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Voltas: Extraordinary benefits
Jan 23, 2007

Performance summary
Engineering services and air-conditioning major, Voltas, has reported lacklustre results for the third quarter and nine-months ended December 2006. For 3QFY07, while topline has grown by 31% YoY, bottomline growth has outperformed the same, mainly on the back of higher other income and an extraordinary income during the quarter. Excluding extraordinary adjustments from 3QFY07 numbers, the bottomline has actually declined by 20% YoY. The performance has been similar for 9mFY07, where topline and bottomline have grown by 25% YoY and 42% YoY respectively, the latter getting inflated due to one time items. The topline growth during 3QFY07 has been largely a result of strong performance from the company’s EPS business, which has reported sales growth of 76% YoY. Operating margins have been under pressure for both the periods, largely due to stock related adjustments and higher staff costs.

Financial performance snapshot
(Rs m) 3QFY06 3QFY07 Change 9mFY06 9mFY07 Change
Sales 4,353 5,689 30.7% 13,392 16,792 25.4%
Expenditure 4,099 5,414 32.1% 12,686 16,052 26.5%
Operating profit (EBDITA) 254 275 8.4% 707 740 4.8%
Operating profit margin (%) 5.8% 4.8%   5.3% 4.4%  
Other income 48 85 78.7% 207 340 64.8%
Interest 15 14 -11.0% 27 32 19.0%
Depreciation 22 29 33.0% 75 93 24.9%
Profit before tax 264 317 20.2% 812 955 17.7%
Extraordinary income/(expense) (114) 13 - (266) 23 -
Tax 37 136 269.0% 78 316 304.6%
Profit after tax/(loss) 114 194 71.0% 468 662 41.5%
Net profit margin (%) 2.6% 3.4%   3.5% 3.9%  
No. of shares       33.1 330.9  
Diluted earnings per share (Rs)*         2.7  
P/E ratio (x)*         37.9  
* On a trailing 12-months basis            

What has driven performance in 3QFY07?
EMPS and EPS lead the way: Voltas’ EPS business was once again the topline driver for the company. For 3QFY07, the segment reported a strong 76% YoY growth in turnover, consequently increasing its contribution to the company’s total revenues to 21% (15% in 3QFY06). Within this business, it was the materials handling and mining & construction sub-segments that grew the most. While the former recorded 108% YoY growth during 3QFY07, the latter grew sales at 84% YoY. The textile machinery segment of the EPS business grew at 24% YoY.

The EMPS business, which is the largest revenue generator for Voltas (62% of total sales), grew by 23% YoY during 3QFY07. This growth was far superior compared to what was recorded during the first two quarters of this fiscal. The management has outlined the fact that the company has begun execution of some of its large international assignments (which it won in 4QFY06), and the result of the same was visible in 3QFY07 performance of the EMPS segment. At the end of the quarter, the order backlog of this segment stood at Rs 24.3 bn (72% YoY growth), almost 1.9 times the segment’s FY06 revenues. Out of the total backlog, around 67% is formed of international projects with the remaining coming from domestic orders.

In its UCP business, Voltas has reported sales growth of 26% YoY during the quarter. The management has indicated that strong growth for the UCP business is on the back of a 39% YoY growth in air conditioner volumes sales, and 54% YoY growth in the water coolers and dispensers segment.

Segment-wise performance
  3QFY06 3QFY07 Change 9mFY06 9mFY07 Change
Electro-Mechanical Projects & Services (EMPS)
Revenue 2,905 3,576 23.1% 8,349 9,254 10.8%
% share 64.9% 61.5%   60.7% 53.7%  
PBIT margin 7.0% 5.1%   6.6% 4.8%  
Engineering Products & Services (EPS)
Revenue 687 1,210 76.1% 1,689 3,050 80.6%
% share 15.4% 20.8%   12.3% 17.7%  
PBIT margin 24.7% 20.6%   28.0% 23.1%  
Unitary Cooling Products (UCP)
Revenue 721 909 26.0% 3,315 4,569 37.8%
% share 16.1% 15.6%   24.1% 26.5%  
PBIT margin -0.6% -3.1%   -0.8% 0.2%  
Others
Revenue 164 123 -25.1% 391 361 -7.8%
% share 3.7% 2.1%   2.8% 2.1%  
PBIT margin 19.3% 34.5%   20.7% 17.8%  
Total*
Revenue 4,478 5,819 29.9% 13,744 17,234 25.4%
PBIT margin 8.9% 7.7%   7.9% 7.1%  
* Excluding inter-segment adjustments

Stock adjustments, higher staff costs dent margins: Voltas’ operating margins contracted by 100 basis points (1%) during 3QFY07. This was mainly due to higher staff costs and stock related adjustments. Raw material costs, however, declined from 77% of sales in 3QFY06 to 74.2% in 3QFY07. The profitability performances of the EMPS and EPS divisions deteriorated further. For the former, the negative impact on margins was due to the fact that the company starts booking profitability from international assignments only after completion of 10% of the project, and since some high value projects in the Middle East are still in their initial stages, the profitability of the EMPS business has been impacted.

As for the EPS business, the impact on margins was due to the fact that Voltas recorded relatively stronger growth in off-take of its own manufactured products (materials handling and mining & construction equipments), which command lower margins vis-ŕ-vis traded equipments (like textile machinery). The pressure on UCP margins was mainly inflicted by higher cost of raw materials like steel, aluminium and plastic.

Extraordinary impact on bottomline: The 71% YoY growth in Voltas’ 3QFY07 bottomline was mainly a result of a lower base, as the company had booked large one-off expenses in 3QFY06, owing to the closure of the Hyderabad unit and corresponding VRS expenses. Adjusted for these extraordinary items, the net profits have actually declined by 20% YoY during 3QFY07. Also, the effective tax rate for the company increased from 13.9% in 3QFY06 to 42.8% in 3QFY07. This was due to the fact that the company has moved from paying minimum alternate tax (MAT) to normal corporate taxes.

What to expect?
At the current price of Rs 103, the stock is trading at a multiple of 13.6 times our estimated FY09 earnings. We expect the EMPS business to record better growth in the subsequent quarters, as revenues and profits start flowing in from the large contracts that Voltas has started executing in the Middle East. We also believe that the expansion at Uttaranchal shall stand the company in good stead with respect to lowering its employee expenses and availing of tax benefits, which shall contribute to the improvement in overall profitability. As for the EPS business, continued strong momentum in the infrastructure, manufacturing and mining space shall aid the growth prospects of the company going forward. However, our concerns remain with respect to execution risks in international contracts and people management issues, especially when we are seen increasing employee turnover in the domestic engineering space. Overall, we maintain our positive view on the stock.

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