Sylvania sales a positive

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1 14 December 2015 Update Sector: Capital Goods Havells India BSE Sensex S&P CNX 25,150 7,650 Stock Info Bloomberg HAVL IN Equity Shares (m) M.Cap. (INR b)/(usd b) 189/ Week Range (INR) 316/236 1, 6, 12 Rel. Per (%) 21/18/22 Avg Val (INR m) 478 Free float (%) 38.4 Financial Snapshot (INR Billion) Y/E Mar E 2017E Net Sales EBITDA Adj PAT Adj EPS (INR) EPS Gr. (%) BV/Sh(INR) RoE (%) RoCE (%) P/E (x) P/BV (x) Shareholding pattern (%) As on Sep-15 Jun-15 Sep-14 Promoter DII FII Others FII Includes depository receipts Stock Performance (1-year) CMP: INR303 TP: INR340 (+12%) Buy Sylvania sales a positive Management focus shifts to India Havells has signed a definitive agreement with Shanghai Feilo Accoustics to divest 80% stake in Sylvania for EUR149mn. Sylvania performance since acquisition uninspiring; divestment by Havells releases cash and management bandwidth. Raise estimates and TP on higher other income and revised multiple (30x) for standalone business; maintain Buy with a TP of INR340. Havells signs a definitive agreement to divest 80% stake in Sylvania for an equity value of EUR149m: Havells Holdings Limited (100% subsidiary of Havells) will sell its stake in Havells Malta while Havells Ltd. will sell its stake in Havells EXIM Limited to Shanghai Feilo Accoustics for EUR149mn, which corresponds to 80% of the stake sale to be received by February 2016 (the balance 20% in Havells Malta to be sold over the next five years). EV of the deal is EUR263m and implies an EV/EBITDA of 9.6x FY17E. Havells subsidiaries in the US, Chile, Thailand and Brazil are not part of the sale Chile subsidiary has been closed down while Thailand and Brazil would be sold depending on their profitability. Sylvania performance since acquisition uninspiring: Havells acquired Sylvania to have a global presence in the lighting market; however, given the weakness in European economy, the demand for Sylvania products remains muted; an adverse cost structure further hurt performance. Havells tried to turn around Sylvania performance by changing the top management and introducing restructuring plans like Phoenix (FY08-09) and Prakaram (FY10-11). However, operations have remained at breakeven levels; this, along with a shift globally toward LEDs, forced management to look for an exit from this business. Key takeaways from conference call with management: a) The four retained subsidiaries incurred a loss of EUR13mn in CY15 and the management intent is to turn around Brazil and Thailand, which would then be sold to Feilo (Chile has already been closed). There would be a loss of EUR12m-15m if not sold while a sale could fetch EUR8m. b) Brazil and Thailand are already at EBITDA breakeven on cost cutting measures and improvement in sales. c) Looking at acquisitions in the domestic market; the move complements Havells product portfolio, distribution and brand image. Valuation and view: Maintain Buy with a revised target price of INR340 We upgrade our standalone EPS by 13% to account for higher other income and share of profit from Sylvania (20% stake retained). We apply a 30x (28x earlier) multiple on our standalone EPS to get our target price of INR340. We assign zero value to subsidiaries. Ankur Sharma (Ankur.vsharma@MotilalOswal.com); Amit Shah (Amit.Shah@MotilalOswal.com); Investors are advised to refer through important disclosures made at the last page of the Research Report. Motilal Oswal research is available on Bloomberg, Thomson Reuters, Factset and S&P Capital.

2 Havells to divest 80% stake in Sylvania for an equity value of EUR149m (implied valuation of EUR186m for Sylvania) Havells has proposed to divest 80% stake in Havells Malta and Havells Exim at an equity value of EUR149m to Chinese company Shanghai Feilo Acoustics limited; this implies a valuation of EUR186m for Sylvania. Subsidiaries in the US, Chile, Brazil and Thailand would not be part of the transaction (~EUR11m loss in CY16). Shanghai Felio Accoustics would also take over the pension liabilities (EUR50m) and the net debt on the books of Sylvania (EUR27m), implying an EV of EUR263m and an EV/EBITDA of 9.6x for the deal. We note that Havells had bought Sylvania for an EV of EUR227mn in FY08 and has made an equity investment of INR9.8b in in the company over the last eight years. Havells will divest 80% of the stake in both the entities by February 2016 and the balance 20% in Havells Malta will be divested over the next five years, while Havells Exim s balance 20% stake would be divested by Havells will retain four units (Brazil, Chile, Thailand and the US), which had cumulative sales of INR4b (~12% of total sales of Sylvania) and reported net loss of INR1.3b in FY15. CY15 loss has declined to EUR13m. Brazil and Chile subsidiaries are already breaking even at the EBITDA level, driven by cost cuts and increased sales. Management aims to bring the subsidiaries back to profitability and sell them to Feilo. Shanghai Feilo amongst the top 10 lighting companies in China Feilo is amongst the top 10 lighting companies in China, with experience in largescale projects including Shanghai Tower and Beijing Olympic Park. The company is also the existing JV partner of Havells China venture. Felio is listed on Shanghai Stock Exchange with current market capitalization of ~USD2b. The estimated revenue for CY15 is ~EUR750 million, with EBDITA of ~EUR125m. Shanghai Felio Acoustics Ltd. is principally engaged in the manufacturing and distribution of lighting equipment. The company is involved in the manufacture and sale of light source electrical appliances, lighting products, the sale and engineering service of audio products and installation works of lighting equipment. Through its subsidiaries, the company is also engaged in the manufacture and sale of lighting electrical appliances, lamps, various pot light source products and automobile parts, electronic products and electrical engineering supplies, as well as the operation of securities business. Divestment of Sylvania stake to improve focus on better RoE generating business We believe that the Sylvania sale is positive for the company as it will improve focus on the domestic business, which is a higher RoE generating business than Sylvania, and free up the bandwidth of the top management which can now focus on the domestic business. The cash generated from the sale of Sylvania can be used to expand the domestic business by organic/inorganic route or be paid out as dividend to shareholders. 14 December

3 Exhibit 1: Havells investment in Sylvania over the last eight years Investments in Sylvania 7,154 7,751 7,751 8,516 9,809 5,314 1,616 2,677 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 Source: MOSL, Company Sylvania performance since the time of acquisition has not been very inspiring Havells acquired Sylvania in FY08 for an EV of EUR227m. EUR30m was a recourse debt from Havells, a pat of which was repaid by Havells by selling stake of EUR50m to Warbug Pincus. Over the past eight years, Havells has invested a total of EUR141mn(INR9.8b). Sylvania has net debt of EUR26.6 m on the balance sheet as of 2QFY16. Sylvania was acquired by Havells to have a global presence in the lighting segment. However, given the weakness in European economy, demand for Sylvania s products remains muted and the adverse cost structure didn t help performance either. Havells tried to turn around Sylvania s performance by taking steps like changing the top management and introducing restructuring plans like Phoenix in FY08-09 and Prakaram in FY10-11 to rationalize the cost structure. Post management s effort, Sylvania s performance was stable but remained muted. Revenue remained flat for the last five years and EBIDTA margin remained stable at 5% (excluding the unfunded pension liability). After adjusting for the pension liability and forex loss, Sylvania was able to break even at PAT level Exhibit 2: Net debt on the books of Sylvania (EUR m) Debt in Sylvania (m Euro) FY11 FY12 FY13 FY14 FY15 2QFY16 - Working Capital revolving facility Term loan New Debt raised Guaranteed debt by Havells India Secured facility by Sylvania Cash Net Debt Source: MOSL, Company 14 December

4 Exhibit 3: Brief snapshot of Sylvania s historical financial performance (EUR m) Y/E March FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 Net Sales Change (%) Raw material Staff cost Other Mfg exp EBITDA % of Net Sales Exceptional items Adjusted EBITDA Margin (%) Depreciation Interest Outflow Non-operating income PBT Tax-Total Tax Rate (%) - Total ,104-3 Extraordinary Income Extraordinary expenditure Reported Net Profit Adjusted PAT Growth (%) Source: MOSL, Company Valuation and view: Maintain Buy with a revised target price of INR340 Domestic revenue growth will be supported by consistent introduction of booster categories (like appliances, Reo switches, pumps, solar lighting and brand extensions). We expect return ratios to improve with the divestment of Sylvania and refocus on the core domestic business by the management. We maintain Buy with a revised price target of INR340. We value standalone business at 30x (versus 28x earlier). We believe that the premium valuations are justified, given (i) demonstrated track record of accelerating growth through new launches, (ii) robust dividend payout and (iii) robust return ratios. Key triggers A] Domestic: Near-term headwinds; long-term drivers intact While the muted revenue de-growth of 1% in 1HFY16 is largely a function of the constrained near-term environment and drop in commodity prices, we believe that long-term drivers remain intact. Havells is being re-positioned as a Household brand rather than a male-dominated brand. The key pillars of domestic growth strategy are given below: New product launches: Over the last few years, HAVL has consistently added new segments / product lines, which have become ~INR5b revenue categories. Its new product portfolios (i) Appliances (FY15, INR2b), (ii) Reo (INR1b), (iii) Pumps (INR0.2b) and (iv) Air Coolers have the potential to generate annual revenue of INR5b+. The consistent introduction of booster categories will support long-term growth. 14 December

5 Expanding channel reach, cementing relationships with dealers: HAVL is the #1 FMEG brand in India, but does not dominate any business segment (except MCBs). This is largely a part of its strategy centered on dealers (and not products). The attempt is to capture an increasing pie of the dealer s sales through product diversification, brand extensions and product innovation. With the launch of Reo switches, HAVL is expanding its distribution network to tier- 2/3 towns which it intends to leverage for most products. Galaxy stores contribute ~INR8.5b to revenue (20%+ of consumer sales) and HAVL is attempting to ramp up the outlets from 270 to 400 in 2-3 years. The Electrician Connect program now has a database of ~200k electricians, with 40-50% redeeming points. 14 December

6 Havells: Operating metrics Exhibit 4: Key operating metrics INR M FY10 FY11 FY12 FY13 FY14 FY15 FY16E FY17E Havells Standalone Revenues Swtichgear 6,941 7,344 8,962 10,781 12,192 12,790 13,174 15,150 Cables and wire 10,686 12,318 15,930 16,925 19,264 21,904 22,342 24,577 Consumer Durables 3,372 4,692 5,721 7,893 8,534 10,283 11,517 14,051 Lighting and Fixtures 3,569 4,447 5,544 6,652 7,207 7,410 7,706 8,669 Others Total 24,907 28,817 36,156 42,250 47,197 52,387 54,739 62,446 Revenue Growth (% YoY) Swtichgear Cables and wire Consumer Durables Lighting and Fixtures Total EBIT Swtichgear 2,611 2,719 3,234 3,653 4,032 4,390 5,006 5,643 Cables and wire ,259 1,540 2,110 2,657 3,016 3,134 Consumer Durables 1,019 1,295 1,610 1,978 2,304 2,580 2,799 3,653 Lighting and Fixtures ,318 1,568 1,787 1,969 1,811 2,341 Others Less: Unallocable Expense 2,324 2,451 3,239 3,883 4,012 4,957 5,305 4,787 Standalone EBIT 2,967 3,289 4,182 4,856 6,221 6,638 7,327 9,984 EBIT Margin (%) Swtichgear Cables and wire Consumer Durables Lighting and Fixtures Standalone EBIT (%) Consolidated EPS (INR/sh) Standalone Sylvania Total Source: MOSL, Company 14 December

7 Financials and valuations Income Statement (Consolidated) (INR Million) Y/E March E 2017E Net Sales 51,626 56,126 65,182 72,478 81,858 85,694 85,739 65,286 Change (%) Raw Materials 29,154 31,925 36,272 41,628 46,398 48,292 48,731 39,314 Staff Cost 7,602 6,405 7,904 9,054 10,869 11,875 10,323 4,556 Other Expenses 11,648 12,226 14,432 15,051 17,167 18,316 17,745 12,278 EBITDA 3,221 5,570 6,573 6,745 7,425 7,211 8,940 9,138 % of Net Sales Depreciation ,097 1,155 1,387 1,468 1,124 Interest ,281 1, Other Income ,937 PBT 1,627 4,101 4,757 4,695 5,941 5,689 7,911 9,901 Tax 932 1,031 1, ,478 1,836 2,367 2,868 Rate (%) Extra-ordinary Inc.(net) (2,935) (31) 0 1, Reported PAT -2,240 3,036 3,699 5,816 4,463 3,853 5,544 7,113 Change (%) nm nm Adjusted PAT 695 2,584 4,252 4,290 5,410 5,159 5,544 7,113 Change (%) Balance Sheet (Consolidated) (INR Million) Y/E March E 2017E Share Capital Reserves 3,690 5,914 8,932 13,797 16,036 17,557 23,205 26,666 Net Worth 4,002 6,537 9,556 14,420 16,660 18,180 23,830 27,290 Loans 10,664 11,065 9,795 9,785 10,506 4, Deffered Tax Liability Minority Interest Capital Employed 14,934 18,166 19,913 25,102 27,687 22,808 24,581 27,791 Gross Fixed Assets 26,963 28,454 27,577 30,054 32,075 30,298 16,261 17,261 Less: Depreciation 18,089 18,499 17,293 18,503 20,451 18,469 6,171 7,236 Net Fixed Assets 8,874 9,955 10,284 11,551 11,624 11,829 10,090 10,025 Capital WIP Goodwill 3,212 3,354 3,625 3,694 4,380 3, Curr. Assets 18,389 22,081 27,187 29,468 36,929 32,519 27,955 33,183 Inventory 8,246 10,860 13,678 13,184 14,934 13,663 7,340 8,290 Debtors 6,982 7,724 8,905 8,623 10,005 6,232 1,873 2,084 Cash & Bank Balance 1,481 1,779 2,336 4,736 8,819 7,775 17,012 20,959 Loans & Advances 1,578 1,206 1,682 2,052 2,114 1, Other Current Assets ,057 3, Current Liab. & Prov. 15,876 17,729 21,846 19,860 25,690 25,504 13,752 15,743 Creditors 6,147 6,637 6,953 9,026 9,988 8,338 4,549 5,312 Other Liabilities 9,408 9,898 12,816 8,761 12,684 13,645 5,467 5,905 Provisions 321 1,195 2,076 2,073 3,018 3,521 3,736 4,526 Net Current Assets 2,512 4,352 5,341 9,608 11,239 7,015 14,203 17,440 Application of Funds 14,934 18,166 19,913 25,102 27,687 22,808 24,581 27,791 E: MOSL Estimates 14 December

8 Financials and valuations Ratios Y/E March E 2017E Basic (INR) Adjusted EPS Growth (%) Cash EPS Book Value DPS Payout (incl. Div. Tax.) Valuation (x) P/E (consolidated) Cash P/E EV/EBITDA EV/Sales Price/Book Value Dividend Yield (%) Profitability Ratios (%) RoE RoCE Turnover Ratios Debtors (Days) Inventory (Days) Creditors. (Days) Asset Turnover (x) Leverage Ratio Debt/Equity (x) Cash Flow Statement (INR Million) Y/E March E 2017E PBT before EO Items 1,627 4,101 4,757 4,695 5,941 5,689 7,911 9,901 Add : Depreciation ,097 1,155 1,387 1,468 1,124 Interest ,281 1, Less : Direct Taxes Paid 932 1,031 1, ,891 1,836 2,367 2,868 (Inc)/Dec in WC 2,403-1, ,868 2,453 3,180 2, CF from Operations 4,806 3,234 5,498 4,744 8,399 9,058 9,316 8,998 EO Income -2, , CF from Oper. incl. EO Items 1,871 3,203 5,498 6,688 8,399 9,058 9,316 8,998 (Inc)/Dec in FA -1,205-1,799-1,691-1,950-1,424-1, ,098 Free Cash Flow 666 1,404 3,807 4,738 6,975 7,528 9,683 7,900 (Pur)/Sale of Investments CF from Investments ,941-1,961-2,020-2, ,947-1,098 (Inc)/Dec in Net Worth , (Inc)/Dec in Debt -1, , ,315-3,691 0 Less : Interest Paid ,281 1, Dividend Paid ,095 2,190 2,219 2,922 3,653 CF from Fin. Activity -2, ,979-2,270-2,206-9,372-4,026-3,953 Inc/Dec of Cash ,399 4,084-1,045 9,237 3,947 Add: Beginning Balance 2,473 1,481 1,779 2,336 4,736 8,819 7,775 17,012 Closing Balance 1,481 1,435 2,658 4,734 8,822 7,776 17,014 20,961 E: MOSL Estimates 14 December

9 CAPITAL GOODS INSIGHTS CAPITAL GOODS GALLERY Detailed Sector Updates Special Reports Initiating Coverage Spotlights 19 November 2015 Fulcrum (Capital Goods Insights) 6

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