappointing Q2, the Crompton Greaves (CRG) share price has moved up 45% in last 3 months (outperforming the BSE Sensex by 40%) on the hope rally related to recent political developments. The shares trade at expensive valuations of 26.9x FY14E and 17.1x FY15E despite low average RoEs of 12% over FY14E-16E.
As a consequence, we downgrade Crompton Greaves Ltd shares to ‘sell’ (from neutral) with a revised target price of Rs 114. Our target price moves up to Rs 114 (from Rs 93) on the back of an increase in the target P/E multiple to 15x (from 13x) to factor in the rerating in industrial stocks, roll forward of target P/E to March 15E (from December 14E) and our EPS revisions of -15% to +2%. Our estimates are 3-11% below consensus expectations.
Consumer products cannot provide the delta. This business has grown at a brisk pace with steady margins and has almost been counter-cyclical vis-ŕ-vis power and industrial. Investors need to contend with the possibility of consumer discretionary spending decelerating in the near future.
CRG’s facilities are operating at ~100% utilisation and should remain so for the next 1.5 to 2 years. This implies the company cannot eke out a 200-300bps margin improvement through operating leverage benefits.
In the days of glory (FY04-12), the standalone business delivered RoEs of 20-40%. Given the company is not sitting on spare capacity, the standalone business would deliver structurally lower 15-17% RoEs over FY14E-16E even if the domestic cycle recovers.