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[Lavanay]

Havells India Ltd (Havells) is a leading player in the fast growing electrical products segment of cables & wires, switchgears, fans, lighting and lighting fixtures. It acquired Sylvania (Germany) to further expand its presence in the global market and lower dependence on growing competition in India.

Performance
Havells India Ltd.’s (Havells) Q3FY08 results were above expectations as a result of improvement in profitability at Sylvania. Havells’ standalone performance was better than expected despite margin contraction in cables & wires (C&W).

Sylvania’s performance boosts profits

Sylvania returned to profitability with a 12% growth in net sales to Rs8bn and a 187bps expansion in OPM to 6%. This helped Sylvania report net profits of Rs75mn vis-a-vis a net loss of Rs60mn in Q2FY08.

Profitability for 9MFY08 was impacted due to high tax rates emanating from its varied geographical presence globally. This situation is unlikely to ease in the near term. A rationalisation of its supply chain should enable it to expand OPM by 100bps to ~7-7.5% over the next 2-3 years. Sylvania will also enable Havells to channel its exports of lighting products to the fast growing Latin American market as well as shift sourcing from other
Asian regions to Havells. These integration benefits should start flowing in by FY09.

Outsourcing ramping up

Havells has commenced outsourcing of CFLs to Sylvania in EU during Q3FY08 with revenues of ~Rs180-200mn in Q3FY08. This should ramp up steadily as Sylvania increasingly shifts sourcing of CFLs from China/South Asia to India. Havells is also diversifying its product portfolio from C&W and switchgears to high HP motors and power capacitors.


QIP to help lower debt burden

Havells is diluting equity through issue of 4.16mn shares at Rs625/share and 2.6mn warrants at Rs690/share by May’09. This will result in a 12.2% dilution of equity to Rs292mn. These funds totaling ~Rs4.3bn (initial inflow of Rs2.8bn), have been utilised for repayment of bridge debt of ~Euro50mn, which is with recourse to Havells. The balance debt is with recourse to Sylvania and will be repaid over the next 4-5 years.

OUTLOOK

We remain bullish on Havells’ prospects in light of declining debt levels and increasing integration benefits to be garnered over the next 2-3 years. Further, its foray into motors and capacitors will enable it to diversify its mix. We have revised our estimates upward to factor in buoyancy in its product segments arising from industrial and retail expansion. We expect net sales of Rs49bn in FY08, which should increase 22% in FY09 to Rs60bn and 20% in FY10 to Rs72bn. OPM will be lower in FY08 at 7.5% due to consolidation with
Sylvania and should expand by 81bps to 8.3% in FY09 and by 27bps to 8.6% in FY10. Net profits should be Rs1.8bn in FY08, Rs2.7bn in FY09 and Rs3.5bn in FY10. We have not factored in amortisation of goodwill arising from the acquisition as we do not have clarity on the treatment under global accounting norms.

VALUATIONS

The CMP of Rs565 discounts FY10E EPS of Rs46.7 by 9.5x and the stock trades at an EV/ EBIDTA of 6.1x FY10 estimates. We believe valuations do not factor in buoyant performance in domestic market, improvement in Sylvania’s performance and scope for outsourcing. With commencement of outsourcing via shift in sourcing base from China/South Asia has commenced, a significant ramp up in the same should accrue over the next couple of
years. Thus, we revise our recommendation upward to ‘BUY’ with a 12-month price target of Rs650.