On to the 'next' phase of growth: Voltas, which has historically been closely associated with air conditioners (close to 40% share market share for over half a decade in the past), has been on a consistent transformation. As a matter of fact, the company suffered significant losses during the early 1990s, much due to the onslaught of MNCs, who launched a series of 'new generation' ACs, which were much superior that the products from Voltas' stable. During the period between 1993 and 1997, with the entry of the Korean, Japanese and other global giants (like LG, Samsung, Electrolux and Whirlpool), Voltas' market share eroded further. By FY01, the company's share of the domestic AC market plunged to a low of 7%. The decline in the market share was accompanied by significant pricing pressure.
That was seemingly a kicker for the company to transform itself through a series of restructuring initiatives, which involved high investments in innovation and product development, sprucing up the distribution network and aggressive marketing and branding initiatives. This has brought Voltas back to owning a 14.4% share of the Indian AC market (FY07 figures; Source: Voltas annual report). The company is the second largest player in the retail AC segment and a market leader in the institutional category. While the retail segment is competitive, Voltas has been concentrating on large commercial establishments, telecom companies, IT facilities, restaurants, large-scale retailing projects, software development parks and export zones. Lower prices, easy availability of low cost finance, higher disposable income and the urge for better living are factors that we believe will help the AC industry and consequently Voltas grow in the future.
Now, during this phase of restructuring between 2002 and 2007, the company also witnessed a tremendous ramp up in its non-air conditioner businesses. Specifically, the businesses of electromechanical projects & services and engineering agency witnessed compounded annual growth in sales of 29% and 49% respectively during FY02 to FY07. Not only did this spruce up the company's overall topline, the fact that these businesses earned significantly higher margins than the air-conditioner segment also helped Voltas expand its profitability and return ratios.
That was for the past. Now, for the period between 2007 and 2010, Voltas is aiming to make it big in the electromechanical space, with growth also duly supported by continued traction in the engineering agency and AC segments. With the domestic market for electromechanical projects opening up further, as also through a deeper foray into the international markets (largely Mid-East), the company is stepping up its move on to a higher growth trajectory going forward, which we believe is positive. With a strong management team and world-class execution capabilities at its side, we believe that Voltas has the ingredients to become a greater force in the electro-mechanical space going forward. We expect this segment to lead the company's overall topline growth of 31% on a compounded annual basis during the period FY07 to FY10.
EMPS - Not just air-conditioning: During its transformation process (as mentioned above), Voltas also built up a track record of executing large, prestigious electro-mechanical projects (EMPS) in the domestic as well as international market (which is spread across the Middle East region, including city states like Dubai, Bahrain and Macau). As a matter of fact, EMPS involves all aspects of construction of infrastructure like electricals and air conditioning barring the civil structure. After strengthening its position in the air-conditioning space, Voltas is now eyeing a large share of the electro-mechanical investments by way of executing the MEP (mechanical, electrical and plumbing, also inclusive of air-conditioning) portion of the projects as well.
As a matter of fact, in a typical MEP project, the share of air-conditioning ranges from 40% to 50% (though its depends on the project size). As such, after already establishing a name for itself in the air-conditioning part, Voltas shall share a higher portion of the total investment in electromechanical projects by way of positioning itself as an MEP player. This, we believe will provide a great boost to the segment revenues. Profitability, though, is almost equivalent in air-conditioning and MEP.
Given the level of economic activity and infrastructure development that is expected to take place in the domestic and Middle East markets (for the latter, largely on account of strong economic growth on the back of high crude prices), the EMPS division is expected to show strong double-digit growth going forward. We estimate revenues for the division to grow at a compounded rate of 35% during the period FY07 to FY10, against the expected industry growth rate of around 20% per annum. Comfort and new business segments like indoor air quality, energy management and refrigeration are likely to be major contributors of growth in the future. At the end of September 2007, the EMPS division had an order backlog of around Rs 27 bn. International orders form nearly 75% of this backlog, and the company expects to convert these orders to revenues in a span of 18 to 36 months.
Cold chain opportunity: In the refrigeration sub-segment of the EMPS business, which is currently 5% of domestic EMPS revenues, Voltas expects strong growth to come from the cold chain opportunity. The company has already executed Rs 150 m cold chain project for the Adani Group. To make inroads into this emerging opportunity, Voltas has tied up with the Netherlands based storage technology specialist Besseling Group to deliver turnkey solutions for storage of horticulture produce. Considering India's agrarian economy, the opportunity for post harvest solution is huge. We believe that the alliance has tremendous scope when one considers the scale and size of the storage solutions market in India, which is as large as Rs 50 bn. Voltas plans on targeting a sizeable chunk of this market and has already bagged several projects including the one from Adanis, International Flower Auction Sector in Bangalore, Abhirami in Chennai and Jaya Cold Storage in Tamil Nadu.
Engineering agency momentum: The performance of Voltas' engineering agency services (EAS) division has been pretty robust over the past few years and the vibes that are emanating from the management with respect to future growth of this business are very positive. The segment's revenues grew 39% YoY during 1HFY08, led by strong performances from the mining and construction and material handling equipment businesses. Although the textile machinery business recorded some weakness owing to the pressure that textile companies are facing on account of Rupee appreciation, the management has indicated that they expect the growth momentum to be maintained over the next few quarters as well. What they have said is that while new machinery orders have slowed down a bit, considering the already overflowing order books of equipment makers like Lakshmi Machine Works (from where Voltas sources a large part of its trading requirements), growth shall be maintained over the next few quarters.
Anyways, to take into account any pressure from the equipment agency business, Voltas is ramping up its manufacturing presence in the EAS segment (sale of own manufactured equipments contribute around 75% of this segment's revenues). Apart from the strong topline momentum, the more important part of growth of this business is its disproportionate contribution to Voltas' consolidated profitability. Against a revenue contribution of 16% in 1HFY08, the segment's contribution to the company's PBIT was 35%. While there was some pressure on profitability of the EAS division during the first half period (PBIT margins declined to 22% against 26% in 1HFY07), even if the segment were to maintain margins at the current levels (which is what we have estimated), considering the strong growth momentum, there will be an overall positive effect on Voltas' profitability going forward.
The EAS division is dependent on the performance of the mining, textile and the engineering sectors in India. And considering large-scale capacity expansion plans in these sectors and India's growing importance as an offshore manufacturing base, we expect demand for machine tools and machinery to be robust going forward. Overall, we expect the EAS division to be a big growth and profitability driver for the company going forward, though well supported by the electromechanical business.
UCP - Turnaround benefits flocking in: During FY06, Voltas had taken a huge Rs 650 m hit on its books on account of cost of VRS for employees at its Hyderabad refrigerator manufacturing unit, which was incurring heavy losses. Now, in lieu of the closure of the Hyderabad unit and in anticipation of higher demand going forward, the company set up a green-field unit for manufacture of commercial refrigerators, air-conditioning equipments and air coolers in Uttaranchal, so as to get advantage of relatively lower employee costs and tax benefits (100% income tax and excise exemption for 5 and 10 years respectively).
The Uttaranchal plant constitutes the following three sub-units:
Additional capacity other than the one at Dadra for the manufacture of air-conditioning equipments.
Manufacturing of commercial refrigerators, water coolers and specialised ACs for the telecom industry (these were earlier being manufactured at the Hyderabad unit).
Additional capacity (other than the one at Dadra) for manufacture of room ACs (in joint venture with Fedders of the US).
This move out of Hyderabad and into Uttaranchal has helped the company improve profitability of the unitary cooling products (UCP) division. Importantly, the management has indicated that against staff strength of 750 in Hyderabad, it only has 40 employees on its rolls in Uttaranchal, with the remaining being on contract basis. This has helped the company pare some of its employee expenses. We expect the division to clock growth of 28% during the period FY07 and FY10, with EBIT margins to stabilize in the 5% to 6% range.
Fruits of rationalisation: One of the prominent reasons for the troubles that Voltas faced during the 1990s was the company's interests in a host of diverse and unrelated businesses.
The company's key divisions were running in losses, its cost structures were looking increasingly unsustainable and a bloated workforce was adding to the troubles. This led to the company registering its maiden loss in FY97 and missing dividend payout for the first time in its 43 years of existence. Businesses not passing the company's sustainability and profitability tests were sold off. Chief among these were the white goods business, the agro-chemicals manufacturing business and the furniture and LPG cylinders divisions. The company also exited subsidiaries such as premium granites and switchgears. These endeavors led to large-scale rationalisation in the company's staff strength, which declined from 10,700 in FY97 to around 2,900 in FY07.
Shedding of non-profitable businesses and selling idle real estate and investments has also coughed up a fortune for Voltas (Rs 4.1 bn in realisations). This money has been used to repay debts of Rs 2.6 bn and also pay for the VRS initiative. Thanks to these and other measures, the company's annual interest payments have declined from Rs 549 m in FY97 to a net interest income of Rs 5 m in FY07. In our view, the return ratios are likely to improve significantly over the long-term.
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