Areva target cut to R180

Updated: Feb 29 2012, 09:27am hrs
Areva T&Ds Q4 EPS came in c55% below our expectations due to c33% revenue miss and c335 bps q-o-q margin erosion. The lower volumes were driven primarily by a delay in delivery pick-ups by customers, mostly Independent power plants (IPPs), which also led to an increase in inventory of c42% in H2.

Order intake on the other hand stayed strong and increased c12% y-o-y in CY11. Management noted that they saw good ordering on the power side, from both Power Grid and states. Management also noted that while they lost out on project business because of dilution of PQ norms by the Power Grid, they made up for it by procuring bulk order for products, including 765kV transformers and circuit breakers.

The order book stood at R4,300 crore 1.4 x CY11 reported sales or 1.5x CY11e transmission sales.

With a strong order book in hand, we estimate Areva will deliver underlying (ex-distribution sales in 1QCY11) sales growth of c17% in CY12 or reported sales growth of c7%. However, given the significant margin miss of c520bp in Q4, we are lowering our margin expectations for CY12/13 by c90bp, thus pushing down our EPS by c27%.

We believe Areva will benefit from an increasing portion of products in its order book and if execution improves, then margins can potentially surprise on the upside. On the other hand, pricing pressure remains intense in the substation segment and a few weak projects can intensify pressure on margins. Hence, we believe margin progression remains a key risk to our estimates. Areva is in the process of selling assets and swift progress in that area can considerably reduce the debt burden and support earnings. Currently, we expect interest expense to remain flat y-o-y, but a material asset sale could drive upgrades.

Areva has risen c23% over the last three months; hence after our earnings downgrade, the stock appears expensive at c31x CY12e PE. Given the competition in the substation segment, it appears unlikely that the company will beat our growth or margin expectations. We downgrade our rating to underweight (we are adding the volatility flag) and reduce our target price to R180. Our target price is derived from our preferred EVA valuation methodology and implies a 12-month target multiple of c21x on 24-month forward estimated EPS

of R8.6. HSBC