Crompton-Havells gap to narrow

Valuation gulf not justified, seen as normalising

Crompton Greaves Consumer Electricals scrip has lagged that of peer Havells India in the past one month as investors cheered acquisition of Lloyd Electric’s consumer durables business by the latter. Part of this weakness can be attributed to profit-booking following a 52 per cent surge over the past one year, outperforming Havells’ 25 per cent gains. But, even after this, Crompton trades at a discount to Havells. Currently, Crompton trades at 37 times the FY18 estimated consolidated earnings as against 42 times for Havells. Experts believe this valuation gap between the two stocks is not justified and should normalise. Naveen Trivedi, analyst at HDFC Securities, says, "At current levels, we believe Crompton has an upside potential of 18-20 per cent, higher than that of Havells (four per cent). I believe both the companies should trade at similar valuations.”
 
Operationally as well, there are a few factors making Crompton a preferred bet of most investors. First, the company derives about 60 per cent of its revenues from brands that enjoy top position in their respective categories (including fans, lighting and residential pumps). This metric stands at less than 10 per cent in the case of Havells. Besides enabling better control on operating profit margins and growth, a higher contribution from leading brands means that the company will benefit most from premiumisation trends witnessed in these categories, leading to better profitability. Second, Crompton has been growing ahead of the industry in most of its key categories in recent times. Third, Crompton's return on equity is higher than that of Havells.
 

“The earnings quality of Crompton will continue improving with respect to Havells as the share of higher-margin consumer durables and premium products ramps up. For Havells, we expect no significant improvement in the product mix, as the switch gear segment faces headwinds due to a medium-term slowdown in real estate," say analysts at Nomura. Bloomberg consensus estimate sees Crompton's consolidated earnings growth at 20 per cent over FY17-19, higher than 16 per cent for Havells.
 
Investors, however, must note that while most analysts are positive on both these companies, they believe current valuations tilt the risk-reward in favour of Crompton. While the Lloyd Electric buyout is a strategic fit, some analysts believe it could lead to some near-term pressure for Havells. "Havells’ acquisition of Lloyd Electric might work over the very long term. However, in the near term it should significantly reduce return on capital employed and cash flows for the company, although we believe the earnings impact is negligible," believes Inderjeetsingh Bhatia of Macquarie Securities. The bigger size and its slightly higher operating profit margin are some key positives of Havells, which is also expected to grow at a healthy pace.
 
Both companies also stand to benefit from the imposition of the goods and services tax as it will secure them gains in market share, particularly from their unorganised counterparts.