How Polycab Beat Havells to Win the Valuation Game

Every time a listed company reports quarterly numbers, business channels flash the following details.

'Company misses analyst estimates.'

'Company beats analyst estimates.'

As an analyst, I have always wondered, 'Shouldn't it be the other way round?' Isn't it the analyst who misses or beats company results and not the company?

After all, it was the analyst who estimated the quarterly numbers based on his assumptions. Why should the company be missing or beating estimates?

The dilemma for a lot of investors is what to do after a sharp reaction of a stock to its results.

I believe, investment calls should not be taken based on one quarterly result. However, a change in trend of a stock's price happens quite often after quarterly results.

For instance, let's take two stocks from the same industry which reported numbers recently.

Polycab India: Superb numbers and management commentary.

Havells India: Subdued numbers and management commentary.

Polycab reported very strong numbers for the quarter with a 42% rise in revenues and an 80% jump in profits.

The stock reaction was sharp with a 10% upper circuit on the next day. The stock jumped 30% over the next 3-4 days.

Havells reported subdued numbers with a 14% growth in revenues. Its EBITDA margins contracted from 8.5% to 8.3% on an annual basis.

In contrast to the 80% jump in profits of Polycab, along with 2.8% YoY margin expansion, Havells' numbers were pedestrian to say the least. The stock price of Havells fell 6% after the results.

The question is, how do you take a call on such results?

There is something most people don't talk about when analysing stocks. The concept of relative valuations. Take the example of Polycab and Havells.

All these years, Polycab never got the P/E multiple which Havells had...and rightly so for the following reasons.

1. Havells is a consumer facing brand while Polycab until 2020 was viewed as a B2B company.
2. The FMEG segment (consumer facing) of Havells contributed to 40% of sales while the B2B segment (wires, cables, switchgears) contributed the remaining 60%. However, in case of Polycab, the FMEG segment barely accounted for 3-5% of total sales. Currently, it accounts for 10% of sales.
3. The FMEG business for Polycab was a drag until recently where it turned profitable. In the case of Havells, the FMEG business generated a good return on capital.

So the reason why Havells always got a higher P/E multiple (30-40% higher) was because it was a consumer company which sold wires. Polycab, on the other hand, was a B2B wires and cables company which sold some consumer products too.

Havells had an average P/E multiple over 60 in the the past 5 years. Polycab got an average P/E multiple of 23 for the same period.

So what has changed now?

For Polycab, the share of FMEG business is increasing. The company is growing profitably. The cables and wires business is also at full throttle. Polycab is the market leader. Everything is going right for the company.

However, it's the change in perception which has worked.

Polycab is gravitating towards a being a strong brand in the FMEG business. The ad spends in the IPL... signing celebrities for brand endorsements... Polycab ticks all the boxes of a B2C company.

Havells on the other hand seems to be losing the plot by consistently reporting poor numbers. For a company to justify an average P/E multiple of 60, it needs more than Amitabh Bacchan as its brand ambassador.

Polycab after the 30-40% run up in the stock price trades at 45-48 times P/E multiple as compared to 25-28 times it did historically. What the June 2023 result did was to upgrade earnings estimates as well as re-rate the multiple.

Major stock upsides come from a PE re-rating. This has happened in case of Polycab, justifying the sharp rally.

So how one should play quarterly results?

Here are two scenarios...

Scenario 1: Good Results

Scenario	Valuations	Management Commentary	Action To be Taken
Good Results	Cheap	Positive	Hold; Buy More
Good Results	Expensive	Positive	Hold
Good Results	Cheap	Negative	Sell
Good Results	Expensive	Negative	Sell Fast

Source: Equitymaster

Scenario 2: Bad Results

Scenario	Valuations	Management Commentary	Action To be Taken
Bad Results	Cheap	Positive	Hold; Buy More
Bad Results	Expensive	Positive	Sell
Bad Results	Cheap	Negative	Sell
Bad Results	Expensive	Negative	Sell Fast

Source: Equitymaster

You may use these tables as thumb rules. The most important point is the management commentary along with your comfort in the stock's valuations.

Warm regards,


Aditya Vora
Research Analyst, Hidden Treasure