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Voltas: Cost, taxes dent bottomline
Oct 20, 2006

Performance summary
Engineering services and air-conditioning major, Voltas, has reported mixed results for the second quarter and half year ended September 2006. While the topline growth has been decent for both the periods, on the back of lower operating margins and excluding the impact of extraordinary expenses in the corresponding quarter of previous fiscal, the bottomline has declined on a YoY basis. The negative impact on operating margins has been due to stock related adjustments and higher staff costs. Significantly higher effective tax rate has also impacted the bottomline performance during the second quarter.

Financial performance snapshot
(Rs m) 2QFY06 2QFY07 Change 1HFY06 1HFY07 Change
Sales 4,673 5,299 13.4% 9,040 11,103 22.8%
Expenditure 4,405 5,098 15.7% 8,587 10,638 23.9%
Operating profit (EBDITA) 267 201 -24.7% 453 465 2.7%
Operating profit margin (%) 5.7% 3.8%   5.0% 4.2%  
Other income 54 153 182.4% 159 255 60.6%
Interest 2 16 642.9% 11 18 59.6%
Depreciation 28 28 1.1% 53 64 21.6%
Profit before tax 291 310 6.5% 548 638 16.5%
Extraordinary income/(expense) (78) 9 - (152) 10 -
Tax 24 69 184.8% 41 180 336.3%
Profit after tax/(loss) 189 250 32.6% 354 467 32.1%
Net profit margin (%) 4.0% 4.7%   3.9% 4.2%  
No. of shares       33.1 330.9  
Diluted earnings per share (Rs)*         2.5  
P/E ratio (x)*         37.6  
* On a trailing 12-months basis            

What is the company’s business?
Voltas, a Tata Group Company (27.4% stake), 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. This division accounted for 50% of revenues in 1HFY07. The company also has presence in manufacture of forklifts, textile auxiliary, agro-chemicals and trading of chemicals. On the unitary division front, the company has presence in air conditioners, commercial refrigerators and visi-coolers. Voltas has a joint venture with Fedders of US for manufacturing of A/Cs. The unitary division contributed to 32% of revenues in 1HFY07. Voltas has emerged from being a consumer appliance company operating in a highly competitive arena to one that has expertise in the niche engineering area of electromechanical projects and services. During the period between FY02-FY06, the company has grown its revenues and profits at compounded rates of 21% and 43% respectively.

What has driven performance in 2QFY07?
EPS and UCP lead topline growth: In continuance with the sluggishness reported by the electro-mechanical projects & services (EMPS) business in 1QFY07, the segment’s performance during the second quarter has been worse. The segment sales have declined by 3% YoY during 2QFY07. Like last quarter, the management has again indicated that the lackluster performance of this business during 2QFY07 has been due to certain large value international contracts still being in their initial stages of execution and, consequently, their revenue being unrealized. We believe that since revenues of the EMPS business are skewed to the second half of the fiscal on the back of higher project deliveries during the third and fourth quarters, investors need to wait for the next two quarters’ performance to get a clear view of business performance. 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. In the domestic market, however, the air-conditioning and refrigeration business has continued to do well, reporting growth of 31% YoY.

At the end of September 2006, the EMPS business’ order backlog stood at Rs 18.3 bn, almost 1.6 times the segment’s FY06 revenues. However, it is pertinent to note that this backlog is lower than Rs 19.2 bn of order book that the company had reported at the end of 1QFY07. This is indicative of some kind of pressure on the EMPS business, as the company has not been able to add up to its order book in the past three months.

Segment-wise performance
(Rs m) 2QFY06 2QFY07 Change 1HFY06 1HFY07 Change
Electro-Mechanical Projects & Services (EMPS)            
Revenue 3,281 3,193 -2.7% 5,445 5,678 4.3%
% share 68.9% 59.1%   58.8% 49.8%  
PBIT margin 6.2% 2.5%   6.4% 3.8%  
Engineering Products & Services (EPS)            
Revenue 575 1,034 79.7% 1,001 1,840 83.8%
% share 12.1% 19.1%   10.8% 16.1%  
PBIT margin 28.0% 25.5%   30.2% 24.8%  
Unitary Cooling Products (UCP)            
Revenue 781 1,082 38.5% 2,594 3,660 41.1%
% share 16.4% 20.0%   28.0% 32.1%  
PBIT margin -3.9% 0.3%   -0.8% 1.0%  
Others            
Revenue 123 98 -20.3% 227 221 -2.4%
% share 2.6% 1.8%   2.4% 1.9%  
PBIT margin 19.8% 37.9%   21.7% 28.9%  
Total            
Revenue 4,761 5,407 13.6% 9,266 11,399 23.0%
PBIT margin 7.5% 7.1%   7.3% 6.8%  

The UCP business has also continued with its good performance, as seen from the 39% YoY growth in sales during 2QFY07. Investors must note that this segment generally rakes in better performance in the first two quarters 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 34% YoY growth in the air conditioner business and 38% YoY growth in the water coolers segment. As for the EPS business, the 80% YoY growth in sales during 2QFY07 is made up of strong performance from both the textile machinery (27% YoY) and material handling (73% YoY) businesses.

Stock adjustments dent margins: Voltas’ largest cost head i.e. raw materials, declined from 76.6% of sales in 2QFY06 to 68.8% of sales in 2QFY07. However, this was not enough to pare the pressure on operating margins, which declined by 190 basis points (1.9%) to 3.8% during the quarter. Pressure on margins was mainly inflicted by high stock handling and staff costs. Based on segments, except the UCP business, the other segments of EMPS and EPS witnessed margin contraction (see table above) during the quarter. 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.

‘Extraordinary’ impact on bottomline: While the bottomline performance seems robust at first glance, if one were to remove the extraordinary impact of 2QFY06, net profits have actually declined by 10% YoY during 2QFY07. Also, the effective tax rate for the company increased from 8.3% in 2QFY06 to 22.3% in 2QFY07, thus adding to the overall pressure on profit and profitability. Higher taxes were due to the fact that Voltas has moved from paying minimum alternate tax (MAT) to normal corporate taxes.

What to expect?
At the current price of Rs 93, the stock is trading at a price to earnings multiple of 17.1 times our estimated FY08 earnings. While the first half performance has almost been in line with our estimates on the topline front, we might have to revisit our profitability and bottomline estimates post a meeting with the management.

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