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Voltas: Extraordinary impact on bottomline

May 15, 2007

Performance summary
Engineering services and air-conditioning major, Voltas, has reported strong results for the fourth quarter and full year ended March 2007. For FY07, while standalone topline has grown by 30% YoY, on the back of substantially higher other income and extraordinary inflows, the bottomline has skyrocketed to a growth of 164% YoY. Excluding extraordinaries, the standalone bottomline growth stands at 22% YoY. What is, however, disappointing is that the company’s standalone operating margins have contracted by 90 basis points (0.9%) to 4.5% in FY07, mainly due to stock-related adjustments and higher staff costs. Against our estimates, Voltas’ FY07 topline and bottomline is lower by 5% and 6% respectively, the latter owing to lower than expected operating margins during the fiscal. The board has recommended a dividend of Re 1 per share (dividend yield of 1%).

Financial performance snapshot
  Standalone Consolidated
(Rs m) 4QFY06 4QFY07 Change FY06 FY07 Change FY06 FY07 Change
Sales 5,139 7,214 40.4% 18,531 24,006 29.5% 19,544 25,267 29.3%
Expenditure 4,838 6,867 41.9% 17,524 22,919 30.8% 18,427 23,988 30.2%
Operating profit (EBDITA) 301 347 15.3% 1,007 1,087 7.9% 1,118 1,280 14.5%
Operating profit margin (%) 5.9% 4.8%   5.4% 4.5%   5.7% 5.1%  
Other income 90 243 169.9% 296 583 96.7% 281 622 121.2%
Interest (13) (37)   14 (5)   36 18 -50.1%
Depreciation 36 30 -17.4% 111 123 11.1% 141 156 10.5%
Profit before tax 367 596 62.3% 1,179 1,551 31.6% 1,222 1,728 41.4%
Extraordinary income/(expense) 4 655 - (262) 677 - (262) 696 -
Tax 134 52 -61.5% 212 368 73.3% 224 407 82.2%
Profit after tax/(loss) 237 1,199 405.3% 705 1,861 164.0% 737 2,017 173.8%
Net profit margin (%) 4.6% 16.6%   3.8% 7.8%   3.8% 8.0%  
No. of shares               330.9  
Diluted earnings per share (Rs)               6.1  
P/E ratio (x)               15.9  

What has driven performance in FY07?
EPS continues to show the way: Voltas’ EPS business was once again the topline driver for the company, as it grew sales by 52% YoY and 71% YoY during 4QFY07 and FY07 respectively. As reported by the management, it was the materials handling and mining & construction sub-segments that grew the most (the former recorded a growth of 62% YoY during FY07). The textile machinery segment of the EPS business grew at 52% YoY.

The EMPS business (57% of standalone sales), grew by 21% YoY during FY07. This growth was mainly on account of a superior performance from the segment during the third and fourth quarters of the fiscal, as the first two quarters were lacklustre. The management has outlined 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 performance of the EMPS segment, which reported sales growth of 50% YoY in 4QFY07. At the end of the quarter, the order backlog of this segment stood at Rs 21.9 bn (18% YoY growth). Out of the total backlog, around 73% is formed of international projects with the remaining coming from domestic orders.

In its UCP business, Voltas reported sales growth of 30% YoY during FY07, contributed both by higher volume sales and price increases. This growth of the UCP business was on the back of 30% YoY growth in air conditioner volumes sales, and 34% YoY growth in the water coolers and dispensers segment. As reported by the management, Voltas’ Pantnagar (Uttaranchal) plant has started operations at full capacity. The company is also said to have made some changes to its strategy on the USP business, where it plans to focus on prices and not volumes. A hint of the same was seen in 4QFY07, wherein Voltas raised prices of some of its consumer products while managing to maintain its market share.

Segment-wise performance
  4QFY06 4QFY07 Change FY06 FY07 Change
Electro-Mechanical Projects & Services (EMPS)            
Revenue 2,952 4,432 50.1% 11,327 13,708 21.0%
% share 56.8% 61.0%   61.0% 56.7%  
PBIT margin 4.9% 5.7%   6.2% 5.2%  
Engineering Products & Services (EPS)            
Revenue 840 1,275 51.8% 2,528 4,325 71.1%
% share 16.1% 17.5%   13.6% 17.9%  
PBIT margin 26.9% 23.4%   27.6% 23.2%  
Unitary Cooling Products (UCP)            
Revenue 1,408 1,557 10.6% 4,723 6,126 29.7%
% share 27.1% 21.4%   25.4% 25.4%  
PBIT margin 1.0% 5.7%   -0.2% 1.6%  
Revenue 5,199 7,263 39.7% 18,578 24,159 30.0%
PBIT margin 7.4% 8.8%   7.5% 7.5%  
* Excluding ‘Others’ and inter-segment adjustments

Stock adjustments, higher staff costs dent margins: The pressure does to seem to get off of Voltas profitability, as the company reported yet another quarter of margin dilution. During 4QFY07, Voltas’ operating margins contracted by 110 basis points (1.1%). For FY07, the contraction on a YoY basis was 0.9%. Pressure on margins was mainly due to higher staff costs and stock related adjustments. The management has indicated of giving a 15% wage hike to its domestic employees during 4QFY07, thus leading to higher staff costs. Also, there was an increase in the number of contract employees, which added to the overall wage burden on the company. As a consequence, Voltas’ staff costs increased from 9.5% of sales in FY06 to 10% in FY07. Raw material costs, however, declined from 77.4% of sales in FY06 to 76.6% in FY07.

Based on segments, both the EMPS and EPS divisions recorded relatively subdued profitability performance during FY07. 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 was the case in the previous quarter.

Other, extraordinary income lead bottomline surge: The 164% YoY growth in Voltas’ FY07 standalone bottomline was mainly a result of a strong rise in other income (inclusive of a one-time dividend income of Rs 120 m) and extraordinary income (arising from sale of properties and investments). Against this, the company had booked one-time losses in FY06, owing to the closure of the Hyderabad unit and corresponding VRS expenses. Adjusted for these extraordinary items, the net profits have grown by 22% YoY during FY07. The effective tax rate for Voltas increased from 18% in FY06 to nearly 24% in FY07. 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 97, the stock is trading at a multiple of 12.7 times our estimated FY09 earnings. Voltas’ FY07 results have been almost in line with our estimates, excepting the performance on the operating margins front, which has room for improvement in the future. We maintain out strong outlook for Voltas’ EMPS business, as revenues and profits start flowing in from the large contracts that the company has started executing in the Middle East. As for the EPS business, continued momentum in the infrastructure, manufacturing and mining space shall aid the growth prospects of the company going forward. The positive momentum shown by the UCP business is in line with our expectations. Overall, we maintain our positive recommendation on the stock from a 2-3 years’ perspective. We shall soon update our research report on the company.

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