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MOSL: VOLTAS (Upgrade to Buy)-Defies slowdown-Raise earnings

VOLTAS: Defies slowdown; Raise earnings; Upgrade to BUY

(VOLT IN, Mkt Cap USD2.8b, CMP INR598, TP INR700, 17% Upside, Upgrade to Buy)

 

• Operating performance exceeds expectations: revenue increased 24% YoY in 1QFY20, exceeding our estimate by 11%, led by strong 47% growth in UCP segment. As a result of a higher effective tax rate (32% v/s our estimate of 27%) and higher losses in JVs, net profit increased at relatively low rate of 6% YoY to INR1.9b (in-line).
• Strong summer trumps consumption slowdown: According to management, industry growth stood at 36% for the quarter. Against the backdrop of slowing consumption in the economy, this validates that the strong summers is the primary driver for AC purchases. UCP segment sales grew 47% YoY, leading to an expansion in market share (at 24.1% for 1QFY20 and 25.3% for Jun'19 v/s 23.7% in FY19 and 23.5% in 1QFY19). We note that even after normalizing for the impact of the delayed summer season, UCP growth stands strong at 22% for VOLT in 1HCY19.
• Inventory levels lower than normal, channel refilling to drive growth: Capital employed for UCP segment turned negative in 1QFY20. Moreover, management mentioned that even distributors have run out of inventory and generated good cash flows during the summer season. This augers well for UCP revenue visibility going into the next season as well into 4QFY20 as channel refilling itself can drive revenue growth. We model in UCP revenue growth of 26%/15% in FY20/21. The ask rate for FY20 stands at 13% and may surprise on upside given the favorable base in the fourth quarter.
• Scope for price hikes emerges, though not our base-case scenario: Even though the summer season surprised positively, the surge was skewed toward 1QFY20 rather than the desired 4QFY19. Coupled with high inventory from last season, this restricted industry wide price hikes as liquidation of inventory was a priority. With lower-than-expected channel inventory, we do see some scope for price hikes to offset the import duty pressure. However, this is not our base-case scenario, as competitors can still be irrational and operate at lower-than-optimal margins in a hunt for market share. We are positively surprised with the PBIT margin expansion (+60bp YoY) in UCP segment. This is attributable purely to operating leverage as there were no price hikes and import duty and exchange rate pressure increased Sep'18 onward. We expect VOLT to attain EBIT margin of 13% in FY21, still below the average of 14% over FY14-18.
• EMP biz to cater to opportunities in domestic market: EMP revenue declined 5% YoY in 1QFY20, in line with our estimate. Management is optimistic on the ordering environment, especially in the domestic market, and is looking to cater to new growth areas of the solar and water industry. We have modeled in modest 3% CAGR in EMP revenue over FY19-21 owing to a strong base of FY19 (+27%). We expect EBIT margin to be stable at current 8%.
• Upgrading to Buy with TP of INR700: We raise our adj. consol. earnings estimate by 2%/6% for FY20/21, led entirely by UCP segment. We continue valuing UCP at a target multiple of 35x FY21E EPS. Our TP now stands at INR700. At CMP, the stock trades at multiple of 28x for core UCP business. We upgrade the stock to Buy.