Management Speak: Voltas (Outperformer) - Inventory levels normalize, all eyes on summer

We met Voltas’ management. Below are the key takeaways:

• Unitary Cooling – inventory levels normalise: Inventory levels have normalised to ~1-1.5 months driven by an uptick in South, specifically in Kerala in Jan-Feb 2019. However, due to extended winters, demand is yet to pick in North (~40%+ of demand), where the season usually picks up post Holi festival. Accordingly, the last fortnight of March are critical for the season. At industry level price hikes are imminent due to increased input costs, however Voltas or other peers have not taken any price hikes as yet and will review price hikes once the season picks up meaningfully. Voltas is focussed on improving profitability by moving up the value chain and improving its product offering such as the adjustable invertor AC (flexible capacity with lower power consumption). Accordingly, Voltas has maintained its UCPL margin guidance at 11% on a sustainable basis.
• Tirupati RAC plant to enhance service to South-West markets: Voltas is setting up an RAC plant in Tirupati, wherein it will invest Rs5bn over the next 5 years. The plant will have a 1mn unit capacity in the initial phase and will gradually add other products such as coolers, commercial refrigeration, etc. The plant will be a replica of the Pantnagar facility with assembly unit and injection moulding. The ideology for the Tirupati plant is to be placed at a strategic location to have access to South and West markets with better and agile response time to changing market trends. The Pantnagar facility will continue to cater to the North and other markets.
• Electro Mechanical Projects – focus on profitable orders: Current order book stands at Rs50bn equally split between rural electrification, urban infrastructure (metros, airports, waste water management etc.) and HVAC. Voltas continues to remain selective and cautious in bidding for projects across domestic and international markets with focus on profitability and cash flows. The competitive intensity in international markets have reduced and should aid sustained order wins for Voltas. On the other hand, domestic orders are likely to sustain from metros, airports, water, rural electrification, etc. Mgmt believes the long term structural margins are likely to be at 7-7.5%.
• Voltas-Beko JV to see gradual ramp up: The investment of US$100mn is expected to be completed by FY20E. The plant will be operational by Dec-19, post which the entire product range and distribution will expand meaningfully. The JV has opened 4 exclusive outlets under the franchise models and aims to launch more outlets with focus on Tier II cities. The JV losses are likely to sustain over the next few quarters.

Valuations and view

The UCPL segment is seeing early signs of a bounce back on back of upcoming summer season led by the uptick in South. Voltas is well positioned with a ~23% market share to capitalise on the growth on back of its scale benefits, deeper reach, higher focus on inverters and cost efficiencies. On the other hand, focus on process improvements, better commercial terms and profitable orders have helped reap benefits, as EMP margins have improved to 7%+. The stock is trading at 31.5x FY20E and 26.4x FY21E earnings. We believe the long-term structural story on RAC penetration, earnings uptick (21% earnings CAGR over FY19-21E), free cash generation and strong balance sheet (Rs20bn+ cash) will keep valuations rich. Maintain Outperformer.