Equity Research Report: Voltas

Voltas may now fall towards 735-600-535 levels on the loss of market share, thin EBITDA margin, and tepid discretionary consumer demand

Company Overview & Business Model:

Voltas is an Indian MNC home appliance (consumer durables) and engineering company specializing in-room air conditioning and cooling technology on a global scale. Voltas is part of the $311B Tata Group of companies, originally incorporated in late 1954 as a JV between Tata Sons (led by Noel Tata) and Swiss-based Volkart Brothers. Apart from room air conditioners, Voltas deals with contract revenue, commercial refrigeration products, and the sale of services. Voltas’ segments include Electro-mechanical Projects and Services (EMPS); Engineering Products and Services (EPS); Unitary Cooling Products (UCP) for Comfort and Commercial use segment and Facilities Maintenance and Hard Services (FMHS).

Voltas is engaged in providing air conditioning and cooling products, engineering projects, and engineering products and services. The UCP segment is engaged in manufacturing, selling, and after-sales services of cooling appliances and cold storage products. EMPS is engaged in electricals, HVAC (heating, ventilation, and air conditioning), plumbing, firefighting, extra low voltage (ELV), and other specialized services.  The FMHS is engaged in Operations and Maintenance (O&M) contracts in various sectors, retrofits, energy management, and Water Solutions, which include water treatment solutions for industrial, oil and gas, and domestic sewage segments. The EMPS segment is engaged with textile machinery and mining and construction equipment services.

Voltas designs, develops, manufactures, and sells products including air conditioners, air coolers, refrigerators, washing machines, dishwashers, microwaves, air purifiers, and water dispensers. Voltas is engaged in the field of air conditioning, and refrigeration, as well as in the business of electro-mechanical projects as an engineering, procurement, and construction (EPC) contractor. The Company is also engaged in the business of engineering product services for mining, water management and treatment, construction equipment, and the textile industry. Voltas offers products, including textile machinery; mining and construction equipment; heating, ventilation, air conditioning and refrigeration (HVAC&R), and water coolers and dispensers.

Almost 60% of the revenue of Voltas comes from UCP, 30% from EPS, 6% from EMPS, and 4% from others. Almost 80% of revenue comes from domestic operations (India), 18% from the Middle East, and 2% from other foreign countries. Voltas is broadly structured into projects and goods & service business. The projects business is divided into the Domestic Projects Group (DPG) and the International Operations Business Group (IOBG). The products business is classified into Unitary Products Business Group (UPBG), Mining & Construction Equipment Division (MCED), and Textile Machinery Division (TMD).

The Unitary Products business group manufactures products in categories including air conditioners, air coolers, commercial refrigerators, water coolers, and water dispensers. It started manufacturing air conditioners in the 1960s under a license from Carrier Corporation. Voltas produced India's first window air conditioner with DC-inverter-based variable-speed motors. DC Inverter is an innovative technology that provides superior cooling while reducing the frequency of turning the compressor on and off. This helps in reducing power consumption to a greater extent. Voltas also has a large network of repair centers. The firm is also a major producer of evaporative coolers, which are widely used for comfort cooling in arid and semi-arid climates.

Voltas has also entered into a joint venture with Turkey-based Ardutch, which is a subsidiary of Arçelik, part of the KOC Group making the Beko brand of home appliances, producing refrigerators, air conditioners, washing machines, and kitchen appliances under the brand name of Voltas Beko. Voltas is a six-decade-old company in India with expertise in Air Conditioning & Cooling technology. Beko, on the other hand, is an international home appliances brand.

With Volta’s strong foothold in the Indian market, the company understands the needs and requirements of modern consumers. From sales to service, Voltas can bridge all gaps. The latest collaboration with Beko's state-of-the-art R&D, patents, and best-in-class technology, will ensure Voltas Beko is a brand that designs products and services with a consumer-first approach. Voltas Beko is an amalgamation of elegance and sophistication that’s designed to simplify Indian consumers’ everyday household needs.

Voltas has executed many prestigious international projects in the Middle East including air conditioning in the world's tallest building, the Burj Khalifa, in the once largest ocean liner, RMS Queen Mary, Palace of Sultanate of Oman, Bahrain City Centre Mall, Ferrari World Theme Park in Abu Dhabi, Sidra Medical and Research Centre in Qatar, Villaggio Mall in Qatar and Dubai’s Mall of Emirates. Voltas also installed an air cooling system in India’s 1^st Rajdhani Express.

Business Competitors & overall market:

Voltas is the largest air-conditioning brand in India, having almost 27% of the market share in 2020 (pre-COVID). But now has a market share of around 21%, while the nearest competitor Blue Star can maintain its market share of around 13%. Voltas is losing its market share mainly to Lloyds (owned by Havells) and also Daikin, especially in split ACs. Overall, the air-conditioning industry is also under pressure after COVID due to various macro headwinds, both locally and globally amid higher inflation/higher cost of living/higher energy prices; lower discretionary consumer spending; higher borrowing costs; higher RM (raw materials) costs and tepid pricing power due to intense competition.

During COVID times, Lloyd was able to beat supply chain disruptions, while most other companies were struggling. Also, overall sales volume was subdued despite some demand from the WFH category. Voltas is a dominant player in South and North India, where it suffered a market dent also due to the aggressive pricing cut strategy of Lloyd; Voltas’ volume was affected due to a 5-6% price hike in Apr’22; eventually, Voltas also went for a similar price discount, but it was not sufficient to regain the lost market share. Also, there are other competitors in energy efficient dual inverter split ACs like LG, Hitachi, Panasonic, Sharp, Samsung, Carrier, Haier, Whirlpool, and Samsung (triple inverter energy saving tech), dominant in various regions due to energy efficiency and competition price factors.

A large part of India falls under a tropical climate with the temperature soaring above 30 degrees Celsius in March and nearly 40 degrees in summer on average. This year there may be extreme heatwave conditions due to possible El Nina weather events (deficient rain and drought conditions). India’s AC demand may reach the 1B mark by 2050 from around 6.5M in 2019 (pre-COVID) due to global climate change, rising middle-class income, and standard of living, increasing WFH/hybrid mode of work, and affordable EMI schemes. In the early 1990s, when the Indian government removed restrictions on FDI, Voltas faced fierce competition from international brands like Carrier, LG, and Samsung. Since Oct’20, the Indian government banned imports of ready-to-install air conditioners, providing a boost to OEMs and other leading AC manufacturers.

Key management: Voltas (led by Bakshi-CEO & ED and Verma-CFO)

Board Members: Voltas

Key Shareholders: Voltas (Promoter: Tata Sons led by Noel Tata)

Highlights of Q3FY23 report card: Voltas (Consolidated-INR 100 Cr. =1B)

·         Operating revenue INR 20.06B vs 17.68B sequentially (+13.42%) and 17.94B yearly (+11.82%)

·         Operating expense INR 19.29B vs 16.68B sequentially (+15.70%) and 1.56B yearly (-50.93%)

·         EBITDA INR 0.76B vs 1.01B sequentially (-24.27%) and 297.06B yearly (+18.65%)

·         Net interest paid INR 0.0643B vs 0.0674B sequentially (-4.60%) and 0.0362B yearly (+77.62%)

·   Core operating profit (EBTDA=EBITDA-INTT) INR 0.70B vs 0.94B sequentially (-25.67%) and 1.54B yearly (-53.99%)

·         Core operating EPS (EBTDA/Share) INR 2.11 vs 2.84 sequentially (-25.67%) and 4.60 yearly (-53.99%)

·         EBITDA margin 3.81% vs 5.70% sequentially (-189 bps) and 8.68% yearly (-487 bps)

·         EBTDA margin 3.49% vs 5.32% sequentially (-18 bps) and 8.48% yearly (-499 bps)

·         Interest/EBITDA 8.42% vs 6.68% sequentially (+17 bps) and 2.33% yearly (+61 bps)

·         The overall report card was subdued/terrible

Highlights of the investor presentation, management commentaries, and Q&A (analyst concall): Q3FY23-Voltas

·         Overall subdued consumer sentiment amid global and to some extent local macro-headwinds, especially higher inflation/higher cost of living

·         Elevated raw material cost due to elevated global commodity prices amid Russia-Ukraine/NATO geopolitical tensions and economic sanctions (led by dual inverter split AC)

·         Unitary Cooling Products (UCP): 61% of total revenue

·         Higher revenue despite seasonally weak quarter for cooling products amid higher demand for high tonnage and better star-rated (energy-saving) products across the segment

·         Overall market share around 22.5% (9MFY23) amid the expansion of exclusive brand outlets and healthy participation with various channels; should help in forthcoming seasonal sales (Dec-Mar)

·         Commercial refrigeration continues to grow with the participation of OEM and retail chains; the company is expanding its product portfolio/capacity and is introducing various consumer-centric products with improved features

·         Also signed a technical agreement with Vestfrost, Denmark for medical refrigeration products

·         The Air Cooler segment is now growing after muted growth during the COVID period; the current market share is around 9.2%

·         The commercial air conditioning segment is now growing with improved margin

·         RN cost increased due to higher global commodity prices, reversing from an earlier downtrend, higher energy cost, and higher USDINR

·         Intense completion resulting in muted pricing power

·         Electro-Mechanical Projects & Services (EMPS):33% of total revenue

·         Domestic project business order booking jumped from Rs.1.85B to Rs.10.40B (y/y) amid infra CAPEX (covering water, electrical, and modern infra work)

·         But overseas projects progress was subdued due to various regulatory/process delays and also resulting in operating margin

·         New MEP project in Saudi Arabia; overall projects progress across ME is at the scheduled pace, while few of them are at the completion stage shortly

·         Delayed collection in a few of the projects in ME continues, resulting in the provision

·         One ME contractor had unilaterally invoked the BG, resulting in exceptional loss; but the company is trying to recover the loss and also fighting legally

·         Domestic projects order book stands around Rs.45.38B containing orders across the water, HVAC, rural electrification, and urban infra projects

·         International order book of around Rs.30.05B

·         Total order book around Rs.75.43B near pre-COVID levels giving fair visibility to future performance

·         Engineering Products & Services (EPS): 6% of total revenue

·         Domestic mining equipment sales & after-sales service was affected due to export duty on iron ore, but the lifting of the same in late November and improved price realization should be positive for the business

·         Good momentum for textile capital machinery despite supply chain disruptions and volatility in yarn prices; the PLI scheme should do well for the industry and the company's machinery business

·         Voltas Beko: Refrigerators, Washing Machine, Microwave, and Dishwashers

·         Cumulative selling of 3M units cumulatively since launch (4 years); overall subdued performance amid tepid consumer sentiment amid various macro-headwinds, even during the festive season

·         Taking an aggressive growth strategy in the consumer durables (Voltas Beko) segment through higher retail channel participation (offline and online) along with higher localization to improve the bottom line and avoid supply chain-related disruptions

·         Outlook:

·         The softening of the rural inflation and buying across sales channels on the forecast of hot weather should support cooling product sales in the coming quarter

·         The easing of supply-led disruption shall bring stability to commodity and other related costs

·         In addition, a focus on the infrastructure by the Government in the operating territories should help in securing profitable orders for the project business.

·         In general, the management remains optimistic about the improvement in the domestic macro-economic environment

Highlights of Q&A:

·         Retail/Dealer/distributor inventory holding levels are now for 75-80 days, keeping in mind likely higher sales for Jan-Mar and Apr-June QTRs (forecast of unusually higher temperature)

·         Lower EBITDA margin due to elevated RM prices and lack of adequate pricing power amid subdued consumer demand and intense competition

·         Elevated RM prices may continue in Q4FY23 due to the recent hardening of global commodity prices and higher USDINR; thus net realization may continue to be muted in Q4, but should see some improvement in margin due to higher volume/demand and pricing power; overall EBITDA margin may continue to be below double-digit

·         Middle East (ME) is a preferred zone for projects compared to SE (South East Asian nations like Pakistan, Sri Lanka, and Bangladesh) because of macro-economic stability (despite the recent incident of invoking BG in Sidra)

·         Project business margin is around 2.5% compared to 5% of peers (like Blue Star) as project business is subject to the economic cycle, having a long gestation period and higher CAPEX

·         Overall operating margin has also been affected due to the current government policy of in-house domestic manufacturing instead of the previous scope of cheap outsourcing (importing) from China or Korea

·         The cost of manufacturing is structurally high in India despite the PLI scheme and this factor along with tepid consumer demand/higher cost of living affects the pricing power and EBITDA margin of all AC manufacturers including Voltas

·         Despite the policy of ‘Make in India’, the industry still imports AC compressors, motors, controllers, etc, which are critical parts of an AC

·         The refrigerator market share is around 10%-on the weaker side; the aim is to take it to 24-25%

Conclusions: Voltas may have run too much compared to its fundamentals/potential

Voltas tumbled after the Q3FY23 report card and analyst concall as the management virtually issued subdued guidance due to loss of market share, higher production cost, muted consumer demand, and subdued pricing power. Now AC is almost an essential product in hot & humid India. This along with rising middle-class income, people’s aspirations, the WFH trend (even after COVID), pent-up demand, and availability of easy EMI (loans) for consumer durable goods, sales of energy-efficient ACs are on the rise. Many households/families are now going for 2^nd AC in a separate room for not only WFH but also for family purposes. But higher borrowing costs coupled with tighter lending norms (for unsecured consumer durable loans) and higher inflation/higher cost of living are also affecting discretionary spending of middle-class consumers-affecting home AC sales.

Indian room AC market size was around $200B in 2021 and is projected to grow by almost +20% CAGR in the next few years (after ~10% CAGR in the last few years). The Indian government is under huge pressure from industry leaders for 28% GST (‘sin tax’) on ‘luxury’ products like cars, ACs, refrigerators, etc. So, the government may also come forward to rationalize GST on such consumer durable goods to spur demand from the middle class in the coming days. The onslaught of scorching summer and the extension of the WFH/hybrid model (even after COVID) is positive for the AC industry. Voltas, on its part, is executing a comprehensive marketing plan to grab the lost market share.

In line with the campaign slogan of ‘Keeping India Cool since 1954’ and being the ‘cooling experts of India,’ Voltas also launched its Air Cooler campaign ‘Ab Garmi Ke Mazey Lo, Bina Garmi Key’, targeting less affluent consumers. Voltas is also giving a thrust of digital media campaigns and sales. Voltas has also opened new exclusive shops in Tier II and III cities for higher distribution reach and market share and to strengthen its leadership position in urban and semi-urban areas.

Voltas-Fair Valuations: Around Rs. 525-600-686 (FY24-26); current fair value around Rs.459

Voltas is both beneficiary and victim of ‘K’-Shaped (uneven) economic recovery. In FY20, Voltas recorded core operating EPS of 20.12 vs 17.49 in FY19 and 19.67 in FY18. Voltas reported core operating EPS of 19.82 in FY22 vs 18.60 in FY21 amid COVID-related disruptions (both on the supply and demand side). As per the current quarterly run rate and company management comments/guidance, Voltas may report core operating EPS around 12.88 in FY23, unless the performance is dramatically improved in Q4FY23. As of now, there is no such indication due to tepid discretionary consumer spending amid various macro-headwinds/higher cost of living including higher energy costs and higher borrowing costs and tightening in borrowing norms, especially for unsecured consumer durable loans by various banks & NBFCs.

Voltas is now suffering from a loss of market share and also margin pressure. Voltas scaled around 1355 lifetime highs in late 2021 in hopes of home AC demand revival but tumbled after a disappointed FY22 report card and guidance coupled with rising borrowing costs (RBI rate hikes). Voltas may have run too much compared to its fundamentals/potential. Voltas is also involved in various domestic projects like railways (air cooling), and water and mining machinery, and due to TATA group branding, it may also enjoy government preference and may get more railway, and airport projects (cooling solution) in the future.

Voltas is a good business model under temporary disruptions. Voltas is a household trusted name/brand in India. Voltas also enjoys a scarcity premium in listing space and thus has a relatively higher core operating PE historically, around 30. Now if we assume FY23 core operating EPS is around 12.88 (as per quarterly run rate, business trend, and management comments), and +20% CAGR on an average in FY24-26 in an optimistic scenario), the core operating EPS should be around 15.46-18.55 and 22.26.

And assuming an average core operating PE of 25 (in an optimistic scenario), the fair value should be around 495-322-387-464 and 557 by FY22-26. Further, if we consider the average fair value for EPS, BVPS, and CFPS, the fair value should be around 459-525-600-686 by FY: 23-26. As the financial market generally discounts 1Y earnings in advance, Voltas may fall to around 525 by June’23 and 600 by Mar’24, and 686 by Mar’25. If the company is not able to improve its core operating EPS substantially, then the average core PE may be also downgraded to 20 instead of the current 25-30 (in line with long-term core operating EPS growths).

C/F Analysis: Voltas (consolidated)-YLY

Technical View: Voltas (LTP: 814; EOD: 29/03/23)

Looking ahead, whatever may be the narrative, technically Voltas has to sustain over 820 for any rally towards 835/862-905/940* and further 995/1065-1255/1360; otherwise sustaining below 795, Voltas may again fall to 775/735*-685/650*, and further to 630/615-535/480-425/370* zones in the coming days. For the time being, 735 is a good positional support zone followed by 650-535-425 areas (for investment buying/accumulation purposes).

P/L Analysis: Voltas (consolidated)-QLY

P/L Analysis: Voltas (consolidated)-YLY

B/S Analysis: Voltas (consolidated)-YLY

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