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Voltas: Momentum intact!
Jan 31, 2006

Performance summary
Engineering services and air-conditioning major, Voltas has reported strong results for the third quarter and nine-month period ended December 2005. Robust performance of the company’s electro-mechanical and engineering projects & services divisions has led the growth in topline during the period under consideration. Operating margins have also recorded strong expansion during both 3QFY06 and 9mFY06.

Financial performance: A snapshot…
(Rs m) 3QFY05 3QFY06 Change 9mFY05 9mFY06 Change
Sales 2,986 4,471 49.7% 9,417 13,787 46.4%
Expenditure 2,932 4,217 43.8% 9,171 13,031 42.1%
Operating profit (EBDITA) 54 254 371.4% 247 756 206.7%
Operating profit margin (%) 1.8% 5.7%   2.6% 5.5%  
Other income 60 48 -21.0% 177 157 -11.5%
Interest 14 15 9.2% 37 27 -27.4%
Depreciation 26 22 -14.5% 80 75 -7.1%
Profit before tax 74 264 255.2% 306 812 164.8%
Extraordinary income/(expense) 9 (114)   39 (266)  
Tax 8 37 390.7% 70 78 11.6%
Profit after tax/(loss) 76 114 49.5% 276 468 69.5%
Net profit margin (%) 2.5% 2.5%   2.9% 3.4%  
No. of shares 33.1 33.1   33.1 33.1  
Diluted earnings per share* (Rs)         21.0  
P/E ratio* (x)         32.0  
* On a trailing 12-months basis            

What is the company’s business?
Voltas is a major player in the electro-mechanical engineering segment, which involves all aspects of construction of infrastructure like electricals and air conditioning barring the civil structure. The company also has presence in manufacturing of forklifts, textile auxiliary, agro-chemicals and trading of chemicals. On the unitary division front, the company has presence in commercial refrigerators and visi-coolers. Voltas has a joint venture with Fedders of the US for manufacturing of air conditioners. During the period FY00 to FY05, Voltas’ revenues and net profits have grown at compounded rates of 14% and 56% respectively.

What has driven performance in 2QFY06?

EMPS leads them all: The Electro-Mechanical Projects & Services (EMPS) division of Voltas continues to lead the company’s overall topline growth in 3QFY06 as well. With the division’s revenues growing by 61% YoY during 3QFY06 and its contribution to total business increasing to 65% (60% in 3QFY05), we see a greater stability in Voltas’ overall performance going forward vis-à-vis the wide variances that used to be the case a few quarters back. The company is witnessing stellar growth in the Middle East region (especially in Morocco and Libya) where a lot of investments are taking place in infrastructure development. Going forward, apart from the Middle East boom, we anticipate the Indian infrastructure story (led by airport modernisation) to provide Voltas a way to diversify its EMPS revenue base much wider. However, the international business shall continue to be a major driver for topline.

At the end of December 2005, the company’s order backlog from the EMPS division stood at Rs 14.1 bn, up 12% over the backlog of Rs 12.6 bn recorded at the end of 3QFY05. Out of the current backlog, while 36% is accounted for by the domestic orders, the remaining is from international contracts (including the Hyderabad International airport project, which Voltas has taken up through its international arm).

Segment-wise performance…
  3QFY05 3QFY06 Change 9mFY05 9mFY06 Change
Electro-Mechanical Projects & Services (EMPS)
Revenue 1,808 2,906 60.8% 4,888 8,351 70.9%
% share 60.3% 64.9%   51.8% 60.5%  
PBIT margin 7.1% 7.0%   5.9% 6.6%  
Engineering Products & Services (EPS)
Revenue 382 687 80.1% 1,079 1,738 61.0%
% share 12.7% 15.4%   11.4% 12.6%  
PBIT margin 27.3% 24.7%   25.3% 27.2%  
Unitary Cooling Products (UCP)
Revenue 652 720 10.4% 3,067 3,326 8.4%
% share 21.8% 16.1%   32.5% 24.1%  
PBIT margin -7.8% -0.6%   -1.1% -0.7%  
Others  
Revenue 154 164 6.5% 405 392 -3.2%
% share 5.2% 3.7%   4.3% 2.8%  
PBIT margin -0.6% 19.3%   12.0% 20.7%  
Total*
Revenue 2,995 4,478 49.5% 9,439 13,806 46.3%
PBIT margin 6.0% 8.9%   6.1% 7.8%  
* Excluding inter-segment adjustments            
* Excluding inter-segment adjustments

The company’s Engineering Products Services division (EPS) has also recorded a robust performance during 3QFY06, with revenues growing by 80% YoY. This has seemingly been on the back of increasing demand from the textile, mining and engineering sectors, which are the major customers of Voltas EPS solutions. Considering the large-scale capex plans of Indian companies in these sectors, we believe that maintaining strong rate of growth shall not be a problem for Voltas. Higher EPS revenues will also aid the overall margin expansion.

The third major division of Voltas i.e., unitary cooling products division, recorded a 10% YoY growth in revenues during the quarter (6% YoY in 2QFY06). While the company continues to do well on the air-conditioning part (led by factors like affordable prices, easy availability of low cost finance, higher disposable income and the urge for better living), the refrigerator division has ailed growth in the past few quarters. This has been due to substantial demand-supply mismatch in the domestic refrigerator market and consequently falling realisations.

The company has offered VRS to the entire workforce at the Hyderabad plant, thus incurring a total cost of Rs 650 m. Out of this, Voltas accounted for Rs 488 m in 3QFY06, thus fully writing off the VRS charge by the end of the quarter. We believe that the reduction in operation at the Hyderabad plant and the consequent decline in employee costs will aid Voltas’ overall margins for the unitary division going forward.

Now, in lieu of the closure of the Hyderabad plant, and in anticipation of higher demand going forward, the company will be setting up a green field unit for manufacture of A/Cs and air coolers in Uttaranchal. By setting up these units in Uttaranchal, Voltas can take advantages of relatively lower employee costs and tax benefits. Total capex for the Uttaranchal venture will be Rs 1.2 bn, spread over a period of three years (FY06-FY08).

Lower staff and other costs aid margins: Despite a strong rise in raw material costs (from 67% of 3QFY05 sales to 75% of sales in 3QFY06), Voltas has reported a tripling of operating margins during 3QFY06. This expansion has mainly been on the back of stock adjustments and decline in staff and other costs.

Based on segments, while PBIT margins of EMPS and EPS divisions contracted marginally on a YoY basis, those for the UCP and other businesses recorded a strong expansion, thereby helping the company to increase its overall PBIT margins. Margins have, however, expanded for all the segments if one were to consider the 9mFY06 performance (see table above). As we have mentioned in the past, the rising revenue contribution of the EPS segment has once again proved beneficial for Volta’s overall margin improvement. With just about 13% share in total revenues during 9mFY06, this division’s PBIT was around 44% of the total PBIT during the said period. While these margins are not sustainable over a long period of time, we believe that the company will be able to maintain the EPS margins at the 35% levels going forward.

Extraordinary impact on bottomline: Despite strong expansion in operating margins and consequently operating profits, a lower other income, extraordinary expenses owing to write off of VRS costs and higher effective tax rates have somewhat pared Voltas’ bottomline growth during 3QFY06. Voltas’ effective tax rate increased from 10.1% in 3QFY05 to 13.9% in 3QFY06, on the back of tax shelter being used up at one of its units. On this basis, the company expects its tax rate to increase further in FY07.

What to expect?
At the current price of Rs 671, the stock is trading at a price to earnings multiple of 13.6 times our estimated FY08 earnings. We derive confidence from Voltas’ growth prospects in the future, mainly from its international ventures. Based on the nine-month performance, we shall have to upgrade our numbers for the company.

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