Earnings over last few years show that the company’s strategy of focusing on a dealer franchise and building a brand is a winning one
For the quarter ending December 2016, Havells reported robust 13% y-o-y revenue growth vs. our estimate of a 1% decline and consensus expectation of flat revenues. This partly reflects market share gains by organised players, in our view. Revenues grew across segments but were strongest in cables and wire (18% y-o-y) and the consumer durable segment (18% y-o-y), while switches and lighting segment revenues grew 2% y-o-y.
Margin, however, declined 112 bps y-o-y, below our estimate of a 20 bps decline: According to the release, this includes the impact of schemes launched by the company to support the dealers in uncertain times (effect of the currency replacement programme). The y-o-y margin comparison also reflects the impact of work force addition in the last few quarters.
Ebitda grew 4% y-o-y, and was 6% ahead of our estimate (7% ahead of consensus): Solid revenue momentum helped.
Valuation methodology and risks
We continue to value Havells on P/E multiple-based sum-of-the-parts. We believe that, in the long term, an earnings discount model (i.e., residual income, discounted cash flow) would better reflect the stock’s intrinsic value. However, amid the current macro uncertainties, investors are focusing on 12-18 months earnings and ascribing multiples based on factors such as earnings visibility/ growth and balance sheet strength; hence, we value Havells on a P/E-multiple basis. Our price target includes: (i) valuing the domestic business on a P/E basis. We believe that Havells is an industry leader with strong brand and balance sheet and should continue to command a premium. (ii) We value the remaining 20% stake in Sylvania at R2.7bn, in line with price of the 80% sale.
To reach our price target of R391, we assign probability weights to our scenario values. We continue to assign a 30% weighting to our bull case, 65% to our base case and 5% to our bear case. Our probability weightings reflect the upside risks we see to our base case earnings estimates.
32x one-year forward EPS for the domestic business—this remains at a 60% premium to history, which we believe is warranted given continued delivery: In our view, the continued track record of achievement in earnings over the last few years (notwithstanding the slowdown in FY17) has demonstrated that the company’s strategy of focusing on a strong dealer franchise and building a brand is a winning one. Though earnings growth will moderate in FY17, we expect it to recover and project a 17% earnings CAGR over FY2017-19.
Bull case assumptions: Macro trends are better than expected in our base case and lead to stronger growth in domestic revenues. Domestic margins also fare better because of the stronger growth. This leads to 15% growth in FY17 and a sharper recovery resulting in 32% growth in FY18 versus 20% in our base case. Our 38x P/E multiple for the domestic business is a premium to the base case—it factors in faster revenue growth and further re-rating with continued earnings delivery.
Bear case assumptions: Growth in the domestic business is weaker than in our base case as recovery is slower than expected and there is increased competitive intensity. We estimate 2% earnings decline in FY17 and 16% in FY18 vs 20% in our base case. P/E contracts; we assign 24x to standalone earnings, a 25% discount to the base case.
Key downside risks to achieving price target: (i) Slower than expected growth in the domestic business. (ii) P/E contraction given near term earnings uncertainty.