Event update: Redington India (Outperformer) - Lira depreciation to weigh on near-term PAT…

Redington India Ltd. (REDI) conducted a conference call to address the possible issues on Arena – its Turkey business after the recent sharp correction in the Turkish Lira (TRY - ~83% YTD depreciation vs USD; ~40% in August 2018). Following are the key takeaways from the call:

• TRY depreciation more prominent on the PAT level: REDI explained that since the tax rate imposed in Turkey (22%) is at the transaction value on the local currency level, the effective tax rate looks far higher at the USD level which is REDI’s functional currency. As a result, effective tax rate was ~157% in H1CY18. The impact would be opposite in the scenario where TRY appreciates versus the USD.
• Measures put in place to safeguard Arena: (1) Orders from vendors put on hold (or cancelled if possible), (2) Focus is on collections over sales currently, (3) Profitable growth remains the focus when looking at sales, (4) 10-12% cost cutting imposed (25-30 sales staff laid off), (5) dealings being done in USD mostly, TRY exposure is squared off within 24 hours, (6) to reduce WC by USD35-45m from USD133m.
• 7-8% impact on Q2 cons. PAT estimated: Arena contributed 9.4%/4.8% to FY18 Rev./PAT and for Q1FY19 the contribution was 6.4%/-3.0%. Given the sharp movement in TRY, REDI’s cons. Q2FY19E PAT could be impacted by 7-8%, as per the management. It is difficult to gauge the impact for FY19E currently. However, REDI believes that Arena can pull itself well in the current storm, given its strong balance sheet strength and expertise in the Turkey market (USD71m net-worth; 0.42x D/E; 26-27% credit limits utilized yet).
• Miscellaneous Call Takeaways: (1) Out of USD133m WC, 60% is receivables (of which 53% is insured), balance is inventory; (2) USD48m investment in Arena (49.4% stake) would be tested for impairment. There could be some write-off in FY19E here; (3) 80-85% Arena revenue from B2C side; (4) ~35-55 days inventory kept, but inventory is not ensured due to strong vendor relationships enjoyed.

Valuation & View:

The sharp depreciation in TRY would weigh on the stock in the near-term as its full year impact remains uncertain (we have not cut est. yet) given its nature. We believe that REDI has to really step up the performance in its India enterprise segment (higher margin) to divert attention from the slew of negative developments (higher provisioning norms under Ind-AS 109, currency impact). The sharp correction in the stock price means that it is now trading at 6.1x FY20E EPS and is an attractive entry point from a medium-term perspective and hence we maintain our OP.