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Voltas: Why has it outperformed?

Sep 13, 2004

As markets have started realising the engineering story (investment in power sector, higher infrastructure spending and upturn in the investment cycle), mid-cap engineering companies like Voltas have witnessed significant buying interest on the bourses in last few trading sessions. The stock has gained around 40% in last two months and has outperformed other engineering companies like ABB (up 8%), Thermax (up 15%) and Siemens (up 23%). Let's have a closer look. Voltas has organized its operations in three segments, namely the electro-mechanical projects & services (air conditioning and electrification of airports etc, water management and treatment), unitary cooling products (commercial cooling equipments like refrigerators, air conditions and contract manufacturing), engineering agency & services (construction, mining and textile equipments) and others.

Taking into consideration last five years, the company's topline has clocked around 12% CAGR, but the bottomline has grown at a faster rate of around 63%. The operating margins of the company stand at below 3%, which is amongst the lowest in engineering universe. Voltas' unitary cooling division is largely responsible for this owing to very high competition. Just to put things in perspective, EBIT margins from this division stood at 1.4% in FY04. However, the company is planning to divest this business and is focusing on growth from its core engineering business.

The engineering agency business is dependent on the performance of the mining, textile and the engineering sectors for growth. With the capacity addition plans laid out by textile companies and expansion of mining capacities, the topline of this segment is expected to grow at a double-digit rate for next two to three years. The operating margins of this business are very high (33% in FY04) since this division is also into maintenance contracts.

As far as its engineering agency business is concerned, the company has built up a track record of executing prestigious projects in the domestic as well as international market (Hong-Kong international airport, Bahrain international airport). With the government's focus on infrastructure development and development activities in Asian region, a healthy revenue growth is foreseeable. The margins from this business are lower (2.8%) because of high competition in bidding contracts and higher raw material cost. However, we expect the margins to reach 5% mark in the 18 months.

The stock currently trades at Rs 145 implying a P/E multiple of 11.9x FY04 earnings, which seems attractive as compared to other engineering peers. However, the valuation has to be viewed in the context of a diversified business mix and volatility in earnings owing to the seasonality of the unitary division. Overall, considering the solid track record of the company on the project execution front, we foresee engineering agency business to remain a key growth driver in the long-term.

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