After a correction of about 17% over the past three months, we believe valuations, though more comfortable now, still do not provide an adequate cushion for risk from possible demand slowdown in India and worsening macro situation in Europe. Havell?s management has indicated that the company has not seen a demand slowdown in India and business in Europe remains steady. We however remain cautious and maintain Sell.

India business? Q1FY12 revenue grew 16% year-on-year, at the lower end of FY12 revenue growth guidance of 15%-18% y-o-y. High margin businesses of switchgear and fans (40% of FY11 revenue) are growing at 10% CAGR (compound annual growth rate) only. Incremental growth is dependent more on the success of new product launches and commoditised cables and wire business. India inventory days increased to 65 days in Q1FY12 from 47 days in Q1FY11, signalling a demand slowdown.

The macro-economic situation in Europe has worsened over the past few months. Europe contributes 30% of Havells? consolidated revenues. The outlook for the lighting business in Europe remains uncertain, though Havells has yet to see any impact on its own business.

We cut the target price to R347 (R425 earlier) as we cut (i) P/E (price-to-equity) multiple on India business to 13.5x (times) from15x earlier to factor in an uncertain demand outlook and macro headwinds; (ii) EV/Ebitda (enterprise value/earnings before interest, taxes, depreciation and amortisation) for Sylvania to 5x from 5.5x. We revise down India business? FY12-FY14 EPS (earnings per share) by 5-7% to factor in slightly lower revenues and Ebitda margins.

Havells? India business has achieved an edge over competitors due to its wide distribution network and brand recall. However, given the risks of demand slowdown, we would wait for a better entry point.

We believe that we remain in a high-risk environment. High inflation, interest rates, slowing industrial and construction activity could impact the demand for Havells? products. The macro outlook for Europe has worsened significantly over the past few months. Europe contributes about 30% of consolidated revenues.

Havell?s India business? Q1FY12 revenue at R8 bn grew 16% y-o-y. Switch-gear sales grew 1% y-o-y due to closure of the OEM contract from the UK. Domestic switchgears sales grew 10% y-o-y. Consumer durable sales growth decelerated to 14% y-o-y in Q1FY12 after growing 40% y-o-y in FY11. Lighting grew at a healthy 21% y-o-y in Q1FY12.

If one examines Havells? India business mix closely, two of the most profitable product categories i.e. switchgears (Ebit margin= 37%) and fans (Ebit margin = 28%) are fairly mature now. These two categories contributed to 40% of revenue in FY11 and are expected to grow at 10% CAGR in FY12 and FY13.

A large part of incremental growth is being driven by new product introductions (small appliances) which is a more competitive space , and new product introduction has its own risks. Cables and wires (44% of FY11 India revenues) is a competitive and commodity type of business with only 7% Ebit margins.

The only established high-margin (Ebit margin of 18%) business which is expected to keep growing at high growth rates (20% CAGR) is the lighting and fixture business (15% of FY11 India revenues).

Sylvania Q1FY12 revenue at 107 m euros grew 1% y-o-y (down 6% q-o-q). European revenues declined 2.6% y-o-y and 13% q-o-q. Emerging markets revenue grew 8% y-o-y and was flat q-o-q. Sylvania Q1FY12 margin at 7.3% fell 62 bps (basis points) q-o-q. Havells has increased margins in the Latin American business to 10% while European business margins fell 128 bps q-o-q to 6.1%.

Havells? India business is well positioned to benefit from growing construction and consumer spending in India.

?Citi