Consumer Durables – one of the safest bet for medium to long-term investment amidst market uncertainties

The Indian electrical and appliances market is expected to reach ~$21bn by 2020 according to the India Brand Equity Foundation (IBEF). The market is a play on improving discretionary spending with favourable lifestyle changes in urban centres, new housing construction and reducing replacement cycles being some of the key drivers of a business. Opportunity size for consumer durables is immense given low penetration, increasing affordability (accelerating per capita income, availability of consumer finance), demographics, urbanization, and last-mile electrification.

India is in a sweet spot as far as consumption demand is concerned for the following reasons-

  • The size of India’s population
  • Favourable demographics
  • Rising middle-class incomes

We believe, governments’ big push to ‘Housing for All’ will build on changes in lifestyle – more independent & self-sufficient living, rise in reach & availability of electricity and expansion in the product line which should only add to an already firm secular demand trend.

Havells India – Well positioned to benefit from industry consolidation

In our opinion, Havells is well poised for achieving robust growth, supported by:

  • Strong brand positioning
  • High focus on dealer/distributor network expansion
  • Consistent new launches
  • Market share gain with margin expansion, and
  • Huge potential in Lloyd’s business.

We forecast Havells to report more than 100% YoY jump in reported PAT in Q4FY18 which is likely to be driven by improving demand dynamics. We are cognizant of the fact that Q4FY17 reported PAT included onetime expenditure of INR 768 million which was recognised by company as an impairment loss on its investments in Havells Holdings Ltd and on account of termination of JV agreement in Jiangsu Havells Sylvania Lighting company. On adjusted PAT basis, the jump in profit is likely to be in the range of 25-30% in Q4FY18. In our opinion, Havells is strongly positioned to benefit from industry consolidation and rising premiumisation with significant scope for ramp up in profitability. The operating margins are also likely to improve owing to cost-controlling measures undertaken by the company. Strong earnings growth, healthy return ratios and cash flows as well as superior brand positioning are some of the key factors supporting the premium valuation of Havells.

We are of the opinion that Havells is a very compelling investment opportunity for medium to long-term. Various factors that we believe make Havells an attractive wealth creator stock are as follows:

  • Branching out into the consumer space – Over the past four decades, Havells has transformed itself from an industrial switchgears company into a full-fledged consumer electricals firm. Since 1958 through trading of industrial switchgears, the company acquired several companies and collaborated & pursued Greenfield expansion to add consumer-based electrical household products. Havells manufactures consumer as well as industrial electricals products. Consumer products include switches, domestic switchgears, wires, fans, lighting & fixtures, water heaters, air coolers and residential pumps & motors. Industrial include switchgears, cables and industrial motors.
  • Newly acquired consumer durable segment to drive growth – Post divestment of Sylvania in FY16, Havells was scouting for an acquisition in the consumer durable space. Through this acquisition, Havells marked its foray into consumer durables industry which is currently estimated at $15bn and growing in double digits with low penetration levels, increasing urbanization, aspirational and expanding middle class. With Havell’s pedigree, we expect the company to start delivering improved performance on near term basis. This acquisition has also helped Havells to get access to LEEL’s 10,000 touch points and ~500 service centres across India (largely tier II, III cities).
  • Expansion in Tier II and Tier III cities – The company has a strong dealer and distribution network across the country (~7600 dealers in +40 countries). The company believes the next leg of growth will be from small towns, as aspirations rise due to increasing income levels. The company is gradually expanding the network to tier II & III cities where demand for lifestyle products is rising with higher income levels. It has a direct presence in towns with a population of >0.5m and has reached most towns with population between 50,000-0.5mn. About 50% of 1,200 towns in India have a population of below 50,000 where the company has an indirect presence. It is working to cover these small towns under its direct dealership.
  • GST to support organised players – We believe that consumer durable companies will be the key beneficiaries of the government’s important reforms like implementation of GST. The lower indirect tax rate for electrical and consumer durables along with the benefit of input tax credit have resulted in price cuts across segments (except cables prices increased in the wake of higher copper prices). Also, GST has created a level playing field for organised players that would result in higher volume growth in medium term. Further, the company has created a strong brand in electrical consumer products in India, which was traditionally a low involvement product category.
  • Demand recovery in Industrial segment – Havells switchgear (High margin business – ~40%) segment recorded revenue CAGR of ~11% in FY11-17 largely due to new product launch, a gradual shift in branded product categories and sustained demand from rural markets. This has helped the company to increase its market share aggressively from 15% in 2006 to 28% in FY17. We are of the opinion that the recovery in demand for industrial products led by higher government spending for power infrastructure improvement would lead to healthy growth in the segment.

To conclude, we expect Havells to record PAT CAGR of ~27% in FY17-20E supported by a change in product mix and revival in industrial and consumer products (led by an acquisition of Lloyd’s CD business). Scalability through acquisition coupled with the launch of premium products into the domestic market would negate the impact of higher commodity prices.

In our view, Havells is a one of the best investment opportunity in Consumer Durables segment with a medium to longer term perspective supported by strong earnings growth, healthy return ratios and superior brand positioning.

Disclaimers:

  1. The following article should not be construed as the Investment Recommendation.
  2. It is safe to assume that this opportunity could be a part of the portfolio recommended to our paid customers.
  3. Most importantly, since we design personalized portfolio as per your risk profile, this investment opportunity may or may not be a part of your portfolio.