VOLTAS LTD PRICE: RS.154 RESULT UPDATE. Numbers are ahead of expectations on account of all-round margin expansion.

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1 RESULT UPDATE Sanjeev Zarbade VOLTAS LTD PRICE: RS.154 RECOMMENDATION: BUY TARGET PRICE: RS.185 FY10E P/E: 15.8X Numbers are ahead of expectations on account of all-round margin expansion. Order backlog is down 22% yoy to Rs 43 bn providing 17 months of revenue visibility for the projects segment. Revised earnings upwards in view of better than expected numbers. Upgrade to BUY with a target price of Rs 185 (earlier Rs 165) Summary table (Rs mn) FY10E FY11E Sales 43,259 50,882 60,643 Growth (%) EBITDA EBITDA margin (%) Net profit (adj) Net cash (debt) EPS (Rs) Growth (%) CEPS DPS (Rs) ROE (%) ROCE (%) EV/Sales (x) EV/EBITDA (x) P/E (x) P/Cash Earnings P/BV (x) , Kotak Securities - Private Client Research Quarterly performance (Rs mn) FY10 YoY (%) H1FY10 H1 YoY (%) Sales Turnover Operating other income Total Operating Expenditure Raw Material costs Purchase of traded goods Staff costs Other expenditure EBITDA Interest Other income Gross Profit Depreciation PBT Tax Adjusted PAT extraordinary items minority interest Reported PAT EPS (Rs) EBITDA (%) Raw material to sales (%) Other exp to sales (%) Staff costs to sales (%) Tax rate (%) Cons Segment Revenues (Rs mn) FY10 % change Electromechanical projects Engg products and services Unitary cooling Kotak Securities - Private Client Research Please see the disclaimer on the last page For Private Circulation 14

2 Electromechanical Projects Segment Revenue booking has maintained momentum in the Electromechanical projects business, which has been the main driver of revenue growth. During the quarter, liquidity crunch among the real estate developers in India and abroad has eased which may have helped in putting several delayed projects back on track. Electro Mechanical Projects and Services, the core business of the Company comprises 63% of the total turnover and reflects a growth of 22% over the corresponding quarter last year. About 70-75% of the segment turnover comes from International Operations. Voltas is looking at the new markets of Saudi Arabia, Kuwait and South Africa. While Saudi market is large and is dominated by few large contractors. However, the market is not as transparent and clean as the Dubai and Abu Dhabi market and Voltas is taking a cautious approach towards tapping this country. Voltas does not see major activity in the Libyan market. The company has plans to take small orders in Saudi and later on graduate to larger ones. Engineering Products Business The engineering products business posted a degrowth of 28% yoy during the quarter. This segment includes commission income on sale of textile machinery for LMW and material handling equipments like forklifts, dumptrucks etc. The degrowth is mainly on account of slow offtake from construction mining and textile machinery divisions. Especially the textile machinery business (commission business) has been badly hit by reduced demand from the US and firm domestic interest rates. As a result, the share of commission revenues in this segment may have fallen thus affecting the profit margins. In the engineering services segment, Voltas also manufactures and markets low and medium-priced material handling equipment under its own brand and also distributes high-end equipment imported from Hitachi and BT Industries, a Swedish firm. Material handling Equipment business is also going through a lean phase. Unitary Cooling Business The unitary cooling sales were up 27% yoy and has being mainly driven by the Split Air Conditioners. Voltas has been consolidating its market share in the room AC business. In, in Room Air Conditioners, Voltas' registered sales growth of 7% against the market growth of 6% and increased its overall market share to 16.5%. This was possible due to innovative product offerings based on energy efficiency and expansion in reach. EBITDA margins expanded 230 bps yoy. Margins expanded 230 bps in FY10 to 11.1%. Raw material to sales ratio has declined as the management indicated that low cost inventory accumulated during the fourth quarter of was responsible in delivering low material costs. Segment margins in engineering services division expanded expectedly due to lower material costs and tight control over overheads. The consumer durables (unitary cooling) business margins improved 420 bps to 8.8% compared to 4.2% in and 10.5% in FY10. We believe lower material costs and price hikes on a combined basis could have yielded margin expansion. The costs in this business have been well controlled and in fact the manpower engagement has been coming down further Kotak Securities - Private Client Research Please see the disclaimer on the last page For Private Circulation 15

3 Segment Margins (%) FY10 FY10 Electromechanical projects Engg products and services Unitary cooling Total Capital engagement has reduced on inventory liquidation in Unitary cooling division On account of the substantial client advances, Voltas's electromechanical projects business has been working on a very lean working capital. The unitary cooling's capital employed as reduced sharply as the company was saddled with excess inventory in the corresponding quarter of the previous year. Capital Employed (Rs mn) FY10 Electromechanical projects Engg products and services Unitary cooling Order backlog is down 22% yoy Order backlog at Rs 43 bn is down 22% yoy. Order book provides revenue visibility of 17 months of trailing four quarter Projects segment revenues. We believe degrowth in order backlog could be mainly due to slowdown in international order bookings. The management is optimistic of having adequate cover by the end of the current year to take care of the growth in turnover for FY11. Also, it has indicated that the order inquiries have not been as vibrant as was expected. Order book (Rs bn) Q3 Q4 Q3 Q4 FY10 FY10 Kotak Securities - Private Client Research Please see the disclaimer on the last page For Private Circulation 16

4 The Company has a number of inquiries including from Saudi Arabia for new business and the business managers are confident of further order booking. In the middle East, which is one of the major market regions for the company, there is likely to be significant Government backed investments in Abu Dhabi, Qatar and Saudi Arabia giving a boost to their economies Future Prospects We project 18% growth in revenues in FY11 mainly led by the engineering products and services business and consumer durables segment. We expect revenue growth in the engineering services segment to gain momentum on the back of ongoing industrial recovery gaining strength in FY11. Consumer durables business should benefit from overall improvement in real estate growth and improved personal incomes (especially the PSU employees). Earnings Revision FY10 Earlier Revised Revenue Rs mn EBITDA % 7.80% 9.2% EPS Es % change 13.1% Source: Kotak Securities - Private Client Research Crude prices have risen to around USD 81 per barrel and this should auger well for the Middle East region which is the main source of overseas business for Voltas. Suitable acquisition in Water Treatment segment could be a possibility Voltas has been adding new business verticals. Through Rohini Electricals it is now undertaking electrical projects for industrial and power sector. Voltas is looking at adding new verticals including water treatment projects. The company is currently handicapped due to lack of membrane technology in water treatment. It is looking at suitable acquisitions in this area. Valuation and Target price raised to Rs 185 Voltas is currently trading at 15.8x and 13.3x FY 10 and FY11 earnings and 9.5x on a EV/EBITDA basis. Based on WACC of 14% and terminal growth rate of 4%, we arrive at a DCF value of Rs 185 based on FY11 numbers. At this price, the stock gets valued at 16x FY11 earnings. Voltas has traded in a PE band of 5x to 40x between FY04-FY10. The average PEx for the stock in the past four years has been 20x. The Voltas stock is trading well below its upper band of PEx however, further rerating of the stock would depend on pace of new order flows. Kotak Securities - Private Client Research Please see the disclaimer on the last page For Private Circulation 17

5 We now recommend to BUY on Volta with a price target of Rs.185 Upgrade to BUY on Adequate upside of 20% in target price from current levels. As the economic outlook has improved across the globe, enquiries have started trickling in from the Middle East. The company is debt free and cash surplus of Rs 4.0 bn, which it can utilize to undertake synergistic acquisitions. Voltas has been adding new business verticals. Through Rohini Electricals it is now undertaking electrical projects for industrial and power sector. Voltas is looking at adding new verticals including water treatment projects. The company is currently handicapped due to lack of membrane technology in water treatment. It is looking at suitable acquisitions in this area. PE band x 10x 15x 20x voltas Apr-02 Oct-02 Apr-03 Oct-03 Apr-04 Oct-04 Apr-05 Oct-05 Apr-06 Oct-06 Apr-07 Oct-07 Apr-08 Oct-08 Apr-09 Oct-09 Source: Capitaline, Kotak Securities - Private Client Research Kotak Securities - Private Client Research Please see the disclaimer on the last page For Private Circulation 18