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Voltas: Not EMPS this time!

Jul 31, 2006

Performance summary
Engineering services and air-conditioning major, Voltas, has reported strong results for the first quarter of FY07, reporting revenue and net profit growth of 33% YoY and 31% YoY respectively. Growth in 1QFY07 topline has mainly been a result of strong performance from the company’s engineering agency and services and unitary cooling businesses. Operating margins have witnessed a marginal expansion, due mainly to stock related adjustments.

Financial performance snapshot
(Rs m) 1QFY06 1QFY07 Change
Sales 4,367 5,804 32.9%
Expenditure 4,181 5,540 32.5%
Operating profit (EBDITA) 186 264 42.1%
Operating profit margin (%) 4.3% 4.5%  
Other income 105 103 -2.2%
Interest 9 3 -72.0%
Depreciation 25 36 44.8%
Profit before tax 257 328 27.9%
Extraordinary income/(expense) (74) 1 -
Tax 17 111 552.9%
Profit after tax/(loss) 166 218 31.4%
Net profit margin (%) 3.8% 3.7%  
No. of shares 33.1 33.1  
Diluted earnings per share (Rs)*   22.9  
P/E ratio (x)*   34.5  
* On a trailing 12-months basis

What has driven performance in 1QFY07?
EPS and UCP lead topline growth: For a change, Voltas’ topline growth during 1QFY07 was led by strong performances from its Engineering Products Services (EPS) and Unitary Cooling Products (UCP) divisions. While the former grew revenues by 89% YoY, the latter reported a growth of 42% YoY. More importantly, these businesses contributed to around 57% of the company’s total revenues, up from 50% in 1QFY06. However, this should be taken as a seasonal pattern, as revenues for the company’s (otherwise) largest business segment of electro-mechanical projects and services (EMPS) segment are skewed to the second half of the fiscal on the back of higher project deliveries during the third and fourth quarters.

On the contrary, the UCP segment shows better performance in the first quarter as, due to the summer season, there are higher sales of air-conditioners, refrigerators and water coolers during this period. The company has reported that strong growth for the UCP business is on the back of a 37% YoY growth in the air conditioner business, and 44% YoY growth in the water coolers segment. As for the EPS business, textile machinery, material handling and mining & construction equipment sub-segments grew by 49% YoY, 99% YoY and 1325 YoY during the quarter, thus contributing to the overall strong performance of the division.

Finally, the EMPS division raked in a growth of 15% YoY. The management has indicated that since some large-value international projects are in their initial phase of execution, their revenues have not yet been realised, and results of the international business for the quarter have consequently been affected, consequently impacting the overall segment performance during 1QFY07. At the end of the quarter, the order backlog of this segment stood at Rs 19.2 bn (74% YoY growth), almost 1.7 times the segment’s FY06 revenues. In the EMPS segment, Voltas is currently involved into some large-scale projects in the Middle East region and these shall start contributing to revenues and profits in the next few quarters.

Segment-wise performance
  1QFY06 1QFY07 Change
Electro-Mechanical Projects & Services (EMPS)
Revenue 2,163 2,485 14.9%
% share 48.0% 41.5%  
PBIT margin 6.8% 5.6%  
Engineering Products & Services (EPS)
Revenue 426 806 89.3%
% share 9.5% 13.5%  
PBIT margin 33.1% 24.0%  
Unitary Cooling Products (UCP)
Revenue 1,813 2,578 42.2%
% share 40.2% 43.0%  
PBIT margin 0.6% 1.4%  
Revenue 104 123 18.9%
% share 2.3% 2.1%  
PBIT margin 24.1% 21.8%  
Revenue 4,505 5,993 33.0%
PBIT margin 7.1% 6.6%  

Stock adjustments lead margin(al) expansion: Voltas has reported a marginal 20 basis points improvement in its operating margins during 1QFY07, much of it due to stock related adjustments. Raw material costs, however, increased from 73.3% of sales in 1QFY06 to 75.1% in 1QFY07. The profitability performances for the EMPS and EPS divisions have, however, deteriorated. The UCP business has reported PBIT margin expansion and, as indicated by the management, it has been due to the ongoing restructuring and relocation of the manufacturing units from high-cost Hyderabad to low-cost Uttaranchal. We believe that margins will improve with subsequent quarters, as Voltas books greater amount of revenues in the EMPS division.

Higher taxes pare bottomline growth: Despite the strong growth in operating profits, Voltas was not able to carry the flow on to the bottomline, mainly due to substantially higher tax expenses. The effective tax rate for the company increased from 6.6% in 1QFY06 to 33.8% in 1QFY07. This was due to the fact that the company moved from paying minimum alternate tax (MAT) to normal corporate taxes. Consequently, the net margins declined from 3.8% in 1QFY06 to 3.7% in 1QFY07.

What to expect?
At the current price of Rs 790, the stock is trading at a price to earnings multiple of 14.6 times our estimated FY08 earnings. As indicated above, we expect the EMPS business, which has been the main growth driver in the past, to continue to benefit Voltas in the subsequent quarters in FY07 and beyond. We also have the belief 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. We maintain our positive view on the stock.

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