Equitymaster Agora Re search Private Limited Independent Investment Research 14 October, 2009

Havells India Ltd

Buy Market data
Current price Market cap NSE symbol BSE code No of shares Free float Face value FY09 DPS (Rs) 52 week H/L Rs 318 (BSE) Rs 19,158 m HAVELLS 517354 60.2 m 39.9% Rs 5.0 2.5 Rs 338/100

Target price: Rs 500

Investment Rationale
A good proxy for the India growth story: Havells India Ltd, our midcap recommendation this week is a company that has perhaps grown the fastest among all the major electrical and power distribution equipment manufacturers in the country. To be precise, between the period FY04 and FY09, its standalone revenues have grown at an average annual rate of more than 40%, courtesy its ability to capitalise on a range of business segments. The company earns majority of its revenues from four major segments (switchgears, lighting and fixtures, cables and wires and electrical consumer durables) and has a dominant position in virtually all of these segments. While it is one of t he worlds t op 10 manufacturers in an important type of s witchgears called MCBs, it is also recognized as a quality manufacturer of cables and wires. Also, the company has emerged as one of the fastest growing fan brands in the world and has set up Indias largest integrated fan plant. And its not just about the companys products. Its immense reach has also helped it to become a force to reckon with in both the domestic and international markets. Henc e, in view of t he strong growth pros pects of the Indian ec onomy and Havells dominant position in its industry, we expect the companys standalone revenues to grow at an average annual rate of 13% over the next three years. Its not just about topline growth: At 9% to 10%, t he c ompanys operating margins are surely on the lower side. But they have remained remarkably consistent as well. In fact, even during the inflationary environment that prevailed during the latter half of FY 08 and first half of FY09, the companys profitability did not come under a lot of threat. This gives us the confidence that it will be in a position to maintain its operating margins in the future as well. On the contrary, with prices of most commodities that the company uses to manufacture its products heading southwards, there are strong chances that margins could s how an impro vement going forward. It should be noted that for the quarter ended June 2009, Havells standalone operating margins stood at over 12%, a significant improvement from the 10% levels witnessed earlier. Taking this into account and also the fact that most commodities may not revisit their peak prices any time s oon, we project a slight improvement in the companys operating margins and expect it to remain at the 11% levels over the medium term. On a strong financial footing: In addition to the growth in revenues and profits, Havells has also managed to take its standalone balance sheet from strengt h to strength in the past few years. Making full use of its limited capex as well as working capital needs, the company
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Rs 100 inve sted i s now worth

240 170
100 30 Havells India: Rs 102 BSE Midcap: Rs 123

Oct-06

Sep-07

Aug-08

Jul-09

Stock price performance

6-Mth 1-Yr 3-Yr Havells India Ltd 92.2% 33.4% 0.7% Index* 87.7% 67.1% 7.2%

Returns over 1 year are compounded annual averages (CAGR) * BSE Midcap

Shareholding (June-09)
Category
Promoters Institutions (Banks, MFs, FIs) FIIs Indian public Others Total

(%)
60.1 1.8 18.1 8.5 11.5 100.0

Report prepared by
Equitymaster Agora Research Privat e Limited www.equitymaster.com info@equitymaster.com

Havells India Ltd

14 October, 2009

has utilized the excess cash generated t owards slowly reducing its debt to equity ratio which as per its latest annual report stood at a mere 0.1x on a standalone basis. Contrast this with the extremely high gearing of 1.7x during FY04 and the improvement in the companys balance sheet becomes evident. Besides strong cash flow from operations, the company has also done well to raise equity to the tune of more than Rs 1.5 bn, which also helped the company improve its standalone debt to equity ratio Sylvania acquisition to be value accretive in the long term: In 2007, Havells acquired a Frank furt headquart ered company called Sylvania for a tot al of US $ 300 m. Taking into consideration Sylvanias annual revenues to the tune of US $ 600 m, the company more than doubled its size, effectively setting a platform for future global ex pansion. The Sylvania lighting group is a global designer and provider of lighting systems, including bot h lamps and fixtures and has a strong brand and distribution network with over 10,000 distributors spread across the globe with main operations in Europe and Latin Americ a. Besides structuring the deal in such a way that it puts as little strain on the standalone entitys balance sheet as possible, we believe that there are some long term synergies that could be exploited from the ac quisition that could lead to greater shareholder value creation in the future. The acquisition gives Havells access to over 10,000 distributors spread in Latin America, Europe, Africa and Asia, which can be used to launch Havells products like switchgear, etc in these markets. There are huge potential synergies in manufacturing and sourcing of lighting products for the two companies. There is a huge potential in joining the R& D activities as well. In view of these benefits, we believe that the Rs 50 per share valuations that we give to Sylvanias businesses from a medium term perspective could become a lot more in the foreseeable future and play a big role in taking the overall intrinsic value of the company higher.

profits and consequently, the companys EPS could be substantial. Just to put things in perspective, if one were to lower the companys FY12 operating margins to 9% from the projected 11%, the companys EPS could come in lower by as much as 21%. Hence, if an inflationary environment develops and the company is unable to pass on the price increase to its end consumer, the lower margins could significantly impact our target price. Product life cycle issue s: Since the business of the company is exposed to segments such as lighting and fixtures and electrical consumables, it is to some extent at the mercy of fast changing consumer habits and shorter product life cycles. This in turn entails higher capital investments thus harming the return ratios of the company and its long term fundamentals. Sylvania could command more investments in the short term: Although Havells has plans of infusing equity capital in its subsidiary in a phased manner, a prolonged slowdown in the developed markets could force the company to commit more funds to Sylvania operations, thus putting pressure on its finances.

Background
Havells India Ltd. is a billion-dollar-plus organization, and is one of the largest & India's fastest growing electrical and power distribution equipment manufacturer covering the entire gamut of household, commercial and industrial electrical needs. Havells owns some of the prestigious global brands like Crabt ree, Sylvania, Conc ord, Luminance, Linolite, & SLI Lighting. Its 8 state-ofthe-art manufacturing plants in India and 7 state -ofthe-art manufacturing plants located across Europe, Latin America & Africa churn out globally acclaimed products. Havells acquired Frankfurt headquartered Sylvania for US$ 300 m in 2007. In the process, Havells, India's leading electrical manufacturing organization, more than doubled its size and with Sylvania set a solid platform for fut ure global expansion.

Investment Concerns
High operating leverage: As mentioned earlier, the companys operating margins are on the lower side. And this could lead to a situation where even if there is a small change in its margins, the resultant change in operating
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Industry prospects
Since the company derives nearly three fourths of its revenues from t he c ables and wires and the switchgears segments, let us focus on the prospects of these two industries going forward. As far as cables and wires is concerned, given the robust surge in demand for energy and the consequent investment planned in power generation, transmission and distribution, the Indian cable industry is slated for a strong growth in demand. The optimism is based on the fact that cables account for 3-3.5% of the total power generation project cost, 1.5-2% of power transmission project cost and approximately 10% of power distribution project cost. Moving on to the switchgear market, a new study by Frost and Sullivan indicates that this market has grown by 15% in 2008 and is expected to grow by 14% till 2015. All indicators point towards the power sector being one of the key future drivers of India's economic growth. The switchgear market has exhibited excellent growth primarily due to sustained demand from the vibrant residential, commercial construction, and infrastructure sectors. Demand from thes e sectors is likely to persist in the near future. However, fierce price competition among the market participants could hurt the overall revenue growth of the Indian LV (Low Voltage) and MV (Medium Volt age) switchgear markets

well as demand from households. However, the sector is also a lot fragmented with hundreds of smaller players operating in this space. Henc e, we assign a medium risk rating to the stock on this parameter. Company standing: With Havells India being the leading player in some of the segments that it is present in, we assign a medium rating to the company on this parameter. Sales: Havells India generated revenues to t he tune of nearly Rs 22 bn in FY 09 on a standalone basis. Further, the company is expected to generate average revenues to the t une of Rs 28 bn over the next three years. We t hus assign a low risk rating of 10 to the stock on this parameter. Operating margins: Operating margin is a measurement of what proportion of a company's revenue is left over aft er paying for variable c osts of production such as raw materials, wages, and sales and marketing costs. A healthy operating margin is required for a company to be able to pay for its fixed costs, such as interest on debt. The higher the margin, the better it is for the company as it indicates its operating efficiency. Havells Indias average operating margins for the past five years has been 9.7% and we expect it to remain nearly stable at 11% during the next three years. As such, we assign a medium risk rating of 4 to the stock on this parameter. Long-term EPS growth: We expect the company's net profit to grow at an average annual rat e of 23% between FY09 and FY12 (average annual rate of 32% during FY06-FY09). In a normal scenario, we consider a compounded growth of over 20% in net profits over a period of 3 to 5 years as healthy for a company. As such, the rating assigned to t he stock on this factor is 7. Return on invested capital: ROIC is an important tool to assess a company's potential to be a quality investment by determining how well the management is able to allocate capital into its operations for future growth. A ROIC of above 15% is considered decent for companies that are in an expansionary phas e. Considering Havells Indias last five years' average ROIC of 27.4%, which is expected to be around 29.7% by FY12, we have assigned a rating of 10 to the stock on this parameter.

Key Management
Mr. Anil Gupta, Joint Managing Director, graduated in Economics from Shri Ram College of Comm erce, Delhi University and is also an MBA from Wake Forest University, Nort h California, USA. He joined Havells in 1992 and started supervising the marketing and sales function. Today, he is instrumental in business development by forming new allianc es and acquisitions wit h foreign collaborators and / or taking over other businesses within India.

Risk Analysis
Note: See the Risk Matrix table on the page 5

Sector: The electrical and power distribution equipment segment is growing at a robust pace on account of the investment activity in the country as
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14 October, 2009

Dividend payout: Havells India has had an average dividend payout of 11% over the last 5 years, which we expect to remain nearly stable at around 10% over the next three. The rating assigned on this parameter is 2. Promoter holding: A larger share of promoter holding indicates the confidence of people who run the company. We believe that a greater t han 40% promoter holding indicates safety for retail investors. At the end of September 2009, the promoter holding in Havells India stood at 60.1%. We have assigned a risk rating of 6 to the stock. FII holding: We believe that FII holding of greater than 25% can lead to high volatility in the stock price. FII holding in the company stood at 18.5% at the end of September 2009. Therefore, the rating assigned is 5. Liquidity: The past 52-weeks average daily volume of the stock is in the range of 70,182 shares, which indicates that the stock is moderate on liquidity. The rating assigned is thus 5. Current ratio: Havells Indias average current ratio during the period FY09 to FY12 is estimated to be around 1.9 times, indicating the company's ability to pay up short-term obligations. A ratio under 1 suggests that the company is unable, at that point, to pay off its obligations if they came due. We assign a low-risk rating of 6 to the stock. Debt to equity ratio: A highly leveraged business is the first to get hit during times of ec onomic downturn, as companies have to consistently pay interest costs, despite lower profitability. We believe that a debt to equity ratio of greater than 1 is a highrisk proposition. Havells Indias debt to equity is expected to remain nearly at 0.1 in the next 3 years. We have thus assigned it a risk rating of 8. Interest coverage ratio: This ratio is used to determine how comfortably a company is placed in terms of payment of interest on outstanding debt. The int erest coverage ratio is calculated by dividing a company's earnings before int erest and taxes (EBIT) by its interest expense for a given period. The lower the ratio, the greater are the risks. Havells Indias average int erest coverage ratio during l ast five years remained at 7 and expected t o be around 14.9 over the next three. Thus, the rating assigned to the stock on this parameter is 10.

P/E Ratio: The P/E ratio (price-to-earnings ratio) of a stock is a measure of the price paid for a share relative to per share income or profit earned by the company. This is one of the important metrics to judge the attractiveness of a stock, and thus gets the highest weightage in our risk matrix. Havells P/E on its standalone earnings of the past four quarters currently stands at around 12 times, which makes the stock attractive on a valuation basis. As such, we have assigned a medium risk rating of 6 to the stock on this parameter. Considering the above analysi s, the total ranking assigned to the company i s 79 that, on a weighted basis, stand at 6.7. Thi s make s the stock a medium-ri sk inve stment from a longterm perspective.

Valuations
We have used s um-of-the-parts method to arrive at a target price of the company from a FY 12 perspective. We have valued the companys standalone business using a rather conservative P/E of 10 times our estimated FY12 standalone earnings per share. It should be noted t hat this is significantly lower than the average P/E multiple of 15x that the company has enjoyed between FY03 and FY09, hence inc orporating a sufficient margin of safety. Also, we value the companys Sylvania operations at Rs 50 per share, effectively valuing the companys stake in Havells holdings, the holding company for Sylvania, at even less than the book value of investments. This once again ensures a sufficient margin of safety. Thus, taking the two together, we arrive at a composite target price in the region of Rs 500 per share for the company from a FY 12 perspective. This translates into a return of around 20% on an average annual basis or alternatively, a point-to-point return of 57%. We thus recommend a BUY on the stock.

Valuation table
Standalone (Rs m) Revenue (Rs m) PAT (Rs m) EPS (Rs) CEPS (Rs) Price to earnings (x) Price to cash flow (x) FY09 FY10 E FY11 E FY12 E 21,984 24,182 27,809 31,981 1,452 24.1 27.1 13.2 11.7 2,226 37.0 40.5 8.6 7.9 2,333 38.8 42.9 8.2 7.4 2,702 44.9 49.6 7.1 6.4

Havells India Ltd

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Risk Matrix
Rating accorded Rating Sector Risk Company Performance parameters Sales Operating margins Long term EPS growth Return on invested capital Technical parameters Dividend payout Promoter holding FII holding Liquidity Safety parameters Current ratio Debt to equity ratio Interest coverage ratio P/E ratio Final Rating** Weightage* (A) 5.0% 5.0% 10.0% 10.0% 5.0% 10.0% 5.0% 10.0% 5.0% 10.0% 5.0% 20.0% Rating# (B) Medium Strong 10 4 7 10 2 6 5 5 6 8 10 6 79 Weighted (A*B) NA NA 0.5 0.2 0.7 1.0 0.1 0.6 0.3 0.5 0.3 0.8 0.5 1.2 6.7

* 'Weightage' indicates the relative importance in percentage terms of the parameter. For instance, for an investor, given all the performance metrics, return on equity should be the foremost criteria for buying/not buying stocks. # The final rating has been arrived at by multiplying the rating/points given on each parameter with the respective weightage

Financials at a glance
Standalone (Rs m) Sales Sales growth (%) Operating profit Operating profit margin (%) Net profit Net profit margin (%) Balance Sheet Current assets Fixed assets Investments Total Assets Current liabilities Net worth Loan Funds Total liabilities FY09 21,984 7.0% 2,025 9.2% 1,452 6.6% FY10 E 24,182 10.0% 2,902 12.0% 2,226 9.2% FY11 E 27,809 15.0% 3,059 11.0% 2,333 8.4% FY12 E 31,981 15.0% 3,518 11.0% 2,702 8.4%

5,514 4,655 3,879 14,047 4,002 9,319 727 14,047

6,720 5,442 4,479 16,641 4,629 11,285 727 16,641

7,414 6,194 4,479 18,087 4,002 13,358 727 18,087

9,102 6,912 4,479 20,493 4,002 15,764 727 20,493

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Important Notice: Equitymaster Agora Research Private Limited is an Independent Equity Research Company. Disclosure: The author of this article does not hold shares in the recommended company. QIS does not hold shares in the recommended company. Equitymaster Agora Research Private Limited This Service is provided on an "As Is" basis by Equitymaster. Equitymaster and its Affiliates disclaim any warranty of any kind, imputed by the laws of any jurisdiction, whether express or implied, as to any matter whatsoever relating to the Servic e, including without limitation the implied warranties of merchantability, fitness for a particular purpose Neither Equitymaster nor its affiliates will be responsible for any loss or liability incurred to the user as a consequence of his or any other person on his behalf taking any investment decisions based on the above recommendation. Use of the Service is at any persons, including a Customers, own risk. The investments discussed or recommended through this service may not be suitable for all investors. Investors must make their own investment decisions based on their specific investment objectives and financial position and using such independent advisors as they believe necessary. Information herein is believed to be reliable but Equitymaster and its affiliates do not warrant its completeness or accuracy. The Service should not be construed to be an advertisement for solicitation for buying or selling of any securities. Havells India Ltd Page 6 of 6