Management Speak: Voltas (Outperformer) - Sweltering summer to boost UCPL performance

We met Voltas’ management; below are key takeaways:

• Unitary Cooling – strong growth in April-May 19: led by strong summers with North continuing to see high temperatures in June 19. Despite demand being strong, Voltas and peers refrained from price hikes (except 1-2% in certain markets), given their primary focus on inventory liquidation and sustained competition. However, margins are expected to expand, led by positive operating leverage and tweaks on promotional schemes, ad spends, etc. A stable INR and fall in commodity prices too should support margins. Management guided for sustainable 11% EBIT margin (10.3% in FY19) in UCPL. Voltas is also focussing on commercial refrigeration and air-cooler segments, considering the immense potential there.
• Tirupati RAC plant to enhance market share in South: Voltas intends to invest Rs5bn over the next 5 years (Rs2bn over the next 2 years in Phase I) to set up the Tirupati plant. The plant will have a 1m unit capacity initially, and see gradual addition of other products. The plant is strategically located for access to India’s southern and western markets, giving the company better and agile response time to cater to changing market trends. The plant will help Voltas extend its reach in the South, reduce logistics costs and aid market share gains there.
• Electro Mechanical Projects – traction in domestic markets: from rural electrification and urban infra (metros, airports, water, hospitals, etc). While RE contributed 40%, UI was 30-40% of the current order backlog of Rs50bn (Rs30bn domestic). Voltas continues to remain selective and cautious in bidding for projects in the international markets, where it recently won an order in Bahrain. Also, due to political tensions in the Middle East, ordering activity in the region is expected to be muted.  Management estimates long-term structural margins at 7-8%.
• Voltas-Beko JV to see gradual ramp up: The plant is expected to be operational by 3QFY20, initially manufacturing refrigerators (direct cooling) and washing machines thereafter. The JV has covered 50-55% of the distribution network, with 100 exclusive outlets under the franchise models, largely in Tier II & III cities. The JV losses are likely to sustain over the next 2-3 years, as spend continues towards establishing the brand, deepening distribution and enlarging product portfolio (investment of US$100mn, which could increase). The JV continues to target 10% market share in its product categories.

Valuations and view

With the onset of summer being strong, we believe demand and thereby, margins are likely to rebound in the UCPL segment over FY20-21, led by Voltas’ scale and cost efficiencies. Concurrently, an uptick in urban infra spend in the domestic market bodes well for domestic EMP over the medium term. We believe the stock looks attractive at 28x FY21E earnings, considering the long-term structural story on room air conditioners (RAC), free cash generation and strong balance sheet. We reiterate our Outperformer rating on Voltas.