V-Guard Industries: Well-insulated

Investors willing to bet on growth in consumer spending in India over the next few years, can consider buying the stock of leading cables and consumer electricals maker V-Guard Industries. From our ‘buy’ recommendation in November 2015 at ₹88, the stock has more than doubled to ₹183 now.

Still, it presents a buying opportunity, being lower than the high of ₹220 seen in May. The stock has been beaten down as the market sees challenges for the company from the GST. The effective indirect tax rate for the company now works out to 28 per cent from about 17-18 per cent earlier. So, the fear is that increase in end prices by 8-10 per cent by the company may hinder sales growth and suppress margins.

The company’s prospects though seem bright.

In the March 2017 quarter, it recorded a revenue growth of 21 per cent (volume growth of 17 per cent) over the same period last year. For the full year 2016-17, revenue growth was 15.5 per cent and profit growth was 36 per cent, year-on-year.

The GST will benefit the company as it will make it difficult for unorganised players to continue in the business. In cables, particularly, where a large share of the market is held by unorganised players in Tamil Nadu, Gujarat, Mumbai and Delhi, there could be a shift to V-Guard and others in the branded segment. And, given that the company will be able to claim input tax credit under GST, impact on profit margins should also not be significant.

Despite price increases, which can be about 8 per cent or more across product categories, V-Guard’s sales should continue to grow. One, demand for consumer electricals is likely to grow in the long term, as the affordability of the middle-class improves. Further, V-Guard’s focus on market expansion by tie-ups with new dealers/distributors in regions outside the South and launch of products across categories should help it grow at rates better than peers. The non-South markets accounted for about 35 per cent of sales in 2016-17, up from 33 per cent in the previous year and 25 per cent in 2012-13.

The stock trades at a valuation of 40 times its expected earnings for 2017-18, less expensive than its peer Havells that trades at about 42 times. On trailing 12-month earnings, V-Guard trades at 50 times. The stock has traded in the band of 30-60 times in the last three years.

After lacklustre growth in the December 2016 quarter due to demonetisation, V-Guard’s sales recovered in the March 2017 quarter. Net sales growth was 21 per cent, y-o-y (₹623.3 crore) with cables and wires, stabilisers, pumps and fans registering growth of 21.4 per cent, 25 per cent, 23.5 per cent and 14.3 per cent respectively. Water heater was the only product category to see a subdued 10 per cent sales growth.

Revenue from new products (that contributed 3 per cent to sales) rose 23.5 per cent over the same period last year, thanks to the launch of smart series inverters (controlled by smart phone app) during the quarter. The non-South markets continued to show robust growth. They contributed 34 per cent to revenues in the March 2017 quarter, up from 32 per cent in the same quarter in the previous year.

V-Guard intends to significantly increase investments in non-South markets this year and capture a high market share.

So, expenses on marketing may be higher. In 2016-17, the company spent ₹95 crore (4.4 per cent of sales) on advertising and promotion to improve brand visibility.

Currently, the company has a network of over 676 distributors, 5,975 channel partners and over 25,000+ retailers. It plans to expand further this year by increasing presence in tier II/III cities.

It was expected that cable makers may see indirect tax under GST go up to 24 per cent, but when the rates came out finally, it was a higher 28 per cent.

It was thus estimated that companies, including V-Guard, will have to take a significant price hike. This weighed on stocks of all consumer electricals makers. But V-Guard’s management does not see significant impact of GST on the company’s margins as it will be claiming input tax credit.

Though consumers and builders may see cost go up, the 8-10 per cent price increase is unlikely to alter the purchase decision. Also, impact, if any, on sales for V-Guard and other players in the cables/wires and consumer electricals space will only be for a short period.

Over the medium to long term, the demand for these products should only grow. The government’s initiatives, including ‘housing for all’ scheme, and payouts from the Seventh Pay Commission should aid demand.

GST is also advantageous for V-Guard and other organised players as it is set to bring more players from the unorganised market into the tax net and bridge the price difference.

The company’s operating profit margin in the March 2017 quarter was 10 per cent, 2.8 percentage points lower than in the same quarter last year.

Higher staff expenses and increase in raw material prices without commensurate increase in end prices contributed to the contraction in margins. However, the company took a price hike of about 4 per cent in April; so, margins in the June 2017 quarter should be better.

Margins may improve in the next one to two quarters if the company decides to remove the discounts it has been offering in the non-south markets. Launch of products in the premium category too, may help.

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