Equitymaster Agora Research Private Limited
Independent Investment Research
22 February, 2013
Crompton Greaves Ltd. Page 1 of 8
-
50
100
150
200
Feb-08 May-09 Aug-10 Nov-11 Feb-13
CGL: Rs 56 Sensex: Rs 111
Market data
Current price Rs 97
Market cap Rs 61,809 m
Face value Rs 2.0
FY12 DPS 1.4
BSE Code 500093
NSE symbol CROMPGREAV
No. of shares 641.5
Free float 58.0%
52 week H/L Rs 161 /95
Rs 100 invested is now worth
Stock price Performance
CGL Index*
1-Yr -38.6% 6.6%
3-Yr -24.4% 6.7%
5-Yr -11.1% 2.2%
Returns over 1 year are compounded
annual averages (CAGR)
* BSE Sensex
Shareholding (Dec-2012)
Category (%)
Promoters 41.7
FIIs 17.9
DIIs 21.8
Others 18.7
Total 100.0
Report prepared by
Equitymaster Agora Research
Private Limited.
www.equitymaster.com
info@equitymaster.com
Crompton Greaves Ltd.
Hold (Target price Rs 130)
Investment Rationale
Performance of subsidiaries will be key to re-rating: Predicting
an earnings turnaround in a cyclical industry is like finding an oasis in
desert. It gets even more difficult when the company is in the midst
of a restructuring process. You have to predict too many unknowns
to arrive at future earnings. This includes time line of the process,
costs involved, benefits to accrue etc. Valuing such a businesses is
equally difficult task. Being too conservative or too optimistic can
both mean poor returns from the stock.
Crompton Greaves Ltd (CGL), our Stockselect for this week, is one
such company. Besides operating in a cyclical industry, the company
has been battered by a poor show of earnings amidst restructuring in
its overseas business. The stock of CGL has fallen by approximately
39% compared to a 7% gain in the Sensex over the last year.
The underperformance is predominantly due to the poor show of its
overseas business in Belgium. 199 employees were relieved from
the Belgium operations during the restructuring. This resulted in a
total outgo of Rs 2.28 bn as severance pay and pension liabilities.
This hurt consolidated profits. The performance of the domestic
power business was also impacted due to a fire in the Nashik plant.
It resulted in a revenue loss of Rs 270 m. Both overseas and
domestic margins were under pressure due to stiff competition.
Overall, a series of unforeseen events have impacted the profits and
stock price off late.
But there is no reason for us to believe that the subsidiaries will keep
weighing down the consolidated performance forever. On the
contrary, the managements plans suggest otherwise. First of all, the
Belgium operations have shifted to Hungary. Management says that
the same is likely to result in cost savings of Euro 3.7 m in 4QFY13.
There would also be a saving of about Euro 15 m in FY14. Also, with
no contingencies (on restructuring) expected in future one can
expect overseas operations to stabilize. This can trigger an earnings
turnaround. However, it goes without saying that the process will be
slow and difficult. And therefore investors will have to be patient.
We believe that the restructuring process, though gradual, will bring
in the much needed stability to CGs earnings. The order backlog of
the company is also healthy at Rs 92.3 bn. This provides visibility to
the future revenues. However, there are execution issues prevailing
in the sector. Also the transformation process going on in the
subsidiaries will be time consuming. Hence, we have been
adequately conservative in our growth forecast.
Going by our conservative estimates, we have arrived at a per share
value of Rs 130 for the stock from an FY15 perspective. This is on
the bases of sum of the parts (SOTP) valuation. Please read more
about the rationale for change in our valuation methodology in the
22 February, 2013
Crompton Greaves Ltd. Page 2 of 8
valuation section of this report. Since the stock
can fetch point to point return of 34% and
average annual return of 15% over the next two
to three years, we recommend investors to
HOLD on to the stock.
Restructuring to bear fruits: Reduction of
overhead cost structure was the primary
objective in restructuring Belgium operations.
The entire restructuring process led to a total
cost of Rs 2.28 bn during 9MFY13. Out of that,
Rs 1.2 bn relates to severance pay while Rs
1.08 bn relates to other related restructuring
cost. The Belgium operations are shifted to
Hungary. The cost savings from the said transfer
is likely to be Euro 3.75 m in 4QFY13 and Euro
15 m in FY14. The capacity at the Hungary plant
will be 9,000 megavolt amperes (MVAs) on an
annualized basis. Management expects
revenues of Euro 17 m from the Hungarian
operations in 4QFY13. Also, it should be noted
that the restructuring process is complete and
no further contingencies are likely to hit the
income statement in future. This is likely to
provide stability to earnings.
Consumer products business is a cash cow:
The consumer products business of the
company comprises of fans, light sources &
luminaries and other household electrical
appliances such as geysers, mixers etc. The
business has very strong return ratios (return on
assets, return on capital employed). In fact, in
FY11 and FY12 consumer products business
segment registered return on capital employed
(RoCE) of 363% and 286% respectively. Thus, it
is a cash cow for the company. Going forward,
we expect the share of consumer product
business to increase from 18.9% in FY12 to
21.1% in FY13 and 22.4% in FY14. Increasing
share of consumer products to the overall
topline is likely to support the return ratios going
forward
Increase in T&D spend to augur well: Power
Grid Corporation (PGCIL), Indias leading
transmission utility, is expected to continue to
increase power-lines network in the country,
which has a long way to go as far as
transmission & distribution (T&D) infrastructure
is concerned. These initiatives augur well for the
company, which is one of the key vendors for
PGCIL. Overall, the planned increase in inter-
regional transmission capacity is expected to
provide tremendous growth opportunity for CGL
going forward. The companys power business
(forming around 62.4% of consolidated 9MFY13
sales) is expected to benefit on the back of
policy support from the government towards
reduction of power deficit with an overall view of
maintaining the economic growth momentum.
Refurbishment and expansion of the
transmission network and implementation of a
large scale rural electrification programme is
likely to boost the companys order book and
revenues in the future.
Recent acquisitions performing well: In July
2012, CGL acquired ZIV, a Spanish company
with strong technological knowhow in grid
automation and metering infrastructure space.
The company has a strong backlog and has
submitted tenders worth Euro 260 m and
reported revenues of Euro 76.9 m in CY12.
Even Emotron, a Swedish company, acquired in
May 2011 performed well and the operating
performance was positive during the quarter.
Investment Concerns
Margin pressures in power systems to
prevail: Margins from the power systems
segment were in the negative territory during
9MFY13. In FY12 too, the margin performance
of the segment was far from satisfactory with
EBIT margins of 3.3%. Historically, the segment
has delivered margins in the range of 8-9%.
Now, while some of the margin erosion is
attributable to the restructuring cost there were
also some issues pertaining to poor quality of
transformers. This resulted in some quality
related losses flowing through income
statement. Also, in the domestic market,
competition has intensified with order pipeline
getting delayed. This has put additional pressure
on margins. While the management stated that
quality issues are not likely to be repeated in
future as they have taken corrective actions if
they do than margins can come under severe
pressure.
Dormant order book: The current order book of
the company stands at Rs 92.3 bn with a book
to bill ratio (BTB) of 0.78x its trailing twelve
month sales. The order inflow during the current
quarter was Rs 22.7 bn. Power systems
registered an order inflow of Rs 17.2 bn while
industrial systems registered an inflow of Rs
5.39 bn. In the previous quarter, backlog stood
at Rs 94 bn with inflows of Rs 25.7 bn. Due to
an industry wide slowdown the order back log of
the company has relatively remained stagnant
for quite some time. Thus, if the ordering
22 February, 2013
Crompton Greaves Ltd. Page 3 of 8
Power
62%
9MFY13 revenue breakup
Industrial systems
16%
Consumer products
22%
environment does not improve in future revenue
growth could be at risk.
Recovery in international subsidiaries can be
prolonged: The restructuring process is
complete and management does not expect any
further contingencies in that regards. However, if
the Hungarian operations do not deliver as
intended it can impact the performance of the
company. Also, it should be noted that margins
at ZIV were lower during the quarter due to a
general slowdown in Spanish markets which
also resulted in deferment of orders. Further, the
capex cycle in UK is on a downward trend and
thus the pickup has been delayed. Even North
America is facing similar issues. If the macro-
economic environment does not improve in
these markets than the recovery of international
subsidiaries can get prolonged.
Background
CGL is a leading player in the power transmission
and distribution (T&D) equipment and services
business in India. In an industry dominated by large
MNCs, the company is India's largest private sector
enterprise engaged in designing, manufacturing and
marketing high technology electrical products and
services related to power generation, transmission,
distribution as well as executing turnkey projects.
CGL is organised into three business segments viz.,
Power Systems, Industrial Systems, and Consumer
Products. Presently, the company is offering a wide
range of products such as power and industrial
transformers, high-tension circuit breakers, railway
signaling equipments, lighting products, fans, pumps
etc.
The acquisition of Pauwels (Belgium) in FY06 and
Ganz (Hungary) in FY07 catapulted CGL to amongst
the top ten T&D equipment companies in the world.
Recently, it also acquired ZIV, a Spanish company
which has strong technological knowhow in grid
automation and metering infrastructure space.
Industry Prospects
The history of the Indian power sector suggests that
the government has traditionally focused more on
the generation end of the value chain to alleviate
power shortage in the country. As a result, the T&D
segment has been neglected and has attracted
significantly less investments. This has led to the
Indian T&D system constrained by exceptionally
high T&D losses (nearly 30%) as compared to global
average of 10% to 15%.
Taking this into consideration the government has
started making an effort to earmark a certain sum for
the development of transmission sector. The central
and state sectors are expected to contribute a
majority of this investment. While the planned
investment is huge and would certainly mean better
times for the power sector in the country, execution
will be a key risk, as has been the case with planned
investments in the past. The opportunity, however,
remains bright for equipment companies serving the
T&D space.
Key management personnel
Mr. Gautam Thapar (Chairman) holds a chemical
engineering degree from the Pratt Institute in US
and joined the family business in 1986. He is
instrumental in charting out the future growth path of
the company. In 2008, he also received the much
coveted Ernst & Young entrepreneur of the year
award in manufacturing.
Mr. Laurent Demortier (CEO & Managing
Director) holds this position since 02 June 2011. He
has an MBA from Wharton School, USA and an
engineering degree in physics from Ecole Centrale
Marseille, France. Prior to joining CGL, he was a
senior vice president at Alstom. Prior to Alstom, he
has also worked with Honeywell Group. Mr
Demortier has a collective experience of 25 years in
the industry.
Risk Analysis
Please see Risk Matrix table on page 6 of this report
Sector: Realizing the importance of T&D in the
overall development of the power sector in India,
there is a continued focus on modernization and up-
gradation of urban and rural power networks.
Capacity additions in existing power plants, setting
up of new power plants (including the ultra mega
power projects), development of transmission
networks and power distribution improvements have
resulted in strong orders for companies operating in
22 February, 2013
Crompton Greaves Ltd. Page 4 of 8
the sector. However, despite these positives,
companies in this sector are finding it difficult to
keep a check on margins owing to volatility in cost of
raw materials and increasing competition. As a
result, we assign a medium risk rating to the sector.
Company standing: CGL is amongst the leading
power T&D and industrial automation equipments
and projects companies in India. The company has
been a major beneficiary of the increased
investments in the T&D sector as also sustenance of
strong momentum in industrial capex. However, in
the last 18 months the performance of the company
has deteriorated. Margins have come under
pressure due to stiff competition and restructuring
process that is going on in the company. Based on
these aspects, we have assigned a medium rating
to the company on this parameter.
Sales: CGL has generated average annual sales of
US$ 1.8 bn over the past three years, growing the
same at a CAGR of 8.8%. Taking into consideration
the overall slowdown in the power T&D sector, we
expect sales to grow at a CAGR of 8.9% during the
period FY12 to FY15. However, considering that the
sales of the company are well above our benchmark
of US$1 bn we assign a low-risk rating of 10 to the
stock on this parameter.
Operating margin: Operating margin is a
measurement of what proportion of a company's
revenue is left over after paying for variable costs of
production such as raw materials, wages, sales,
marketing and administrative costs. A healthy
operating margin is required for a company to be
able to pay for its fixed costs, such as interest on
debt. The higher the margin, the better it is for the
company as it indicates its operating efficiency.
CGLs average operating margins for the past three
years has been 11.5%, which we expect to average
6.6% during the next three. Based on our
parameters, we assign a rating of 4 to the stock on
this factor.
Long term EPS growth: CGLs net profits have de-
grown at CAGR of 12.6% in the past three years due
to restructuring cost incurred in right sizing the
Belgium operations. However, during the next three
years, we expect the CAGR in profits to be 18.6% as
the restructuring process is now complete. As such,
the rating assigned to the stock on this factor is 6.
Return on invested capital (ROIC): ROIC is an
important tool to assess a company's potential to be
a quality investment by determining how well the
management is able to allocate capital into its
operations for future growth. A ROIC of above 15%
is considered decent for companies that are in a
growth and expansion phase. CGL has earned an
average ROIC of almost 33.7% over the past three
years, which we expect to decrease to around
12.2% over the next three. The rating assigned on
this parameter is 5.
Dividend payout: A stable dividend history inspires
confidence in the management's intentions of
rewarding shareholders. CGLs average payout ratio
has been 19.2% over the past three fiscals. Thus,
we have assigned a rating of 5.
Promoter holding: A larger share of promoter
holding indicates the confidence of the people who
run it. We believe that a greater than 40% promoter
holding indicates safety for retail investors. At the
end of December 2012, the promoter holding in CGL
stood 41.6%. We have thus assigned a rating of 7 to
the stock.
FII holding: We believe that FII holding of greater
than 25% can lead to high volatility in the stock
price. The FII holding in CGL at the end of
December 2012 stood at 17.8%. Based on our
parameters, the rating assigned is 5.
Liquidity: The average daily trading volumes of
CGLs stock over the past 52 weeks on both BSE
and NSE stand at around 1,339,000 shares, which
make it comfortably liquid. The rating assigned is 10,
which is part of the low-risk category.
Current ratio: CGLs average current ratio during
the period FY10 to FY12 has been 1.4 times. This
indicates that the company is comfortably placed to
pay off its short-term obligations, which gives
comfort to its lenders. We assign a medium-risk
rating of 5.
Debt to equity ratio: A highly leveraged business is
the first to get hit during times of economic
downturn, as companies have to consistently pay
interest costs, despite lower profitability. Considering
CGLs average debt equity ratio of 0.2 over the past
three years which we expect to increase to 0.4 over
the next three, the rating assigned to the stock is 7.
Interest coverage ratio (PBIT/Interest payment): It
is used to determine how comfortably a company is
placed in terms of payment of interest on
outstanding debt. The interest coverage ratio is
calculated by dividing a company's earnings before
interest and taxes (EBIT) by its interest expense for
a given period. The lower the ratio, the greater are
22 February, 2013
Crompton Greaves Ltd. Page 5 of 8
the risks. Given CGLs average interest coverage of
33.8 times over the past three years, the rating
assigned on this parameter is 10.
P/E Ratio: The P/E ratio (price-to-earnings ratio) of
a stock is a measure of the price paid for a share
relative to the per share income or profit earned by
the company. This is one of the important metrics to
judge the attractiveness of a stock, and thus gets the
highest weightage in our risk matrix. CGLs P/E on
its trailing 12 months earnings stands at 160 times. It
may be noted that the PE ratio appears to be
inflated as the company has made losses due to the
restructuring exercise undertaken over the last nine
month period. Based on these factors, we have
assigned a rating of 1 to the stock on this parameter.
Considering the above analysis, the total ranking
assigned to the company is 73 that, on a
weighted basis, stands at 5.5. This makes the
stock a medium-risk investment from a long-
term perspective.
Valuation rationale
Earlier we used to value the consolidated entity as a
whole on price to earnings (P/E) basis. But as the
subsidiaries started making losses we have decided
to value the standalone entity and subsidiaries
separately. As such, we now value the company on
sum of the parts (SOTP) basis. The reason for
switching to SOTP is persistent losses at subsidiary
level which makes assigning a PE multiple at a
consolidated level a difficult task.
We assign a PE multiple of 16x to the standalone
business. It may be noted that this in line with the
trailing twelve month average PE multiple since May
2011. We specifically gauged the standalone PE
multiple since May 2011 in order to value the
standalone business. Thats because it is from May
2011 the power business margins started coming
under pressure. Also, it was after May 2011 the
governance policies of the company came under the
scanner as it bought a corporate jet and its then
non-executive vice chairman sold off his stake in the
company. Thus, the TTM earnings multiples after
May 2011 reflect governance discount and
downtrend in the power business. Hence, we feel
that 16x is a reasonable multiple that the standalone
business can command even in this environment.
Applying a multiple of 16x to the standalone EPS of
FY15 (assuming standalone earnings are stagnated)
fetches us a per share value of Rs 116.
Considering that the subsidiaries are loss making we
value them on a P/BV basis. We have assigned a
multiple of 1.1x as the restructuring exercise is over.
This gives us a per share value of Rs 14 per share.
Thus, our SOTP based target stands at Rs 130 per
share. From the current price the stock can therefore
fetch a point to point return of 34% and CAGR of
15% over the next two to three years. As such, we
recommend investors to HOLD on to the stock.
Valuations
(Rs m) FY12 FY13E FY14E FY15E
Revenue (Rs m) 112,486 116,864 129,346 145,210
PAT (Rs m) 3,736 548 5,152 6,229
EPS (Rs) 5.8 0.9 8.0 9.7
Price to earnings (x) 16.5 112.8 12.0 9.9
Price to book value (x) 1.7 1.7 1.6 1.4
Price to sales (x) 0.5 0.5 0.5 0.4
22 February, 2013
Crompton Greaves Ltd. Page 6 of 8
Risk Matrix
(Rs m) FY10UA FY11E FY12E FY13E
Sales 124,627 40,124 43,861 47,668
Sales growth (%) 15.4% -67.8% 9.3% 8.7%
Operating profit 37,921 11,998 13,234 14,172
Operating profit margin (%) 30.4% 29.9% 30.2% 29.7%
Net profit 27,397 7,699 8,434 9,356
Net profit margin (%) 22.0% 19.2% 19.2% 19.6%
No of shares 91.7 91.7 91.7 91.7
EPS 298.8 84.0 92.0 102.0
Net fixed assets 18,290 22,735 27,152 29,476
Current assets 11,642 5,944 6,017 8,147
Investments 63,248 63,248 63,248 63,248
Total assets 93,181 91,926 96,417 100,870
Current liabilities 11,351 5,615 5,891 6,206
Net worth 71,454 75,934 81,150 87,288
Total debt 10,376 10,376 9,376 7,376
Total liabilities 93,181 91,926 96,417 100,870
Rating accorded
Rating Weightage* (A) Rating# (B) Weighted (A*B)
Sector risk - Medium NA
Company's standing - Medium NA
Performance parameters
Sales 5.0% 10 0.5
Operating margins 5.0% 4 0.2
Long term EPS growth 10.0% 4 0.4
Return on invested capital 10.0% 5 0.5
Technical parameters
Dividend payout 5.0% 5 0.3
Promoter holding 10.0% 7 0.7
FII holding 5.0% 5 0.3
Liquidity 10.0% 10 1.0
Safety parameters
Current ratio 5.0% 5 0.3
Debt to equity ratio 10.0% 7 0.7
Interest coverage ratio 5.0% 10 0.5
P/E ratio 20.0% 1 0.2
Final Rating** 73 5.5
# Rating has been assigned on the basis of the company's performance over the past five years and expected performance over the next 3 to
5 years. Rating is on a scale of 1 to 10, with 1 indicating highest risk and 10 indicating lowest risk. * 'Weightage' indicates the relative
importance in percentage terms of the parameter. For instance, for an investor, given all the performance metrics, Return on Equity should be
the foremost criteria for buying/not buying stocks. ** The final rating has been arrived at by multiplying the rating/points given on each
parameter with the respective weightage
22 February, 2013
Crompton Greaves Ltd. Page 7 of 8
Consolidated financials at a glance
Consolidated (Rs m) FY12 FY13E FY14E FY15E
Net sales 112,486 116,864 129,346 145,210
Sales growth (%) 12.4% 3.9% 10.7% 12.3%
Operating profit 8,036 4,558 9,960 11,762
Operating profit margin (%) 7.1% 3.9% 7.7% 8.1%
Net profit 3,736 548 5,152 6,229
Net profit margin (%) 3.3% 0.5% 4.0% 4.3%
Balance Sheet
Current assets 60,014 60,834 66,175 74,461
Fixed assets 16,693 19,590 22,003 24,099
Others 10,945 15,632 15,677 15,723
Total assets 87,652 96,056 103,854 114,283
Current liabilities 37,828 39,730 43,086 47,986
Net worth 36,109 35,763 39,796 44,908
Loan funds 9,849 16,653 16,986 17,326
Other Liabilities 3,865 3,910 3,986 4,063
Total liabilities 87,652 96,056 103,854 114,283
22 February, 2013
Crompton Greaves Ltd. Page 8 of 8
Equitymaster Agora Research Private Limited. All rights reserved.
Disclosure:
Equitymaster Agora Research Private Limited (hereinafter referred as 'Equitymaster') is an independent equity research
Company. The Author does not hold any share in the company/ies discussed in this document. Equitymaster may hold
shares in the company/ies discussed in this document under any of its other services.
Disclaimer:
This document is confidential and is supplied to you for information purposes only. It should not (directly or indirectly) be
reproduced, further distributed to any person or published, in whole or in part, for any purpose whatsoever, without the
consent of Equitymaster.
This document is not directed to, or intended for display, downloading, printing, reproducing or for distribution to or use by,
any person or entity, who is a citizen or resident or located in any locality, state, country or other jurisdiction, where such
distribution, publication, reproduction, availability or use would be contrary to law or regulation or what would subject
Equitymaster or its affiliates to any registration or licensing requirement within such jurisdiction. If this document is sent or
has reached any individual in such country, especially, USA, the same may be ignored.
This document does not constitute a personal recommendation or take into account the particular investment objectives,
financial situations, or needs of individual investors. Our investment recommendations are general in nature and available
electronically to all kind of investors irrespective of subscribers investment objectives and financial situation/risk profi le.
Before acting on any advice or recommendation in this document, investors should consider whether it is suitable for their
particular circumstances and, if necessary, seek professional advice. The price and value of the investments referred to in
this material and the income from them may go down as well as up, and investors may realize losses on any investments.
Past performance is not a guide for future performance, future returns are not guaranteed and a loss of original capital
may occur. Information herein is believed to be reliable but Equitymaster and its affiliates do not warrant its completeness
or accuracy. The views/opinions expressed are our current opinions as of the date appearing in the material and may be
subject to change from time to time without notice. This document should not be construed as an offer to sell or solicitation
of an offer to buy any security in any jurisdiction. Equitymaster and its affiliates, its directors, analyst and employees wi ll
not be responsible for any loss or liability incurred to any person as a consequence of his or any other person on his
behalf taking any investment decisions based on this document.
Important Message from Equitymaster:
We request you to sign up for the following to ensure that you make the most of your Equitymaster Subscription:
RSS feed for StockSelect Get intimated about a new report as soon as it is released
RSS feed for Views on News and Subscriber Features Do not miss out on any new investment idea/update
that we have posted on Equitymaster for our subscribers.
