Negative impact of weak Q1 and Q4 AC demand, Voltbek JV expenses and lower than expected engineering margins all hit Voltas in FY19.
Soaring summer temperatures and FY19 low base have led to 20% y-o-y growth for ACs as per media reports in April-May 2019. Our FY20e EPS builds 13% y-o-y growth for the Unitary cooling segment. Every 5% revenue uptick here is a 3% change in FY20e profits. We believe Voltas missed some post-election upside vs industrial peers given the weak Q4 engineering margins. Recovery in Q1FY20e coupled with strong AC growth should drive further upside.
Negative impact of weak Q1 and Q4 AC demand, Voltbek JV expenses and lower than expected engineering margins all hit Voltas in FY19. We believe the stock did not materially de-rate as faith remains in the AC business growth potential and also confidence that the engineering segment revenues still have recovery left, as FY13-FY19 saw only a 2% CAGR. April-May 2019 have been good summer months and set a favourable tone for FY20e earnings. Given the industry declined in FY19, even if timely rains come, FY20e should see reasonable growth between price hikes taken and a volume rise.
Consumer behaviour points to moving rating notch lower when prices rise
The industry has made representations to the Bureau of Energy Efficiency to delay the CY20 rating changes, stating it should be concerned with energy conservation vs label changes. Consumers prefer purchasing 2-3-star ACs vs 5-star ACs as prices rise. May 2019 saw a sharp surge in demand for regular split ACs vs inverter, due to higher prices post the rating change. This trend shouldn’t be extrapolated but helps Voltas as it is perceived to be stronger in regular split vs inverter ACs.
Industry pricing discipline should help margins improve sequentially
Our channel checks indicated that industry inventory was running at 90 days+ till December 2018 and dropped to 45-60 days in Jan-Feb 2019. Post introduction of the new energy rated products in CY18, AC prices have generally moved higher by 10%+ for a similar rating AC. Our current estimates for Q1FY20e factors 10% y-o-y revenue growth in Unitary Cooling for Voltas with 11% Ebit margins vs 12.5% y-o-y and 10.4% q-o-q.
As we believe FY20e Voltas will benefit from better AC growth and the low base effect of FY19, we maintain Buy with a PT of `700, 30x PE FY21e (premium to its 10-year average of 23x). Downside risk: Domestic AC demand collapse.
Voltas is a part of one of India’s largest conglomerates, Tata Group. Voltas provides engineering solutions for areas like heating, ventilation and air conditioning, refrigeration, electro-mechanical projects, textile machinery, etc. It has three manufacturing facilities located at Thane, Dadra and Pantnagar.