Voltas is running ahead of fundamentals

After a prolonged period of underperformance, the Voltas stock outperformed the BSE Sensex and BSE Capital Goods Indices in three months with gains of 26.4 per cent (weekly gain of nine per cent) despite a disappointing operational performance in the June quarter. After touching its 52-week high of Rs 138.50 today, the stock is seeing some profit-booking.

However, the stock’s run-up seems to have happened without the fundamentals having changed meaningfully or even likely to change in the immediate future. The outlook for all of the company’s three businesses continues to be subdued.

Though the government’s initiative to push for reforms is welcome, it will take time for the infrastructure sector to pick up as inflation and interest rates are likely to remain high. There is an upward risk to food inflation due to delayed monsoon and commodity prices could trend higher on account of quantitative easing by the US Fed.

Subdued industrial activity does not augur well for the engineering projects and services division (seven to eight per cent of consolidated sales). Competitive intensity in both electro-mechanical projects (especially in West Asia) and unitary cooling products (market leader in multi-brand retail segment of room air-conditioners), which form 90 per cent of total revenues, also continues to be high.

Analysts see continued risk to margins, especially in the electro-mechanical projects segment, going ahead, as there are fewer foreign orders and the activity has been subdued in the domestic market. There may be further provisioning required for the Sirda Medical project after the techno-commercial audit in the September quarter, which continues to see further upward revision in costs, changes in design and delay in completion.

Says Sanjaya Satapathy, analyst, Bank of America-Merrill Lynch, in a September 27 report, “Profit margin could decline further contrary to expectation.”

In this backdrop, the valuation (16.5 times FY13 estimated earnings) seems to have run ahead of fundamentals and is above the five-year average multiple of 15 times.

Says Lokesh Garg, analyst, Kotak Institutional Equities in a report dated September 26, “Valuations turn unattractive and receding earnings outlook prompts downgrade. Hence, we downgrade the stock to ‘reduce’ with a target price of Rs 135 based on 15 times one-year forward earnings."

Adds Satapathy, “Voltas is trading at a PE of 15.6 times FY14 estimates, which is quite high in our view given weak earnings outlook.”