INITIATING COVERAGE CROMPTON IN EQUITY July 07, …reports.ambitcapital.com/reports/Ambit_CromptonConsumer_Initiation... · INITIATING COVERAGE CROMPTON IN EQUITY July 07, 2016 Crompton

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Priced to perfection

A much awaited demerger, new management and industry-beating growth guidance (with stable margins) have led to Crompton’s valuation (28x FY18 eps) rivalling market leader Havells. However, Crompton’s growth would at best track Havells (~16%; FY16-18) given (1) leadership in fans (23.4% share) caps upsides amid 7-8% industry growth potential; (2) weak appliance franchise—portfolio of just mixers/grinders/irons sold only at MBOs not traditional channel; (3) weak retail presence in lighting and ‘next big driver’ LED. We model margin dip as Crompton catches up with peers on ad spend (1% vs 3-4% for peers) with limited scope for cost reduction. These headwinds and rising competition from focused players imply imminent de-rating to 22.5x FY18E eps, a 25% discount to Havells. Key risk: strengthening of appliances and retail lighting channel.

Competitive position: STRONG Changes to this position: POSITIVE Under-invested brand; consumer connect on single product Crompton incurs a meagre 1% of revenue on ad spend vs 3-4% by peers like Havells and V-Guard. However, highest spend on IPL-2016 among peers and visible promotions (new dummies/catalogue and foreign trip) signal a change. Consumer connect is only through fans (45% of revenue), appliances (5%) and some lighting; this is a function under-investment in brand/ reach for new categories, lack of management focus and dearth of senior management. New management offers hope; but bring limited history of profits Both Shantanu (MD) and Mathew Job (CEO) are known to chase revenues at the cost of margins. Adopting a similar strategy may be margin disruptive as Crompton’s positioning is that of a mass brand like Bajaj. Financial investor Advent has global experience in home building, but it’s too early to say if it will be brought to India (channel checks suggest modest trade interaction).

Growth to track industry at best; margins, cash conversion to weaken We expect Crompton to grow in line with market (16%/15%/16% revenue CAGR for Crompton/Havells/V-Guard). However, margins would decline 80bps in FY17 to 11.1% and remain flat in FY18 due to higher ad spend and opex. We assume cash conversion to deteriorate by 8 days over FY16-18 to positive 3 days as Crompton loosens its credit terms to build channel beyond fans.

Valuations mirror Havells’ despite weaker franchise Valuation of 28x FY18 P/E is in line with Havells, a leader in multiple categories with an entrenched promoter. Despite its strengths, Havells is yet to make a mark in consumer durables; we doubt Crompton will succeed in the segment given high competitive intensity and newbies riding on ecommerce. Of all the consumer/light electrical players though Crompton is the second best today, others like V-Guard are scaling fast and hence we expect a de-rating. Key risk: Success in appliances and margin improvement.

INITIATING COVERAGE CROMPTON IN EQUITY July 07, 2016

Crompton ConsumerSELL

Light Electricals

Recommendation Mcap (bn): `89/US$1.3 1M ADV (mn): `174/US$2.6 CMP: `142 TP (12 mths): `115 Downside (%): 19

Flags Accounting: NOT APPLICABLE Predictability: NOT APPLICABLE Earnings Momentum: NOT APPLICABLE

Catalysts

Decline in EBITDA margin by 80bps over FY16-18

Limited success in appliances over FY16-18

Deterioration in cash conversion cycle by 8 days over FY16-18

Performance (%)

Source: Bloomberg, Ambit Capital Research

95

100

105

110M

ay-1

6

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-16

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-16

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16

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16

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16

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16

Sensex CGCEL

Research Analysts

Bhargav Buddhadev

+91 22 3043 3252

[email protected]

Deepesh Agarwal, CFA +91 22 3043 3275

[email protected]

Key financials YE March (̀ mn) FY16E FY17E FY18E FY19E

Operating income 35,869 41,685 48,366 54,967 EBITDA (%) 11.9 11.1 11.1 11.2

EPS (`) 4.2 4.1 4.9 5.7 RoE (%) 114.3 71.4 56.7 58.9

RoCE (%) 30.5 27.8 27.6 30.2

P/E (x) 34.0 33.0 27.8 23.7 P/BV (x) 38.9 17.3 14.5 13.5

Source: Company, Ambit Capital research

mailto:[email protected]


Crompton Consumer

July 07, 2016 Ambit Capital Pvt. Ltd. Page 2

Snapshot of Company Financials Profit and Loss Company Background Year to Mar (̀ mn) FY16E FY17E FY18E

Net revenues 35,869 41,685 48,366

EBITDA 31,586 37,064 42,991

Depreciation 125 128 115

Interest expense 338 642 642

Other Income 22 45 153

PBT 3,842 3,896 4,771

Tax 1,227 1,286 1,574

PAT 2,616 2,610 3,197

Profit and Loss Ratios

Gross margin (%) 30.5 31.4 31.2

EBITDA Margin (%) 11.9 11.1 11.1

Net profit margin (%) 7.3 6.3 6.6

EV/ EBITDA (x) 21.2 19.7 16.9

P/E (x) 32.3 32.4 26.5

EV/Sales (x) 2.5 2.2 1.9

Crompton Greaves Consumer Electricals (Crompton) has its origins in REB Crompton & Co., which was incorporated in 1878 to manufacture electrical equipment and then merged with F&A Parkinson to form Crompton Parkinson. In 1947, the Thapar family bought Crompton Parkinson and later restructured it in 1966 to form Crompton Greaves (CRG).

In Oct 2015, the consumer electrical business of CRG was demerged into Crompton and the Thapars sold its stake to Advent International and Temasek Holdings (both private equity firms).

Balance Sheet Cash flow Year to Mar (̀ mn) FY16E FY17E FY18E

Total Assets 16,487 20,266 22,551

Fixed Assets 8,581 8,581 8,581

Current Assets 7,907 11,685 13,970

Investments - - -

Total Liabilities 16,487 20,266 22,551

Total networth 2,288 4,898 5,841

Total debt 7,172 7,172 7,172

Current liabilities 7,206 8,374 9,716

Deferred tax liability (178) (178) (178)

Balance Sheet ratios

RoCE 30.5 25.3 27.5

RoE 114.3 72.7 59.5

Net debt (cash)/ Eq (x) 2.7 0.8 0.7

P/B (x) 37.0 17.3 14.5

Year to March (̀ mn) FY16E FY17E FY18E

PBT 3,842 3,896 4,771

Depreciation 125 128 115

Interest 338 642 642

Tax (1,227) (1,286) (1,574) (Incr) / decr in working capital - (453) (703)

Others

CFO 3,079 2,927 3,250

Capex (125) (128) (115)

CFI (125) (128) (115)

Issuance of equity

Incr / (decr) in borrowings - - -

Others (338) (642) (642)

CFF (338) (642) (642)

Net change in cash 2,616 2,157 2,493

Crompton’s franchise – market leader in fans (figures indicate FY15 market share)

Fans Lighting Pumps Appliances + water heater

Industry Size (̀ bn) 63




Crompton 23.4% Philips 20.70% KBL 15.00% Bajaj 15.20%

Orient 14.4% Surya 7.00% KSB Pumps 8.10% Philips 10.10%

Havells 12.3% Crompton 6.00% CRI 7.00% Preethi 3.90%

Bajaj 10.4% Bajaj 5.50% Crompton 5.80% Havells 2.70%

Usha 8.7% Havells 4.50% Grundfos 4.00% Crompton 2.20%

Source: Bloomberg, Ambit Capital research

Crompton Consumer


Strong franchise, under-invested brand Crompton is a stellar franchise with market leadership in fans and a top 3 position in lighting and domestic pumps. Over the past decade, Crompton reported 17% revenue CAGR led by (a) strong growth in fans (18% CAGR) and lighting (26% CAGR). It has also reported strong EBITDA margin of 12% and RoCE of 186% over FY05-15. However, Crompton lacks product diversification (fans get 45% revenue) due to under-investment in brand, lack of management focus, and dearth of senior management in the team.

A strong franchise… The genesis: Crompton Greaves Consumer Electricals (Crompton) has its origins in REB Crompton & Co. that was incorporated in 1878 to manufacture electrical equipment and was merged with F&A Parkinson to form Crompton Parkinson. In 1947, the Thapar family bought Crompton Parkinson and in 1966 restructured it to form Crompton Greaves (CRG). In Oct 2015, the consumer electrical business of CRG was demerged into Crompton and the Thapar family sold its stake to Advent International and Temasek Holdings (both private equity firms).

Market leader in fans

Crompton is India’s fourth-largest light electrical company with a revenue market share of ~4.3% in FY15. Crompton has four products in the light electrical space – fans (entered in 1937), lighting, pumps and small appliances (entered in FY09). In fans, Crompton is the market leader with a market share of ~23.4% as of FY15 (900bps higher than the second-largest player Orient). In lighting and pumps, Crompton is the third-largest and fourth-largest player with market shares of 6% and 5.8% respectively. However, in domestic appliances, Crompton is a small player with a market share of just ~2.2%; it has struggled to make a mark (entered and exited the segment twice).

Exhibit 1: Crompton’s franchise – market leader in fans (figures indicate FY15 market share)

Fans Lighting Pumps Appliances + water heater

Industry Size (̀ bn) 63 Industry Size (̀ bn) 164 Industry Size (̀ bn) 100 Industry Size (̀ bn) 92

Crompton 23.4% Philips 20.7% KBL 15.0% Bajaj 15.2%

Orient 14.4% Surya 7.0% KSB Pumps 8.1% Philips 10.1%

Havells 12.3% Crompton 6.0% CRI 7.0% Preethi 3.9%

Bajaj 10.4% Bajaj 5.5% Crompton 5.8% Havells 2.7%

Usha 8.7% Havells 4.5% Grundfos 4.0% Crompton 2.2%

Source: Company, MCA, Ace Equity, Industry, Euro Monitor, Ambit Capital research

Strong revenue growth and RoCE

Over the past decade, Crompton has reported 17% revenue CAGR led by (a) strong growth in fans (18% CAGR) and lighting (26% CAGR); and (b) entry into appliances (6% of revenue in FY15 vs nil in FY05). Crompton reported strong EBITDA margin of 12% and RoCE of 186% over FY05-15 led by negligible ad spend (0.9% of FY05-15 revenue) and asset light model (outsourcing from vendor at 46% of revenue in FY15).

Crompton is India’s fourth largest light electrical company

FY15 figures

Light Electrical market (̀ bn) 745

Market share

Havells 7.0%

Polycab 5.8%

Philips 5.8%

Crompton 4.3%

Bajaj Electricals 3.9%

Source: Industry, Ambit Capital research

Crompton saw 17% revenue CAGR and 186% ROCE over FY05-15

Crompton Consumer


Exhibit 2: Crompton’s revenue has increased at 17% CAGR over FY05-15…


Exhibit 3: …with stellar EBITDA margin of 12% and RoCE of 186% over FY05-15...

Source: Company, Ambit Capital research, Note – FY15 RoCE is not comparable as the capital employed turned negative due to debt taken for demerger

Exhibit 4: …led by strong capital employed turnover (asset-light model)…

Source: Company, Ambit Capital research, Note: FY15 figure is not comparable as the company took

Exhibit 5: …due to reliance on outsourcing from vendors Outsourcing cost as % of revenue FY12 FY13 FY14 FY15 Average

Fans 37% 36% 38% 34% 36%

Lighting 53% 56% 57% 50% 54%

Pumps 59% 60% 61% 60% 60%

Appliances 76% 81% 76% 75% 77%

Total 49% 51% 51% 46% 49%


…but lacks diversified product portfolio Crompton is primarily a single-product company with fans accounting for 45% of FY15 revenue (FY16 data unavailable) followed by lighting at 30%. It has neither diversified into switchgears, non-electrical appliances, cables & wires nor scaled up its business in the small electrical appliances and water heaters portfolio. This is because of:

Under-investment in brand: Ad-spend as a percentage of revenue stood at a meagre 0.9% over FY05-15 (FY16 data unavailable) vs 2.3% for peers. This may have been on account of cash burn in the conventional power and industrial business of the erstwhile CRG;

Lacked management focus: Despite the consumer business accounting for 48% of CRG’s consolidated profit, both MDs Sudhir Trehan (FY01-11) and later Laurent Demortier (FY12-16) were technocrats and, hence, used to spend maximum amount of time in the power and industrial business. This was also visible in analyst interactions where disproportionate time was spent discussing the power and industrial business. Even on the senior management side, the consumer business was under-staffed vis-à-vis the engineering business (see exhibit 10).

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Capital employed turnover (x)

Crompton has primarily been a single product company with fan accounting for 45% of revenue followed by lighting at 30%

Crompton spent 0.9% of revenue on advertisement over FY05-15 vs 2.3% by peers

Both Sudhir Trehan and Laurent Demortier were technocrats and hence spent maximum time on power and industrial business

Crompton Consumer


Dearth of senior management in the team. As per our channel checks, Crompton did not have many senior people in their consumer team (see exhibit 10 below). This may have been because of the great brand recall that Crompton brand enjoys in the market. Given this sector does not need any cutting edge technology, the business runs on people relationships (discussed in detail on page 17), which in turn typically help build distribution – the main driver of revenues alongside product differentiation.

A few examples senior people making a difference are: Sachin Jha, who was a blue eyed boy of QRG (ex CMD of Havells), helped V-Guard (South India based company) in building a strong presence in the North; Ramakrishna, who was the executive director at Bajaj Electricals, is helping Polycab in building a consumer portfolio for the company which has a primary focus on cables and wires.

Exhibit 6: Crompton is predominantly a fans company…

FY11 FY12 FY13 FY14 FY15

Revenue (̀ mn)

Fans 9,097 9,122 11,138 12,120 14,782

Lighting 5,703 6,667 7,689 8,790 9,836

Pumps 5,217 5,019 5,869 5,790 6,585

Appliances 969 1,211 2,120 1,817 2,010

Total 20,986 22,019 26,816 28,517 33,213

Revenue share (%) Fans 43% 41% 42% 43% 45%

Lighting 27% 30% 29% 31% 30%

Pumps 25% 23% 22% 20% 20%

Appliances 5% 5% 8% 6% 5%


Exhibit 7: …with poor diversification into other product categories…

Category Product Crompton Havells Philips V-Guard Bajaj Orient Finolex Polycab

Electrical consumer durables Fans

Water heater

Irons

Kitchen appliances

Stabilisers, Invertors

Lighting CFLs

LEDs

Indoor Luminaries

Outdoor Luminaries

Switchgears / Switches Domestic switchgear

Switches

Cables and wires Low voltage

High voltage

Residential wires

Source: Industry, Ambit Capital research; Note: represents amongst top four players, represents amongst top 5-10 players, represents weak presence

and represents absence in the category

As per our channel checks, Crompton did not have senior people in their consumer team; this may have been on account of the great brand re-call that the Crompton’s brand enjoyed

Crompton Consumer


Exhibit 8: Lower than industry ad spend over FY05-15…

Ad spend as a % revenue FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 Average over

FY05-09 FY10-15 FY05-15

Havells (standalone) 2.8 3.1 2.0 2.6 2.3 3.5 2.5 3.1 3.1 2.4 3.0 2.6 2.9 2.8

Finolex 0.4 0.3 0.4 0.5 0.3 0.4 0.4 0.5 0.5 0.4 0.7 0.4 0.5 0.4

V-Guard 5.3 4.7 5.4 5.7 5.1 5.1 3.8 4.2 4.3 3.9 4.0 5.2 4.2 4.7

Philips 3.2 3.3 2.9 3.1 2.8 3.7 3.3 2.9 2.7 2.8 3.5 3.1 3.2 3.1

Khaitan 2.8 3.2 2.2 2.4 2.1 1.7 2.3 2.0 1.2 1.7 1.1 2.6 1.7 2.1

Surya Roshini 1.2 1.0 1.1 0.6 2.3 2.0 1.3 0.6 0.5 0.4 0.8 1.2 0.9 1.1

Bajaj (non-E&P) 2.5 2.6 2.3 2.1 1.9 2.2 1.9 1.8 1.6 2.2 1.9 2.3 1.9 2.1

CRG (consumer) 0.6 0.5 0.9 1.0 1.1 1.5 0.5 0.7 0.9 1.0 1.0 0.8 0.9 0.9

Average (excl. CRG) 2.6 2.6 2.3 2.4 2.4 2.6 2.2 2.2 2.0 2.0 2.1 2.5 2.2 2.3

Source: Company, MCA, Ace Equity, Capitaline, Ambit Capital research, Note – we take CRG’s ad spend as a % of its total standalone revenue

Exhibit 9: …due to cash burn in the power and industrial business of CRG…

Source: Company, Ambit Capital research, we calculate FCF of power and industrial business by subtracting FCF of consumer business from consolidated FCF of CRG

Exhibit 10: …and lack of senior management focus in the consumer business

Name Designation FY15 salary (̀ mn) Comment

Consumer business

Ashwani Gupta EVP (consumer/global strategy)

28.4

Shared between global strategy and consumer business

Uday Mahajani VP - fans 9.2 Ramesh Kumar Global Sales

Head 7.4 Raj Ray GM - design 6.7 Premanand Bhat GM - Pumps 6.4 Sundar Iyer GM - Consumer 6.1 Dhruva Chandrie GM - Appliances 3.4 Power and industrial

Laurent Demortier MD 65.6 Primarily involved in power and industrial

Jayant Kumar EVP 21.6 Dileep Patil EVP & CTO 17.7 Anil Raina EVP (Industrial) 15.5 Srinivas Ponnaluri VP & CTO 11.6 Vijay Lele Global product

line head 7.9 Sajal Mukherjee VP - LT motors 6.6 Anil Kamra DGM 5.1 Shrirang Karandikar GM 3.9 N. Viswanath VP - logistics 3.9 Source: Company, Ambit Capital research

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Consumer business Power and industrial

`

Crompton Consumer


Awaited demerger and new management team – another Havells in the making? Crompton’s awaited demerger builds in lot of hopes around the new management transforming Crompton into a market leading diversified franchise like Havells. The stock now trades in line with segment leader Havells, at ~28x FY18E P/E, given expectations that newfound aggression would drive: (a) greater share in premium fans, (b) successful diversification into water heaters/appliances (`101bn organised market); and (c) sustenance of margins (at 2HFY17 level of 11.6%) despite aggressive investment in brand building. Advent’s (a top 20 private equity firm globally) investment in Crompton is being compared with successful investments of PE firms like Warburg Pincus in Havells and Nalanda in V-Guard; both Havells and V-Guard saw strong share price performance after the investments by the private equity investors.

Hopes galore riding on the new team Crompton’s listing has been a dream debut. The stock is currently trading at 28x FY18E P/E, in line with Havells, on the expectations that the new management will transform Crompton into what Havells is today. Havells today is a market leader in light electricals with presence across 17 categories; it is a top 3 player in switchgears, YY and ZZ. Our interaction with a lot of investors suggests that there are 3 expectations from the new team of Mr Shantanu Khosla (MD), Mr Sandeep Batra (CFO) and Mr Matthew Job (CEO):

Increase the share of premium fans: Crompton’s share in premium fans (selling price >`2,000) is only 10% (as per management) compared to ~70%/50% for Havells/industry. This is despite he fact that the premium fans segment has been growing at the fastest pace in the overall fans category, with revenue CAGR of ~32% over FY10-15. Industry growth has been driven by an increase in the share of premium fans from 20% in FY10 to 50% in FY15. Also, premium fans enjoy higher margins; Havells in electrical consumer durables (~70% sales is fans) does 14.6% EBIT margin (net of un-allocable expenses) vs 7-8% for other fans players.

Moreover, only premium fans are growing; the overall fans market is in slowdown mode with revenue CAGR decelerating from 15% over FY05-10 to 6% over FY10-15. This is led by the share of the unorganised market declining from 75% in FY01 to 30% in FY15 (see exhibit below).

Advent’s investment in Crompton is being compared with successful investments of PE firms like Warburg Pincus in Havells and Nalanda in V-Guard; both Havells and V-Guard saw strong share price performance after the investments by the private equity investors.

Crompton’s listing has been a dream debut; at CMP on FY18 P/E it is trading in line to Havells. Investors have a lot of hope from the new management team of Shantanu, Sandeep and Matthew

Share of premium fans for Crompton is only 10% vs ~70%/50% for Havells/industry

Only premium fans market is growing; share in total fans has increased from 20% in FY10 to 50% in FY15

Exhibit 11: Industry volume growth has tapered from 15% over FY05-10 to 6% over FY10-15…

Source: Euro Monitor, Ambit Capital research

Exhibit 12: …as the pace of decline in share of unorganised players reduced (as per channel partners)…

Source: Channel partners, Ambit Capital research

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Fans volumes (mn)

14% CAGR over FY01-05



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Crompton Consumer


Diversify product portfolio by increasing revenue of water heaters and domestic appliances: As highlighted in exhibit 6, Crompton lacks product diversification. This is despite the electrical channel being able to sell fans, cables & wires, water heaters, stabilizers & inverters, and switches & switchgears. With Matthew Job now CEO, there is widespread expectation that Crompton will expand aggressively in water heaters/small appliances, which are `15bn/`62bn per annum markets. Expectations on Matthew Job come from the fact that he was MD of Racold, the market leader in water heaters, and before that spent 15 years as senior marketing officer at Philips, India’s no 1 premium appliances brand.

Exhibit 17: Fans channel can sell multiple products Product/dealer selling the product

Electrical dealer

Appliance dealer

Hardware dealer

Modern retail

Electrical cables and wires Fans

Water heater

Switches

Switchgear

Lighting

Luminaries

Induction cooktop

Mixer/grinder

Iron

Pumps Source: Industry, Ambit Capital research

Exhibit 13: …and per household penetration of fans hit 1.9x in FY11 from 1.5x in FY01

FY01 FY11

Fans volume organised (mn) A 8 28

Share of unorganised players B 75% 45% Fans volume organised + unorganised (mn) C = A/B 32 52

Fans population (assuming useful life of 9 years) D = C x 9 284 466

Number of households (mn) E 187 245

Fans per household (x) F = D / E 1.5 1.9

Source: Channel partners, Euro Monitor, Ambit Capital research

Exhibit 14: However, fans value growth has been higher than volume growth over FY10-15…


Exhibit 15: …led by increase in the share of premium market to ~50% in FY15 from 20% in FY10…

Source: Channel partners, Ambit Capital research

Exhibit 16: …as corroborated by increase in average selling price by 4% over FY10-15 vs 0.5% over FY01-10


Crompton lacks product diversification; with Matthew Job as CEO there is an expectation that Crompton will expand aggressively in small appliances and water heaters given his background in Philips and Racold

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Fans industry (`bn)







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4.0% CAGR over FY10-15

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Break-up of fans industry (value)

Crompton Consumer


A multi-product company has the key advantage of sweating its brand. One of the reasons for Havells’ sustained above-industry growth is its consistency in launching new products. Havells has the highest number of categories in its repertoire, 13, compared with just ~7 for Crompton. Our channel checks suggest that it makes the job of the channel much easier to sell a brand which has multiple products given that the customer for various categories is the same. If the customer likes the product of a particular brand, there is high probability that the channel will also sell him other products of the same brand. This is corroborated by various advertisements on TV where the emphasis is more on depicting the brand rather than the product.

Exhibit 18: Havells has consistently outperformed industry growth…

Revenue in ̀ mn FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 CAGR over FY05-15

Havells 5,820 10,035 15,472 20,556 21,984 23,712 28,817 36,156 42,250 47,197 52,387 54,369 25%

Polycab 10,824 12,556 19,674 21,304 22,473 25,114 31,767 37,756 37,195 38,423 43,219 NA 15%

Philips 25,780 29,600 28,001 20,492 24,820 25,612 NA 27,822 37,912 40,601 43,175 NA 5%

Bajaj 5,585 5,992 7,721 10,105 12,417 14,904 19,082 22,653 26,981 28,956 29,219 30,602 18%

Crompton 6,712 8,166 9,927 11,667 13,218 16,119 20,207 21,324 25,915 28,457 32,318 35,869 17%

Finolex 5,708 7,478 10,330 13,838 13,415 16,187 20,358 20,640 22,707 23,590 24,491 24,611 16%

V-Guard 1,341 1,701 2,227 2,786 3,174 4,547 7,266 9,936 13,602 15,176 17,459 18,626 29%

Orient Electric 1,648 1,919 2,425 2,851 3,414 4,808 6,423 7,557 9,118 11,033 11,639 12,961 22%

Surya Roshni 2,691 3,127 3,237 3,472 3,818 5,599 7,502 7,698 9,064 10,772 11,852 14,718 16%

Khaitan Electric 1,122 1,904 2,843 3,200 2,847 3,569 4,659 4,413 5,118 5,137 4,300 NA 14%

Top ten players 67,230 82,477 101,856 110,269 121,581 140,171 146,080 195,956 229,861 251,971 270,059 NA 15%

Excl. Havells 61,411 72,442 86,384 89,713 99,597 116,460 117,264 159,800 187,611 204,774 217,672 NA 13%

Source: MCA, Ace Equity, Ambit Capital research, Note – FY16 financial for Polycab, Philips and Khaitan not available

Exhibit 19: ...led by launch of new products on a regular basis

Product Launched in

Fans 2003

CFL 2003

Lighting 2003

Electric water heater 2010

Domestic Appliances 2011

Pumps 2013


Needless to say, with annual-turnover-related incentives being a big part of dealers’ total commission (~2% of sales), the company with the highest number of categories will always find more takers.

Exhibit 20: Annual-turnover-related incentives form a large part of the dealer’s total commission

Dealer’s earnings As % of sales

Turnover incentives (cash + kind) ~2%

Trading commission 3-4%

Total earnings 5-6%


Maintain profitability despite market leading growth: There is widespread expectation that Crompton will maintain margins despite rising advertisement/promotion spend. The extra spend on advertising/promotion should get offset by (a) improvement in gross margin with rising premiumisation, and (b) favourable operating leverage as Crompton grows revenue faster than industry. Historically, Crompton has lagged Havells on revenue growth. On the gross margin front, too, Crompton has lagged Havells in 2HFY16 (data prior to 2HFY16 is unavailable).

Advantage of being a multi-product player is one can sweat the brand more. Havells is a classic example

With annual-turnover-related incentives being a part of the dealer’s total commission, the company with highest number of categories will always find more takers

Crompton has lagged Havells on revenue growth over FY11-16


14%

12%

11%

12%

13%

14%

Havells CGCEL

Revenue CAGR over FY11-16

Crompton Consumer


What does Advent bring to the table?

In Apr 2015, Advent International along with Temasek entered a deal with Avantha Holdings (promoters of Crompton Greaves) to buy 34.4% of Crompton Greaves’ consumer product business at `93.6/share. Consequent to this deal, the consumer business got demerged from Crompton Greaves into a separate company called Crompton. The balance shareholding (65.6%) on the day of listing was the same as the shareholding in Crompton Greaves as on the record date, 16 Mar 2016 (see exhibit 69 and 70 on page 31).

With a private equity (PE) investor coming on board, there is an expectation that it will be aggressive on (a) spending on brand building, (b) expanding the product portfolio and (c) improving profitability. The expectation is on the back of a high hurdle rate for private equity (PE) investors. As a thumb rule, PE investors have a hurdle rate expectation in excess of 15%. Both Havells and V-Guard have seen strong share price performance after entry of PE investors; whilst V-Guard’s share price has appreciated 8x since Nalanda became shareholder in Jan 2011, Havells’ share price has appreciated 5x since Warburg invested in Oct 2007. Whilst Nalanda is still holding on, Warburg exited in May 2013 after doubling its money over FY08-14.

Exhibit 21: Havells has seen strong share price performance post entry of PE investors…


Exhibit 22: …ditto for V-Guard


Founded in 1984, Advent International is among the top 20 PE firms globally. Advent, with AUM of US$30bn, has done 310 transactions over 40 countries since incorporation in 1989. The firm specializes in investing in five core sectors; financial services, healthcare, industrial, retail/consumer/leisure and technology/media/telecom. It is difficult to assess the track record of Advent’s investee companies given limited information available. Advent has ~104 investments globally in its portfolio; these are primarily in the USA (31) followed by Brazil (10) and the UK (9). In India, Advent has only four investments; Crompton is its fifth investment. Within sectors, 29 investments globally are in the consumer discretionary space, but only one investment (Allied in Brazil) in electrical consumer durables (see exhibit 72 on page 32 for details). Allied SA has consumer durables modern retail format store (sales and service store) for cell phones, laptops, tablets, etc in Brazil for Apple, LG, Philips, Nikon, Motorola, etc.

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Warburgacquires 11% stake in Havells

Warburg sold entire stake with 2x return

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Nalanda acquires 8% stake in V-Guard

Both Havells and V-Guard saw strong share price performance after entry of PE investors

Advent is a multinational PE investor with more than 300 transactions across 40 countries

Crompton Consumer


Optimism on new team ignoring some formidable headwinds We don’t believe Crompton’s new management team will match up to investor optimism. In fans, Crompton may struggle to gain market share given (a) share of premium fans in revenue is already high at ~35% (as per channel) vs management’s claim of 10%; (b) growth in appliances is tough given long gestation period required to build a new distribution network; and (c) maintaining profitability will be a tall task with ramp-up in ad-spend (from 1.5% in FY16E to 3% in FY18E) and management track record of being revenue rollers at the cost of margins.

Premium fans share much higher than Crompton claims Crompton’s fan portfolio has grown at 14.1% CAGR over the last five years vs 16.7%/10% for Havells/industry. Crompton’s levels seem improbable given premium fans form only 10% of its total portfolio.

Exhibit 23: Crompton’s market share improved from 19% in FY10 to 23% in FY15… ` bn FY10 FY11 FY12 FY13 FY14 FY15 CAGR over FY10-15

Revenue Crompton 7.6 9.1 9.1 11.1 13.1 14.8 14.1%

Orient 4.8 5.9 6.6 7.4 8.6 9.1 13.7%

Havells* 3.6 4.9 5.7 6.8 7.5 7.8 16.7%

Bajaj 3.8 5.1 5.5 6.1 6.2 6.6 11.9%

Top 4 players 19.8 25.0 26.9 31.4 35.4 38.3 14.1%

Industry size 39.3 44.7 49.5 53.7 58.4 63.2 10.0%

Market share Crompton 19.4% 20.4% 18.4% 20.7% 22.4% 23.4% Orient 12.2% 13.2% 13.3% 13.9% 14.7% 14.4% Havells* 9.1% 11.0% 11.5% 12.6% 12.8% 12.3% Bajaj 9.6% 11.5% 11.0% 11.4% 10.6% 10.4% Source: Euro Monitor, Company, Ambit Capital research, Note – * we estimate Havells’ fans revenue from the market share data in the annual report

Exhibit 24: …which implies premium portfolio is >10% given industry growth is led by premium fans

` bn FY10 FY15 CAGR over FY10-15

Economy and Standard 31.5 31.6 0.1%

Premium 7.9 31.6 32.1%

Total fans industry 39.3 63.2 10.0%

Crompton's fans 7.6 14.8 14.3%

Source: Euro Monitor, Channel Partners, Ambit Capital research

As per our channel checks, relative to Havells and Orient, Crompton’s share of premium fans may be lower but not as low as 10%. This should put to rest expectations of very high growth in fans led by significant under-penetration in premium fans. Moreover, our channel checks suggest enough reasons for Crompton’s sales in premium fans being lower than Havells and Orient. Three reasons for our view are:

Outsourced model: As per our channel checks, Crompton’s premium fans are primarily outsourced as opposed to economy and standard fans being manufactured at the Goa and Baddi facility. As a result, there are several complaints pertaining to availability of spare parts given vendors for Crompton’s fans are not exclusive. After domestic appliances, fan is the next product in terms of servicing requirement. This is one of the reasons why distributors don’t push Crompton’s premium fans over Havells and Orient which manufacture theirs in-house at their Haridwar and Kolkata/Noida/Faridabad factory.

Crompton’s 14% CAGR in fan over the last five years cannot be possible with premium fans forming only 10% of the total portfolio

Relative to Havells and Orient, Crompton’s share of premium fans may be lower, but not as low as 10%....

….this should put to rest expectations of very high growth in fans led by significant under penetration in premium fans

Crompton’s premium fans are primarily outsourced leading to complains pertaining to availability of spare parts

Crompton Consumer


Exhibit 25: Crompton’s premium fans SKUs are lower than those of Havells/Orient

Company No. of fan SKUs above ̀ 2K on Amazon

Havells 116

Orient 60

Usha 49

Bajaj 57

Crompton 53

Standard 23

Source: Amazon, Ambit Capital research

We believe Crompton may look at scaling up manufacturing of premium fans to gain market share. If this happens then it would boost growth for the overall fans segment; we have assumed 17.5% revenue growth in fans over FY16-18 vs 14.1% over FY10-15. However, Crompton has lost the first mover advantage that Havells enjoyed in premium fans; hence, we don’t believe its premium portfolio can match Havells’ (share of premium in overall fans is 70%).

There are also several players emerging with a rising focus on the premium portfolio. Bajaj Electricals, V-Guard and Finolex (recent entrant) have increased focus on the premium range especially given decelerating growth of economy and standard fans.

Exhibit 26: Competition in premium fans is rising with V-Guard…


Exhibit 27: …and Bajaj launching new premium models


No new hires in sales team: As per our discussion with management, there has been no new hiring in sales after the arrival of the new management. Given that sales team has monthly targets, there is a very high probability that they will continue to focus on their core strength of economy and standard fans.

Brand recall among youth is weak: Arguably, premium fans are largely bought by the youth (vs utility bias for older customers). Havells has a strong connect with the youth given consistent ad spend, strong online presence and highest number of SKUs on the e-commerce portals (refer exhibit 28), while Crompton lags on all these fronts. Whilst Crompton has started to focus on building its youth connect through advertisement (started only in FY17), we believe it will have to go through a long gestation period given the periodicity of purchase of electrical products is not as frequent as that of FMCG products.

Rising competition in premium fans from players like V-Guard, Bajaj and now Finolex will make Crompton’s foray into premium fans that much more difficult

Don’t believe Crompton can match Havells in the premium fan business given it has lost the first mover advantage

With no new sales team hired, there is a high probability that the team will sell what they know the best given monthly targets

Younger generation prefers premium fans given vs utility in the case of veterans; Crompton lags Havells on this

Crompton Consumer


Exhibit 28: Havells has an impressive online presence…


Exhibit 29: …while Crompton only recently launched its new website


Diversification into domestic appliances challenging Crompton should succeed in scaling up water heaters

We believe Crompton may succeed in water heaters given Matthew Job’s stint as the MD of Racold, which is India’s no.1 water heater company.

Racold has been the consistent no.1 player in water heaters: Matthew Job joined Racold as its MD after 15 years at Philips as senior marketing director and 2 years as MD of Grohe India (sanitaryware firm). Racold is the market leader in water heaters. The strengths of Racold are: (a) state-of-the-art factory at Chakkan; (b) product range and quality given strong parent pedigree – R&D and designing of the product are done by the parent, (c) strong processes which ensure timely availability of products to the distributor and timely addressability of consumer complaints; and (d) strict compliance to company policies on schemes offered to different channel partners.

Exhibit 30: Racold saw revenue CAGR of 14% over CY11-14 after Matthew joined

Source: MCA, Ambit Capital research

Matthew could improve water heater market share: Water heaters are in the electrical channel which sells fans, switches, switchgears and cables & wires. Given Crompton is a market leader in fans and this channel also sells water heaters, Matthew needs to introduce a good quality water heater in the market. We believe this is likely given his success at Racold. Crompton has been selling water heaters, but its market share is a low 8% (as per channel) as it does not have a credible premium model and lacks marketing effort.

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Revenue (Rsbn)

14% CAGR over CY11-14Mathews Job joined Racold

Strengths of Racold: (a) state of the art factory; (b) strong product range and quality; and (c) strict adherence to company policies.

Matthew has already started meeting large fan distributors to take feedback on the type of water heater to be launched in the market

Crompton Consumer


Our channel check suggests that Matthew has started meeting large fan distributors for feedback on the type of water heaters that Crompton should sell. Given Racold’s market leadership in water heaters and Crompton’s strong brand in fans, Matthew can leverage on his relationships with key water heater distributors to help Crompton.

Exhibit 31: Crompton’s market share in water heaters is a paltry 8% given…

FY15 figures ` bn Market share (%)

Industry 15 Players Racold 2.8 19%

Bajaj 2.5 17%

V-Guard 2.3 15%

Crompton 1.2 8%

Source: Company, Industry, Ambit Capital research

Exhibit 32: …non-impressive models…


Exhibit 33: …vs Racold


Exhibit 34: …and V-Guard


Diversified pan-India players except BJE absent in top 3: Racold, Bajaj Electricals and V-Guard are India’s top 3 water heater players with FY16 revenue of `2.8bn/`2.5bn/`2.3bn. Amongst the pan-India diversified players, only BJE figures in the top 3 list. Havells and Crompton, which have wider distribution networks than Racold and V-Guard, have yet not focused on the water heater market. Crompton has a lot of scope to become the top 3 water heater by leveraging its strong distribution network and improving product portfolio and Matthew Job’s experience in the segment.

Crompton will face several challenges in scaling up domestic appliances

Crompton has historically faced challenges in scaling up its domestic appliances business; in fact, it has on more than one occasion entered and exited the appliances segment. Even Crompton’s peers like Havells, Orient, Usha, V-Guard have not been able to become successful players in appliances. Apart from BJE and Philips, which are diversified pan-India players, the industry has been dominated by pure play regional appliance companies like Gandhimathi, Maharaja Whilteline (now Groupe SEB India) and Preethi. Note TTK Prestige and Hawkins are primarily in kitchen appliances and have weak presence in electrical appliances.

Probability of Crompton succeeding in water heaters is high as none of the pan India incumbent players except BJE are top 3 players in water heaters

Crompton has historically faced challenges in scaling up its domestic appliances; in fact it has on more than one occasion entered and exited the appliances segment

Crompton Consumer


Exhibit 35: Only pure play appliance companies have been successful in appliances

` mn unless specified (FY15) Appliances (excl. water heater) Market share (%)

BJE 11,460 13.4%

Philips 9,247 10.8%

Preethi 3,580 4.2%

Groupe SEB India (Maharaja White line) 3,400 4.0%

Gandhimathi Butterfly 3,328 3.9%

Havells* 1,483 1.7%

Crompton 810 0.9%

Orient 710 0.8%

Jaipan 293 0.3%

Source: Company, MCA, AceEquity, Industry, Ambit Capital research, Note - * we estimate Havells appliance revenue by using market share data given in the investor presentation

The reasons we believe it is a challenge for diversified electrical companies to achieve success in domestic appliances are:

Different distribution network: The appliances segment has a completely different distribution network from traditional electrical products like fans, switches, switchgears, lighting and cables & wires. Domestic appliances sell in the modern retail format, utensils channel and e-commerce format vs traditional electrical products that are sold via the electrical and hardware channel.

Moreover, a sales team which sells standard electrical products may not be skilled enough to sell domestic appliances. This is one of the reasons why pan-India players like Havells, Finolex Cables, Polycab and Orient are either not present or are not successful in appliances.

Our interaction with channel partners suggests that there is a dearth of sales people in the domestic appliances market. This is one of the reasons why companies like Havells and V-Guard are scouting to acquire domestic appliance companies. Appliance companies, in turn, are also struggling to diversify given no scope to sweat their distribution networks and sales teams. These are among the key reasons why they have stagnated and are looking out to merge with electrical companies.

Exhibit 36: Appliances sells through a completely different distribution network Product/dealer selling the product

Electrical dealer

Appliance dealer

Hardware dealer

Modern retail

Electrical cables and wires

Fans

Water heater

Switches

Switchgear

Lighting

Luminaries

Induction cooktop

Mixer/grinder

Iron

Pumps


After sales service network extremely weak: The after sales service network is critical for appliances given the probability of damage for these is the highest among all electrical products given rigorous daily use in every home. Appliance companies like BJE and Philips spend 2.2%/3.3% of their revenues on after sales service support vs 1.4-1.5% for pure electrical companies.

Appliances sell in modern retail, utensils and e-commerce platforms which is different from the traditional electrical and hardware channel

Sales team which sells standard electrical products may not be trained to sell appliances; this is one of the reasons why pan India players like Havells, Polycab, Finolex Cables and Orient are either not present or not successful in appliances

Importance of after sales service network is very critical in appliances given the probability of appliances getting damaged is the highest amidst all electrical products

Crompton Consumer


Exhibit 37: Appliance companies spend higher amount on after sales service support at 2-3% vs 1.4-1.5% by other electrical companies

Amount spent on after sales service support

` mn As % of revenue

FY15 FY14 FY15 FY14

Bajaj Electricals 943 834 2.2% 2.1%

Philips 1,022 1,021 3.3% 3.5%

Havells 808 652 1.5% 1.4%

V-Guard 236 143 1.4% 0.9%

TTK Prestige 62 1 0.4% 0.0%

Finolex Cables Nil Nil Nil Nil


Most of these domestic appliance companies have exclusive arrangements with their service networks. This is one of the reasons why very few new companies have become successful in domestic appliances. As per our channel checks, it is very difficult to build an after sales service network from scratch at a pan-India level given shortage of skilled labour; several new companies have tried but failed.

Whilst Crompton will also face challenges in building a service network, our channel checks suggest it may not be as difficult for it given strong brand recall alongside decent size of business for a service operator to get lured (`36bn of revenue in FY16). However, building a distribution network and designing SKUs with low R&D spend are bigger challenges.

Domestic appliances not a standardized segment: Unlike several electrical products which are standardized, domestic appliances are region-specific. Grillers and microwave are more popular in north and east due to non-vegetarian food habits whereas mixer and grinder are more popular in west and south due to vegetarian food habits. Also colour preferences are different, whilst bright colours are more popular in south, non-south markets prefer light colours. This is the reason why this industry is dominated by strong regional players. In fact, except for BJE there is no other pan-India player in the appliances sector.

New management has lots to prove Only Matthew Job has relevant experience in top management

Crompton appointed Shantanu Khosla and Matthew Job as the new MD and CEO respectively. Shantanu was the MD of Procter & Gamble India (P&G) for 13 years (2002-15) and Matthew Job the MD of Racold for 4 years (2012-15) and before that the Philips’ marketing director for 15 years. Whilst Shantanu has a rich experience of managing the distribution network given his stint in P&G, he may have to adapt to the new set-up given the distribution in light electricals is more relationship-based and works on a push-based rather than a pull-based model of FMCG. Matthew has experience primarily in water heaters and lighting given Racold is prima facie a water heater company and Matthew handled mainly lighting in Philips.

Exhibit 38: MD has limited overlap with the light electricals industry

Name Past experience Industry

Shantanu Khosla P&G (32 years) FMCG

Matthew job Philips India (15 years); Grohe India (2 years); Racold (4 years) Light Electrical, Sanity ware


Shantanu and Matthew are known to chase revenue

Shantanu and Matthew have been responsible for stellar revenue growth at P&G and Racold respectively. P&G/Racold saw strong revenue CAGR of 24%/14% over FY04-14 /CY11-14 since Shantanu and Matthew joined as MDs. Consequently, P&G became India’s third-largest FMCG company (after HUL and Amul) and Racold became India’s No.1 water heater company.

Most appliance companies have exclusive tie-up with their service network which makes it very difficult for new players to build service networks

Appliance market in south and west is very different from that in North and East given diverse food interests

Shantanu Khosla (earlier MD of P&G India and Matthew Job (earlier MD of Racold) have been appointed as MD and CEO of Crompton

Common thread between both of them is they transformed respective companies into top companies

Crompton Consumer


However, both of them achieved this at the cost of margins. P&G made losses in 5 out of the 11 years that Shantanu was MD; also the average EBITDA margin in the 11 years in his stint was only a modest 1.7% vs HUL’s 14.7%. Same is the case with Matthew, who stepped up spending on advertisement and promotion. EBITDA margin halved to 6% between CY11 to CY14. Possibly this is one of the reasons why Shantanu may have hired Matthew as Crompton’s CEO.

Exhibit 39: P&G’s margin were paltry when Shantanu was the MD

P&G’s financials FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 CAGR/Average

Revenue (` mn) 5,151 7,127 8,327 9,976 13,683 12,955 21,098 29,104 39,525 48,908 53,685 23.7%

Revenue growth (%) 1314% 38% 17% 20% 37% -5% 63% 38% 36% 24% 10% NA

Gross margin (%) 33.8% 31.5% 43.7% 49.1% 51.7% 46.0% 55.8% 46.5% 45.5% 45.5% 48.4% 45.2%

EBITDA margin (%) -1.8% 3.2% 8.0% 8.3% 8.8% 0.6% 12.3% -9.3% -6.2% -6.3% 1.6% 1.7%

PAT margin (%) 1.6% 0.2% 6.7% 4.8% 5.7% -0.9% 9.2% -11.0% -8.7% -10.0% -0.4% -0.3%

Source: MCA, Note financials for FY15 not available

Exhibit 40: Racold saw decline in margins after Matthew took over as MD

` mn unless specified CY11

Ma

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s Jo

b jo

ined

in F

eb'1

2 CY12 CY13 CY14

Revenue 1,936 2,459 3,013 2,842

EBITDA 252 263 300 165

PAT 164 142 156 71

Ratios Revenue growth (%) NA 27% 23% -6%

EBITDA margin (%) 13% 11% 10% 6%

PAT margin 8% 6% 5% 2%

RoCE (%) 29% 15% 14% 5%

RoE (%) 33% 15% 15% 6%

Source: MCA, Note financials for CY15 not available

People relationships key to becoming a successful player in electricals

Apart from Matthew Job, we don’t believe there is any new member in the team who enjoys a strong relationship with distributors. When we met management, it confirmed that Crompton was not hiring anyone in the sales team. People relationships in this business matter a lot given there are no technological entry barriers in this industry. The relationship with the channel is the biggest entry barrier. This is aptly corroborated by deep relationships of successful promoters with the distribution network – QRG of Havells, Shekhar Bajaj of Bajaj Electricals, Mithun Chittilappilly of V-Guard, TT Jagannathan of TTK Prestige, Inder Jaisinghani of Polycab, Deepak Chhabria of Finolex Cables. Given Shantanu’s lack of experience in this industry, we believe it may be difficult for him to replicate what some of the above companies have done especially in a short to medium term.

Exhibit 41: Incumbent companies in electricals have/had promoters who enjoyed strong relationship with the trade channel

Company Promoter

Havells QRG

Finolex Cables Deepak Chhabria

Polycab Inder Jaisinghani

TTK Prestige TT Jagannathan

V-Guard Mithun Chittilappilly

Bajaj Electricals Shekhar Bajaj

Source: Ambit Capital research

However, market leadership was achieved at the cost of margins. Whilst P&G reported lower than industry margins, Racold’s margins halved to 6% between CY11-14

People relationships matter a lot in the light Electrical industry given technology is not an entry barrier

Given Shantanu’s inexperience in this industry and no fresh recruitment in sales, we believe it may be difficult to ascertain whether Crompton can become the next Havells

Crompton Consumer


Advent likely to play a passive role in Crompton Management highlighted that Advent (new promoter with ~22% stake) will have nominees on Crompton’s board; however, they will be non-executive in nature. We don’t believe Advent will play an active role in driving Crompton’s strategy given this is Advent’s first investment in the consumer sector in India. Whilst Advent International has 29 investments in the consumer space globally give it rich experience in terms of brand, distribution and consumer psychology, it is too early to say it will be brought to India as our checks suggest modest trade interaction. At best, experts from Advent global will sit on the Board of Crompton but are unlikely to be involved in day-to-day functioning.

Exhibit 42: Crompton is the first consumer investment of Advent in India Investee company Country Sector Investment date Comment

Crompton India Consumer durables Jul'15 QuEST Global Singapore Technology, Media & Telecom Feb'16 CARE Hospitals India Healthcare Mar'12 CAMS India Business & Financial Services Oct'07 Sold 45% stake to NSE for `5.7bn

Source: Advent, Ambit Capital research

Crompton Consumer


Key assumptions Exhibit 43: Crompton - key assumptions ` mn unless specified 2HFY16 FY16* FY17E FY18E FY19E Comment

Product-wise revenue

Fans NA 16,408 19,198 22,654 26,052 Revenue CAGR of 17% over FY16-19 led by market share gain in the premium segment. % YoY NA 11% 17% 18% 15%

Lighting 5,627 11,115 13,115 15,345 17,647 Revenue CAGR of 16% over FY16-19 led by improvement in share of LED in retail sales and higher sales under EESL. % YoY NA 13% 18% 17% 15%

Pumps NA 7,112 7,965 8,762 9,463 Revenue CAGR of 10% over FY16-19 led by improvement in real estate activity and improvement in water table levels due to normal monsoon. % YoY NA 8% 12% 10% 8%

Appliances NA 2,251 2,589 2,977 3,364 Revenue CAGR of 14% over FY16-19 despite low base as we believe Crompton will face challenges in building distribution network for appliances. % YoY NA 12% 15% 15% 13%

Key assumptions

Net revenue 18,117 35,869 41,685 48,366 54,967 We model revenue CAGR of 15% over FY16-19

%YoY NA NA 16% 16% 14%

Gross margin (%) 29.9% NA 31.4% 31.2% 31.1% We expect gross margin to improve from 29.9% in 2HFY16 to 31.4% despite benefit of low commodity prices in 2HFY16 as Crompton has cut vendors’ prices across its product portfolio

Employee cost 1,005 NA 2,422 2,643 2,857 For FY17, we model 10% increase in employee expenses given senior management cost will now be for full year vs 6 months in FY16. For FY18/FY19 we expect 8%/9% growth in employee expenses.

Selling expenses

2,315

NA 3,835 4,595 5,387 As against 7.6% of revenue in 3QFY16, we model selling expenses at 9.2% of revenue due to increase in ad spend from 1.5% of revenue in 3QFY16 to 3% in FY17.

Manufacturing expenses NA 459 532 605 We model manufacturing expenses to remain constant at 1.1% of revenue over FY17-19 (in line with 3QFY16 figure) given Crompton will continue outsourcing

Administrative expenses NA 1,753 1,945 2,081 We model administrative expenses to decline from 4.7% in 3QFY16 to 4.2%/4%/3.8% of revenue in FY17/FY18/FY19 due to benefits of favourable operating leverage.

EBITDA 2,095 NA 4,621 5,375 6,165 We expect EBITDA margin to decline from 11.6% in 2HFY16 to 11.4% in FY17 due to increase in ad-spend. EBITDA margin (%) 11.6% NA 11.1% 11.1% 11.2%

Depreciation 63 128 115 115 Expect depreciation to remain flat given no capex on building new factories.

EBIT 2,032 4,158 4,493 5,260 6,051 Consequently, EBIT margin is likely to contract from 11.6%/11.2% in FY16/2HFY16 to 11.1% in FY17. We expect 20bps/10bps improvement in FY18/FY19 led by favourable operating leverage. EBIT margin (%) 11.2% 11.6% 10.8% 10.9% 11.0%

Interest 338 NA 642 642 642 We model interest rate of 8.95%, in line with Crompton's NCD rate.

Other income 22 NA 45 153 165 We expect 5% yield on surplus cash. We model dividend payout ratio of 60%/75% in FY18/FY19. For FY17, we do not model any dividend payout.

PBT 1,716 NA 3,896 4,771 5,573 We expect PBT CAGR of 20% over FY17-19.

Less: Tax 525 NA 1,286 1,574 1,839 Assume full tax rate of 33%.

Tax rate 31% NA 33% 33% 33%

PAT 1,191 NA 2,610 3,197 3,734 We expect PAT CAGR of 20% over FY17-19.

CFO NA NA 2,927 3,250 4,360 We expect CFO CAGR of 22% over FY17-19.

FCF NA NA 2,799 3,135 4,246 We expect FCF CAGR of 23% over FY17-19.

Source: Company, Ambit Capital research; *FY16 figures are based on Ambit estimates as full year figures are not available

Exhibit 44: Ambit vs consensus ` mn unless specified Ambit Consensus Divergence (%) Comment Revenue - FY17 41,685 41,030 1.6%

Our revenue estimates are marginally ahead of consensus - FY18 48,366 47,296 2.3% EBITDA margin (%) - FY17 11.1% 11.4% -30bps Lower margin estimate led by our expectation of headwinds to

margin due to increase in ad spend by 170bps over FY16-18 and 13% increase in administrative expenses over FY16-18. - FY18 11.1% 11.9% -80bps

EBITDA - FY17 4,621 4,690 -1.5%

Consequent to lower EBITDA margin assumption. - FY18 5,375 5,628 -4.5% PAT - FY17 2,610 2,699 -3.3%

Consequent to lower EBITDA expectation. - FY18 3,197 3,386 -5.6%


Crompton Consumer


Valuations: Riding on hope At 28x FY18E PE, Crompton trades in line with Havells despite (a) Havells emerging as the best consumer company on our competitive matrix; (b) Crompton unlikely to grow significantly ahead of Havells on earnings; and (c) lack of experienced of both promoters and new management in the electrical sector. On a relative basis, Crompton trades at a 25% premium to peers Havells, Bajaj Electrical, TTK Prestige and V-Guard despite sustainability of growth for peers being higher (see exhibit 67 on page 29). V-Guard and TTK Prestige are expanding across India though share of South revenues is high at ~50% and 33% respectively. BJE is changing its business model to a distribution-led company through implementation of Theory of Constraints. Our DCF-based TP of `115 implies FY18 P/E of 22.5x, which is at a 25% discount to Havells.

DCF valuation of `115/share We value Crompton at `115/share (implied FY18 P/E of 22.5x) using a free cash flow (FCF) model. Our FCFF metric is ’cash profit – increase in working capital – capex’. Our FCFF model has three distinct phases:

Exhibit 45: SOTP-based TP of ̀ 115/share

Particulars Value (̀ bn)

Value per share (̀ )

Implied P/E (x)

FY17 FY18

SOTP 72 115 27.6 22.5


FY17-20: We have modelled revenue CAGR of 14.7% over FY16-20E. We expect EBITDA margin to decline by 30bps over FY16-20 led by increase in ad spend from 1.5% in FY16 to 3.5% in FY20.

FY20-23: We model deceleration in revenue CAGR from 14.7% over FY16-20E to 11.4% over FY20-23E. We expect EBITDA margin to improve by 20bps per annum to 12.1% in FY23 led by benefits of scale.

FY23-31: We model stable revenue CAGR of 11% over FY23-31E and average EBITDA margin of 12.7%.

FY30 onwards: We have assumed a terminal growth rate of 5%.

We have assumed weighted average cost of capital of 12.9% for Crompton. We value Crompton at `115/share, which implies FY18 P/E of 22.5x.

Exhibit 46: DCF value of Crompton is ̀ 115/share Particulars ` mn

Present value of cash flows over FY18-31 43,352

Terminal value 37,965

Total value of firm 81,317

add investments/associates -

less net debt (cash) 9,377

less minorities -

Total Equity Value 71,940

Number of shares outstanding (m) 627

Value per share (`/share) 115


On a relative basis, it is trading at 25% premium to peers (Havells, Bajaj Electrical, TTK Prestige and V-Guard) despite the sustainability of growth for peers being higher

We assume WACC of 12.9% and terminal growth rate of 5%

Particulars Cost of equity 15.0%

Cost of debt 10.0%

Debt/Equity 0.25

Corporate tax rate 33%

WACC 12.9%

Terminal growth rate 5.0%


Crompton Consumer


Exhibit 47: FCF profile of Crompton


Exhibit 48: Revenue and margin evolution of Crompton


Exhibit 49: Crompton is a far weaker franchise than Havells

`mn unless specified V-Guard Havells Bajaj Electricals Crompton

consumer Remarks Standalone (consumer)

1 Brand strength

FY16 revenues (in ` mn)

18,626 54,369 30,602 35,869

Whilst Havells scores the best on account of higher revenues and better EBITDA margins, Crompton closely follows Havells on account of the highest RoCE and strong EBIT margin. Bajaj ranks third due to poor margins and low advertising spends, owing to its strategy of focusing more on incentivising the return on investment for dealers and given its established brand recall (thanks to the Bajaj pedigree). V-Guard scores last due to poor RoCE and lowest EBIT margins.

Ranking

FY11-16 revenue CAGR (%) 20.7% 13.5% 9.9% 12.2%

Ranking

FY16 EBIT margins 8.6% 12.1% 5.1% 11.6%

Ranking

Average EBIT margin over FY11-16 (%) 8.3% 12.6% 7.5% 12.3%

Ranking

FY15 RoIC (%) 26% 59% 41% 482%

Ranking

Average RoIC over FY11-15 (%)*

23% 54% 47% 244%

Ranking

% spend on adv. 4.1% 2.6% 1.9% 1.0%

Ranking

Overall rank

2 Distribution network

Distributors 470 2,500 1,000 4,000

Bajaj scores the highest because it has >400,000 retailers for its lighting and appliances products and >2,200 distributors across India, it is the first company to implement theory of constraints concept (margin-accelerative), and has a credible distributors’ online portal. Havells with 5,600 distributors and >100,000 retailers and credible distributors’ online portal is the second-best despite having reduced dealers’ incentives recently. Crompton, with a distribution channel of 4,000 distributors, comes third given it lacks a credible online distributors’ portal. V-Guard scores the last due to its weak presence in non-South markets. However, V-Guard is a favourite amongst dealers given product quality and dealers’ margins.

Retailers

15,000 retailers

and 3,000 channel partners

100,000

400,000 retail outlets and 4,000

authorised dealers

Not Available

Branches 28 41 19 In-house Nil 250 Havells

galaxy stores 103 Bajaj World

stores Nil

Ranking

Automation in distribution

Improving online portal

Credible online portal

Credible online portal,

implementing TOC to boost

margin

Lacks credible

online portal

Ranking

Feedback from channel

Dealer friendly

company

Recent reduction in

dealers’ margin is a big dis-incentive for dealers

Product quality complaints and poor after-sales

service dis-incentivise the dealers to push

Lacks aggression in dealing

with channel

Ranking

Overall rank

10%

30%

50%

70%

90%

-

1.0

2.0

3.0

4.0

FY18

E

FY19

E

FY20

E

FY21

E

FY22

E

FY23

E

FY24

E

FY25

E

FY26

E

FY27

E

FY28

E

FY29

E

FY30

E

FY31

E

PV of FCFF (Rsbn) on LHS WACC (%) RoCE (%)

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

-

50.0

100.0

150.0

200.0

FY17

EFY

18E

FY19

EFY

20E

FY21

EFY

22E

FY23

EFY

24E

FY25

EFY

26E

FY27

EFY

28E

FY29

EFY

30E

FY31

E

Revenue (Rsbn) EBITDA margin (%) on RHS

Crompton Consumer


`mn unless specified V-Guard Havells Bajaj Electricals Crompton

consumer Remarks

Standalone (consumer)

3 Range of products

Havells offers the widest range of products (fans, switchgears, CFLs, luminaries, wires, cables, geysers and other domestic appliances). Crompton has the second-widest range, with integrated security systems and wiring accessories in addition to other light electrical products that are similar to its peers’ product portfolios.

Number of products

Fans, Stabilisers, LT Power Cable, PVC Cable,

UPS, Induction Cooker,

Water Heater

Fans, Domestic Appliances(18 types), Cables,

Wires, Switches, Water Heater, Switchgears,

CFL, Luminaries

Domestic Appliances (23 types),Water Heater, Fans,

Lighting & Luminaries

Fans, Appliances,

Lighting, Pumps, home automation, integrated

security systems, wiring

accessories Ranking

4 Exposure to various segments/ products

Segment-wise (higher rank for low exposure to competitive segments) Crompton has a high presence in institutional sales and sales to economy and sub-economy segments (especially in fans). Typically, margins from this segment are the lowest along with low entry barriers for new players. The share of the premium segment in Havells’ revenue is the largest; institutional exposure is low. However, our primary checks suggest Crompton has become aggressive in the ultra-premium category of fans (higher than `15,000) with more than 50 new models.

Highly competitive (institutional)

Moderately competitive (economy and sub-economy)

Least competitive (premium)

Ranking

5. Product-wise (higher rank for low exposure to commoditised products)

Commoditised products (cables and wires)

The biggest advantage which Crompton possesses over its peers is its absence in the cables & wires segment (owing to the presence of many unorganised players). Whilst the cables & wires segment is the largest revenue driver for peers, margins in this segment are typically the lowest. However, despite a strong industrial switchgear presence, Crompton lacks presence in domestic switchgears, which is a high-margin product.

Non-commoditised with large vendors (fans, appliances, lighting)

Quality driven products (switchgear)

Ranking

Average Ranking

Overall ranking

Source: Company, Industry, Ambit Capital research, Note - * FY16 figures are not available for ad-spend

Revenue growth unlikely to be ahead of Havells

We estimate Crompton’s revenue CAGR of 15% will track Havells’ 15% over FY16-19. We don’t believe Crompton can grow significantly faster than Havells given its matured fans, pumps and lighting portfolio, small market size for water heaters and no defined strategy for growth in domestic appliances.

Already market leader in fans; incremental growth capped: Given leadership in fans, Crompton would need to clock strong growth in premium fans, where its share (~35%) is lower than that of Havells (70%). However, we doubt that Crompton will be able to significantly improve premium fan market share. Consequently, we model Crompton’s fans business to see revenue CAGR of 15% over FY16-19, which is in line with Havells’ CAGR of 15%.

Exhibit 50: We model Crompton fans revenue to grow in line with Havells’ over FY16-19

` mn FY16E FY17E FY18E FY19E CAGR over FY16-19

Crompton 16,408 18,870 21,700 24,955 15%

Havells 7,800 8,970 10,316 11,863 15%


Third-largest player in lighting: After Philips and Surya, Crompton is India’s third-largest lighting company. It has grown in line with industry leaders with a revenue CAGR of 15% over FY10-15. Whilst the bull case is the Crompton’s lighting franchise can register strong growth given still weak presence in the retail market, our channel checks suggest this will be difficult because: (a) The retail market in lighting is fragmented. It will be a challenge for Crompton to gain market share especially as it has historically not focused much on this segment; Crompton is a strong B2B player in lighting with its prime customers being commercial offices, malls and government departments.

We don’t believe Crompton can grow revenues faster than Havells given matured pumps, fans and lighting portfolio, small market size of water heaters and no defined strategy for growing appliances

Crompton is already a market leader in fans and there are doubts on it being able to improve market share in premium fans

Crompton Consumer


(b) Weak LED portfolio: In FY16, Crompton was ranked fifth in LEDs (vs third in overall lighting). Havells, despite being fifth in overall lighting, sells more LEDs. Moreover, as LED is likely to be the next big thing in lighting many new players like Syska, Eveready and Fiem have done aggressive ad spends and are building credible names in the space. For e.g., Elcoma expects a revenue CAGR of 33% over FY16-21; which implies the risk that Crompton may be a laggard. Hence, Crompton would find it challenging to become a top 3 player in LED.

(c) Overestimation of Matthew Job’s capabilities: Despite having handled lighting in Philips, he may face challenges in scaling up Crompton’s lighting business. Whilst bulls may argue that Matthew Job, who has spent a considerable time at Philips selling lights, can use his experience to build the retail presence of Crompton, we believe it will be a tall task. This is because it’s been 7 years since Matthew quit Philips. He has since then worked with Grohe and Racold, which are not into lighting. Also, from our channel checks we understand that Philips never enjoyed a very palpable rapport with distributors given the perception that its brand is far superior to the distribution channel. Consequently, we doubt if Matthew enjoys a very good rapport with the lighting retail channel.

Exhibit 51: Crompton is the third-largest player in lighting…

Revenue CAGR

over FY10-15 FY15 FY16E

Philips 15.4% 20.8% 20.5%

Surya 15.5% 7.0% 8.1%

Crompton 14.8% 6.0% 6.1%

Bajaj 10.9% 5.5% 5.8%

Havells 14.6% 4.5% 4.4%

Source: Company, Ambit Capital research, Note Philips figures are as per Ambit Estimate

Exhibit 52: …however, its LED portfolio is weak…

Rank Player FY16 LED revenue (̀ mn)

FY16 market Share (%)

1 Philips* 9,711 19%

2 Syska 4,820 9%

3 Havells* 4,008 8%

4 Bajaj 3,850 8%

5 Crompton* 3,386 7%

6 Bajaj 3,850 8%

7 Fiem 1,180 2%

8 Eveready 920 2%

Industry size 50,920 Source: Company, Elcoma, Ambit Capital research, Note – * revenue for Philips, Havells and Crompton as per Ambit estimate.

Exhibit 53: …which may cause Crompton to underperform

` mn FY16E FY17E FY18E FY19E CAGR over FY16-19

Crompton 11,115 12,893 14,827 16,755 14.7%

Havells 8,016 9,392 10,908 12,560 16.1%

Source: Company, Ambit Capital research, Note – Crompton’s FY16 figure is as per Ambit estimate

Fourth-largest player in pumps: Crompton is already amongst the top two players in domestic pumps with a 35% share of the overall pumps market. Growth in this segment has decelerated since FY13 due to slowdown in real estate activity and depleting water table levels due to deficient rainfall. With a pick-up in the pace of under-construction projects and probability of a better monsoon this year, we assume a recovery in the pumps market. We model revenue growth of 11% over FY16-18E vs 7% over FY13-16E.

Crompton will see headwinds in growing presence in retail given (a) market is fragmented, (b) Crompton’s LED portfolio is weak, and (c) CEO Matthew Job’s stint at Grohe and Racold did not involve lighting

In pumps Crompton is already amidst top 2 players in household pumps; however it will be difficult to get traction in agriculture and industrial pumps given weak distribution in rural areas and dominance of technologically superior players respectively

Crompton Consumer


Exhibit 54: Crompton is among the top 3 players in domestic household pumps


Exhibit 55: Revenue growth to recover due to pick-up in under-construction projects and likely better monsoon


We don’t expect Crompton to make much breakthrough in the agriculture and industrial pumps markets, which account for 45% and 25% of the overall market respectively. In agriculture, Crompton does not have the requisite distribution network and the market is dominated by Kirloskar Brothers (KBL), Shakti Pump and C.R.I. In industrial pumps, the market is dominated by technologically strong players like KSB and Grundfos.

Small appliances can drive significant growth; but Crompton not yet prepared: If Crompton has to grow revenue significantly faster than Havells it has to be primarily led by small appliances. As discussed in the above section, we don’t believe Crompton can grow fast in small appliances; we model only 14% revenue CAGR over FY16-19 (small appliances + water heaters) vs 20% for Havells.

Exhibit 56: Crompton’s consumer appliances + water heater portfolio is likely to grow slower than Havells

FY15 FY16E FY17E FY18E FY19E CAGR over FY16-19

Crompton 2,010 2,251 2,589 2,977 3,364 14%

Havells 2,483 3,611 4,302 5,042 6,191 20%


Overall, we expect Crompton to register revenue CAGR of 15.3% over FY16-19 compared with 15.1% for Havells.

Exhibit 57: We expect Crompton to grow in line with Havells at 15% over FY16-19 CAGR over FY16-19 Havells Crompton

Switchgears 11.3% NA

Electrical Cables and wires 15.3% NA

Fans 15.0% 16.7%

Lighting 16.1% 16.7%

Pumps NA 10.0%

Small appliances +Water heater 20.0% 14.3%

Overall 15.1% 15.3%


Margin risks ahead

We model Crompton’s EBITDA margin to decline by 80bps YoY in FY17 to 11.1%. The decline in EBITDA margin is on account of higher ad-spend. We expect Crompton to increase ad spend from 1.5% in 3QFY16 to 3% in FY17 given the new management’s thrust on building the brand. In 1QFY17, Crompton has already spent heavily on advertisement in IPL (spend on IPL in 1QFY16 is likely to be at least `0.6bn vs our full-year FY17 ad-spend estimate of `1.3bn).

14%

7%

9%

3%3%

4%6%2%

48%

4%KBL

KSB Pumps

C.R.I.

Shakti Pumps

Grudfos

Flowserve

Crompton Greaves

Vguard

Others

8%

12%

-5%

0%

5%

10%

15%

20%

FY12

FY13

FY14

FY15

FY16

E

FY17

E

FY18

E

Pumps YoY (%)

We don’t expect Crompton to make much breakthrough in agriculture and industrial pumps

We expect Crompton’s EBITDA margin to decline by 80bps over FY16-18 led by increase in ad send

Crompton Consumer


We expect ad-spend to increase further from 3% in FY17 to 3.2%/3.5% in FY18/FY19. However, EBITDA margin is likely to improve to 11.2% in FY19 led by benefits of favourable operating leverage. The reason for modeling such high ad-spend is that peers like Havells and V-Guard spend 3.5-4% of revenue on advertisements.

Exhibit 58: We model in higher ad spend over FY16-18

Source: Ambit Capital research, Note – we assume FY16 ad-spend as % of revenue to be same as 3QFY16 expenses

Whilst management is guiding for zero dilution in EBITDA margin, we don’t understand which expense item can offset the increase in ad-spend. Whilst we believe gross margin expansion can happen led by lower raw material cost as Crompton has cut prices of its vendors, there is limited scope to control employee cost and other expenses.

Reduction in raw material cost is achievable and to some extent can offset the increase in ad-spend. Crompton has cut prices of its key vendors by ~2% and hence we have assumed 90bps reduction in raw material cost as a percentage of revenue in FY17 vs 2HFY16.

We don’t believe there is any scope for cutting employee cost from FY16 levels given the recruitment of new MD, CEO and CFO and administration staff. Alongside this, Crompton may also have to give pay rises to its staff given the renewed aggression in the firm and also look at hiring more if it wants to roll out the ‘Go To Market’ initiative in the same manner as BJE rolled out TOC. Our understanding from channel partners is that the current version of the ‘Go To Market’ initiative is a very diluted version of what BJE has rolled out through TOC.

We don’t believe there is any scope for decreasing other expenses as well given Crompton now has a separate office administration while it was shared when the consumer business was part of CRG. Also, Crompton will have to incur costs on IT implementation (earlier shared), rent out new sales depots and related aspects as it tries to increase penetration in rural markets. The company would also incur costs on upgrading after sales service (recruit more franchisees for service, set up customer call center) as it attempts to make a name in small appliances and provide for warranty (common with appliance companies).

V-Guard, when it was building its non-south franchise, had to undergo a steep increase in other expenses for the same reasons highlighted above. For Crompton, we have assumed administration expenses will increase by 16%/11% in FY16/FY17 over annualised 3QFY16 administration expenses. We model administration expenses at 4.2%/4% of revenues in FY17/FY18.

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

FY16

E

FY17

E

FY18

E

FY19

E

Ad spend as % of revenue

Whilst management is guiding for zero dilution in EBITDA margin, we don’t understand which expense item can offset the increase in ad-spend

We assume reduction in raw material cost as percentage of revenue given Crompton has cut prices of key vendors

With the recruitment of new MD, CEO, CFO, new admin staff and higher pay rises to employees given renewed aggression, controlling employee cost can be a challenge

Scope for controlling other expenses is low given (a) company bears entire admin cost, which was shared earlier; (b) IT implementation cost; (c) rent on new sales outlets and related costs as Crompton enters new areas; and (d) higher costs on after sales support as Crompton becomes aggressive in appliances

Crompton Consumer


Exhibit 59: V-Guard saw strong growth in other expenses while expanding in non-South geographies


Consequently, we model 80bps decline in EBITDA margin over FY16-18. In FY18, we expect Crompton to report EBITDA margin of 11.1% vs 15.4% for Havells. Consequently, we also model ROIC to decline from 482% in FY16E to 253% in FY18 led by decline in margins and decline in invested capital employed turnover from 61x in FY16 to 28x in FY18.

Exhibit 60: We expect ROIC to decline from 482% in FY16 to 253% in FY18 led by decline in margins and decline in invested capital employed turnover

FY16E FY17E FY18E

RoIC (%) 482% 370% 253%

EBITDA margin (%) 11.9% 11.1% 11.1%

Invested capital employed turnover (x) 61.1 40.1 27.7


…but should Crompton trade higher because of Havells cable business skew? There is a theory that Havells should trade at a lower multiple than Crompton given 41% of its revenue comes from the cables & wires business, which is commoditized in nature. We believe otherwise because of the following reasons: Contribution of cables & wires on profit is much lower (24%) than revenue

(41%); also cables ROIC is strong at 49%: Whilst cables & wires contribute 41% of Havells’ revenue, contribution at the EBIT level is only 24%. Moreover, segmental ROICs were a healthy 49% in FY16 vs overall company-level ROIC of 59%. As per our channel checks, the biggest advantage of being present in cables & wires is the opportunity to cross-sell more products. This makes logical sense given that cables & wires distributors also sell other products like pumps, fans, water heaters, lighting, switches, switchgears, etc and cables & wires is the largest market in electricals with a size of `219bn (29% of overall industry). For e.g., one of the main reasons for V-Guard’s successful non-South expansion is its presence in cables & wires.

0%

5%

10%

15%

20%

25%

30%

35%

11.0%

11.5%

12.0%

12.5%

13.0%

13.5%

14.0%

14.5%FY

12

FY13

FY14

FY15

FY16

Other expenses as % of revenue Share of non-South (%) (RHS)

We model 80bps decline in EBITDA margin over FY16-18. Consequently, we also model ROIC to decline from 482% in FY16E to 253% in FY18

Biggest advantage of being present in cables & wires is higher opportunities to cross-sell products

Crompton Consumer


Exhibit 61: Cables & wires is the largest market in electrical; hence presence in the segment is critical to cross-sell other categories of products

Product Organised market size (̀ bn)

in FY10 in FY15 Growth over FY10-15 (%)

Share in total pie in FY15

Electrical cables and wires

Housing wires 37 88 19% 12%

Industrial and power cables 55 131 19% 17%

Switchgear and switches

Domestic switchgears 11 17 10% 2%

Industrial switchgears 27 46 11% 6%

Switches 17 40 19% 5%

Fans

Premium 8 32 32% 4%

Sub-economy and economy 31 32 0% 4%

Consumer appliances

Electric water heaters

40

15

20%

2%

Small appliances 62 8%

Induction cooktops 12 2%

Stabiliser 12 2%

Consumer appliances 101 13%

Lighting & Fixtures

CFL, LED, lighting 39 86 17% 11%

Luminaries 36 78 17% 10%

Pumps 62 100 10% 13%

Total industry 363 750 16% 100%


Exhibit 62: Cables & wires contributes only 24% of Havells’ EBIT despite contributing 41% of revenue


Exhibit 63: Segmental ROIC in cables & wires is very high at 49% vs company average of 59% RoIC (%)

Havells average 59%

Switchgears 80%

Cables 49%

Lighting & Fixtures 46%

Electrical Consumer Durables 64%

Source: Company, Ambit Capital research, Note – we calculate RoIC by adjusting un-allocable expenses to the segmental EBIT and un-allocable capital employed

Havells’ consumer business is much superior to Crompton: Havells’ EBIT margin in the non-cable & wire business at 16.1% is higher than Crompton’s 11.2% reported in 2HFY16 (full year for Crompton is not comparable). Even on a like-to-like basis, Havells’ margins in electrical consumer durables and lighting at 13.8% and 12.9% is higher than those of Crompton’s 13.4% and 6.4% respectively. Whilst bears may argue that this should be the case given that Havells is a manufacturing company, our argument is that its ROIC in non-cable business at 65% is stellar despite being a manufacturing company.

41%

24%

0%5%

10%15%20%25%30%35%40%45%

Revenue share (%) EBIT share (%)

Share of cables and wires for Havells (FY16)

Havells EBIT margin in the non-cable and wire business at 16.1% is higher than Crompton’s 11.2% margin reported in 2HFY16

Crompton Consumer


Exhibit 64: Havells’ non-cables margins are higher than Crompton’s overall margins

2HFY16 Havells Crompton

Switchgears 20.3% NA

Cables 7.5% NA

Lighting & Fixtures 12.9% 6.4%

Electrical Consumer Durables 13.8% 13.4%

Non-cables and wires margin 16.1%* 11.2%

Source: Company, Ambit Capital research, Note- we take 2HFY16 as comparable for Crompton are not available for full year. * We calculate EBIT margin by adjusting un-allocable expenses to the segmental EBIT

Capital deployed by Crompton is a paltry `0.8bn; hence one should NOT read too much into ROICs of 482%: Crompton is not a manufacturing company given its net block as of FY16 is only `0.8bn (excluding goodwill) vs revenue of `36bn. Consequently, its invested capital (excluding goodwill) in the business is only `0.8bn. Havells is a manufacturing company as corroborated by its net block of `10.8bn, which is 14x of Crompton as of FY16.

Havells making ROICs of 59% on a capital employed of `8.4bn compares much better than Crompton making ROICs of 482% on `0.8bn. Moreover, Havells’ has achieved consistent improvement in ROICs despite deploying large capital regularly, which is a credible task and reflects in premium valuations. Consequently, we believe one should not read too much into Crompton’s apparently strong RoICs.

Exhibit 65: Crompton’s invested capital (excluding goodwill) is a paltry ̀ 0.8bn (̀ mn) FY16

Consumer durables (358)

Lighting 849

Total Segmental capital employed 491

Goodwill 7,794

Other Un-allocable 275

Invested capital 8,560

Invested capital excluding Goodwill 766

RoIC (%) 34%

RoIC (%) excluding Goodwill 482%


Exhibit 66: Havells has seen improvement in ROICs despite consistent increase in capital employed in the business


0%10%20%30%40%50%60%70%80%

0.0

2.0

4.0

6.0

8.0

10.0

FY07

FY08

FY09

FY10

FY11

FY12

FY13

FY14

FY15

FY16

Capital Employed (Rsbn) RoIC (%) on RHS

Havells’ making ROIC of 59% on a capital employed of `8.4bn in our view is much meatier than Crompton making ROIC of 482% on a meagre capital employed of `0.8bn.

Moreover, Havells’ has seen consistent improvement in its ROIC despite deploying large capital on a consistent basis, which is credible and reflects in premium valuations.

Crompton Consumer


Relative valuation At CMP, Crompton is trading at 28x FY18 P/E, a 25% premium to peers (Havells, Bajaj Electrical, TTK Prestige and V-Guard). We don’t believe the premium to peers is justified as the sustainability of growth for peers is higher.

Crompton may see pick-up in revenue growth from 12% over FY14-16 to 16% over FY16-18 led by new management team, sustaining such growth levels would be challenging as the company is already a market leader in fans, a top 3 player in lighting, and growth in small appliances would be challenging as discussed earlier. Whilst Crompton’s revenue CAGR of 16% is marginally higher than the peer average of 15.7%, we expect Crompton to underperform peers over FY19-30 with revenue CAGR of 10.7% vs peer average of 12.6%.

Exhibit 67: Expect Crompton to underperform peers over FY19-30


Moreover, Crompton is trading in line with Havells on FY18 P/E, which we believe is unjustified as explained earlier. Our implied FY18E target P/E multiple for Crompton of 22.5x is at a 25% discount to Havells’ implied target multiple of 30x. We expect Crompton’s valuation multiple to de-rate given: (1) it would miss management guidance of maintaining EBIT margin in FY17 (at 2HFY16 levels of 11.2%); (2) challenges in appliances growth; and (3) deterioration in working capital turnover.

Exhibit 68: Crompton is in trading in line with Havells on FY18 P/E

Company CMP Mcap P/E (x) P/B (x) EV/EBITDA (x) RoE (%) CAGR (FY16-18)

INR US$mn FY17 FY18 FY17 FY18 FY17 FY18 FY17 FY18 Revenue EBITDA

Havells 367 3,421 34.8 28.2 7.7 6.9 23.8 19.5 24.6 26.1 14.9 26.4

Bajaj (non-E&P) 245 368 19.3 16.2 NA NA NA NA NA NA 12.2 28.6

TTK Prestige 4,503 784 30.8 22.8 6.6 5.7 20.4 15.4 22.4 26.8 20.0 38.8

V-Guard 346 790 19.0 16.5 3.4 3.1 15.0 13.4 18.9 19.5 16.2 12.3

Crompton 1420 636 29.9 24.5 7.3 6.0 19.5 16.3 27.0 27.0 15.9 24.1 Average (excl Crompton) 142 1,328 34.1 27.8 18.2 15.2 20.6 17.7 72.7 59.5 16.1 10.5

Divergence 24.8 20.0 5.8 4.9 18.3 15.0 22.8 24.4 16.1 26.0 Divergence with Havells 40% 41% 34% 39% 30% 30% 190bps 170bps -120bps 40bps

Source: Ambit Capital research, Note – prices as on 06 July 2016; we calculate the valuation of Bajaj’s non-E&P business trades at Ambit’s fair value of `62/share (implied 7.7x FY18 P/E)

10.7%

8%

9%

10%

11%

12%

13%

14%

15%

16%

CGCEL Bajaj V-Guard TTK Havells

Revenue CAGR over FY19-30

Crompton is trading at 28x FY18 P/E, a 25% premium to peers (Havells, Bajaj Electrical, TTK Prestige and V-Guard)

Crompton may see pick-up in the revenue growth from 12% over FY14-16 to 16% over FY16-18; however, we expect Crompton to underperform peers over FY19-30

Our implied FY18 target P/E multiple for Crompton at 22.5x is at 25% discount to Havells’ implied target multiple of 30x

Peer average 12.6%

Crompton Consumer


Catalysts Decline in EBITDA margin by 80bps over FY16-18: We model 80bps decline

in EBITDA margin over FY16-18 to 11.1% led by increase in ad-spend by 170bps from 1.5% in FY16E to 3.0%/3.3% in FY17/FY18. Moreover, we do not expect favourable operating leverage to kick-in in a big way given that administrative expenses are likely to see 13% CAGR over FY16-18 due to additional administrative costs post demerger (corporate office, senior management team salary) and expenses related to expansion of distribution network.

Limited success in appliances: We model only 15% revenue CAGR in appliances over FY16-18 despite low base of ~`2.3bn in FY16. Modest growth in appliances is negative as Crompton’s leadership in fans and lighting implies it would grow either in line with industry or slightly ahead. Any aggressive growth in water heaters is unlikely to significantly move Crompton’s overall revenue growth as it is a very small market (`15bn) compared with appliances (`86bn).

Deterioration in cash conversion cycle: We have assumed deterioration in cash conversion cycle from negative 5 days in FY16 to positive 3 days in FY18. Crompton may have to extend credit period as it starts becoming dealer friendly and also stock more inventory to improve product availability especially for retail lighting, water heaters and appliances. Deterioration in working capital cycle can act as a negative catalyst given it may come as a negative surprise.

Risks Significant market share gains in fans and lighting: We have assumed

Crompton will track industry growth in fans and lighting given its matured portfolio. Our thesis would be at risk if Crompton achieves higher growth led by strong growth in premium fans as also in lighting retail.

Success in appliances: We have assumed Crompton will only track industry growth in appliances despite a low base. If Crompton reports strong growth in appliances by establishing strong connect with a new distribution network and setting up a pan-India service network then our thesis of in-line industry growth could go wrong.

Margin expansion: We have assumed 80bps decline in EBITDA margin over FY16-18. Our expectations would be at risk if Crompton can either maintain or improve margins led by cost efficiency and improvement in gross margin.

We model deterioration in cash conversion cycle from negative -5 days in FY16 to positive 3 days in FY18

Crompton Consumer


Appendix Exhibit 69: Crompton mirrors the shareholding of Crompton Greaves… Holders (%)

Promoter – Avantha group 34.4

Institutions

- Mutual Fund 23.0

- Financial Institutions / Banks 6.3

- FII 13.4

Other 22.9

Total 100.0

Source: BSE, Ambit Capital research

Exhibit 70: … with only the promoters being separate(pre-open offer) Holders (%) Promoter – Advent International 22.2 Promoter – Temasek 12.2 Total Promoter shareholding 34.4 Institutions - Mutual Fund 23.0 - Financial Institutions / Banks 6.3 - FII 13.4 Other 22.9 Total 100.0

Source: BSE, Ambit Capital research

Exhibit 71: Whilst Advent has 29 investments (excluding Crompton) in consumer discretionary sector globally…


2916

1211

109

85

31

0 10 20 30

Con. Discre.HealthcareTechnology

FinancialsIndustrialsMaterials

Con. staplesCommun.

EnergyUtilities Companies

Crompton Consumer


Exhibit 72: ...includes electronics, home improvement, apparel, etc; giving Advent experience of brand, distribution, consumer psychology, etc

Company Industry Country Acquired Currency Investment

Ammeraal Beltech Holding BV Textile & Textile Products Manufacturing Netherlands Jul-15 NA NA

LifeMiles BV Airlines Panama Jul-15 USD 344

Faculdade da Serra Gaucha Educational Services Brazil Jun-15 NA NA

Allied SA Consumer Electronics Stores for Apple, Motorola, Asus, etc Brazil Feb-15 USD 1,000

Distribution International Inc Home Improvement USA Dec-14 NA NA

Learning Lab/The Educational Services Singapore Oct-14 SGD 300

Cataratas do Iguacu SA Leisure & Travel Services Brazil Aug-14 NA NA

Corialis Group Home Improvement Belgium Aug-14 NA NA

Serta Simmons Bedding LLC Home & Office Furnishings Manufacturing USA Aug-12 NA NA

Morrison Supply Co LP Home Products Stores USA Nov-11 NA NA

Bojangles' Restaurants Inc Restaurants USA Jul-11 NA NA American Builders & Contractors Home Products Stores USA Jun-10 NA NA Supply Co Inc

DFS Trading Ltd Home Products Stores UK Apr-10 NA NA

Iuni Educacional Ltda Educational Services Brazil Mar-10 NA NA

Equiniti X2 Solutions Ltd Professional Services UK Jan-10 GBP 190

Charlotte Russe Holding Inc Specialty Apparel Stores USA Oct-09 USD 305

Kroton Educacional SA Educational Services Brazil Jun-09 BRL 280

Frango Assado SA Restaurants Brazil Sep-08 NA NA

Lojas Quero-Quero Home Products Stores Brazil Sep-08 NA NA

Amscan Inc Home & Office Furnishings Manufacturing USA Aug-08 NA NA

Gerard Darel UK Ltd Specialty Apparel Stores UK Jun-08 NA NA

KAI Group Home Improvement Bulgaria Dec-07 EUR 110

Grupo Gayosso SA de CV Funeral Services Mexico Oct-07 USD 317

Milano Operadora SA De CV Apparel, Footwear & Accessories Design Mexico Jun-07 NA NA

Controladora Milano SA de CV Specialty Apparel Stores Mexico May-06 USD 200

lululemon athletica Inc Specialty Apparel Stores Canada Dec-05 USD 377

Dufa Deutek SA Home Improvement Romania Aug-05 EUR 15 National Bankruptcy Services LLC Other Commercial Services USA Feb-05 USD 40

Tillimpa SA Other Commercial Services Brazil Jul-04 NA NA


Crompton Consumer


Balance Sheet

Year to March (̀ mn) FY16E FY17E FY18E FY19E

Cash 900 3,057 3,297 3,610

Debtors 4,165 5,139 6,360 7,229

Inventory 2,100 2,627 3,313 3,765

Loans & advances 734 853 990 1,125

Miscellaneous/Other Current Assets 7 8 10 11

Investments - - - -

Fixed assets 8,581 8,581 8,581 8,581

Total assets 16,487 20,266 22,551 24,321

Current liabilities & provisions 7,206 8,374 9,716 11,042

Debt 7,172 7,172 7,172 7,172

Other liabilities - Deferred Tax Liability (178) (178) (178) (178)

Total liabilities 14,200 15,368 16,710 18,036

Share Capital 1,254 1,254 1,254 1,254

Reserves & surpluses 1,034 3,644 4,587 5,030

Total networth 2,288 4,898 5,841 6,284

Net working capital (206) 245 947 1,077

Net debt (cash) 6,272 4,115 3,875 3,562


Income Statement

Year to March (̀ mn) FY16E FY17E FY18E FY18E

Operating income 35,869 41,685 48,366 54,967

% growth 11.0 16.2 16.0 13.6

Operating expenditure 31,586 37,064 42,991 48,802

EBITDA 4,284 4,621 5,375 6,165

% growth 2.1 7.9 16.3 14.7

Depreciation 125 128 115 115

EBIT 4,158 4,493 5,260 6,051

Interest expenditure 338 642 642 642

Non-operational income

PBT 3,820 3,851 4,618 5,409

Tax 1,227 1,286 1,574 1,839

PAT 2,593 2,565 3,044 3,569

Reported PAT 2,593 2,565 3,044 3,569

% growth (5.0) (1.1) 18.7 17.3


Cash flow statement Year to March (̀ mn) FY16E FY17E FY18E FY18E

PBT 3,842 3,896 4,771 5,573

Depreciation 125 128 115 115

Interest 338 642 642 642

Tax (1,227) (1,286) (1,574) (1,839)

(Incr) / decr in net working capital - (453) (703) (131)

Others

Cash flow from operating activities 3,079 2,927 3,250 4,360

(Incr) / decr in capital expenditure (125) (128) (115) (115)

Cash flow from investing activities (125) (128) (115) (115)

Cash flow from financing activities (338) (642) (642) (642)

Net change in cash 2,616 2,157 2,493 3,604


Crompton Consumer


Ratio analysis

Year to March FY16E FY17E FY18E FY18E

Gross margin (%) 30.5 31.4 31.2 31.1

EBITDA margin (%) 11.9 11.1 11.1 11.2

Net profit margin (%) 7.2 6.2 6.3 6.5

Return on capital employed (%) 30.5 25.3 27.5 30.5

Return on equity (%) 114.3 72.7 59.5 61.6

Return on invested equity equity (%) 481.8 369.8 253.2 224.1

Capital employed turnover (x) 3.9 3.5 3.8 4.1

Cash conversion days (5) (1) 3 3


Valuation parameters

Year to March FY16E FY17E FY18E FY18E

EPS (`) 4.1 4.1 4.9 5.7

Book value per share (`) 3.7 7.8 9.3 10.0

P/E (x) 32.6 33.0 27.8 23.7

P/BV (x) 37.0 17.3 14.5 13.5

EV/EBITDA (x) 21.2 19.7 16.9 14.7

EV/Sales (x) 2.5 2.2 1.9 1.7

EV/EBIT (x) 21.9 20.2 17.3 15.0


Crompton Consumer


Institutional Equities Team Saurabh Mukherjea, CFA CEO, Institutional Equities (022) 30433174 [email protected]

Research Analysts

Name Industry Sectors Desk-Phone E-mail

Nitin Bhasin - Head of Research E&C / Infra / Cement / Industrials (022) 30433241 [email protected]

Aadesh Mehta, CFA Banking / Financial Services (022) 30433239 [email protected]

Aakash Adukia Oil & Gas / Chemicals / Agri Inputs (022) 30433273 [email protected]

Abhishek Ranganathan, CFA Retail (022) 30433085 [email protected]

Achint Bhagat, CFA Cement / Home Building (022) 30433178 [email protected]

Anuj Bansal Mid-caps (022) 30433122 [email protected] Ashvin Shetty, CFA Automobile (022) 30433285 [email protected]

Bhargav Buddhadev Power Utilities / Capital Goods (022) 30433252 [email protected]

Deepesh Agarwal, CFA Power Utilities / Capital Goods (022) 30433275 [email protected] Dhiraj Mistry, CFA Consumer (022) 30433264 [email protected]

Gaurav Khandelwal, CFA Automobile (022) 30433132 [email protected] Girisha Saraf Mid-caps / Small-caps (022) 30433211 [email protected]

Karan Khanna, CFA Strategy (022) 30433251 [email protected]

Kushank Poddar Technology (022) 30433203 [email protected] Pankaj Agarwal, CFA Banking / Financial Services (022) 30433206 [email protected]

Paresh Dave, CFA Healthcare (022) 30433212 [email protected]

Parita Ashar, CFA Metals & Mining / Aviation (022) 30433223 [email protected]

Prashant Mittal, CFA Strategy / Derivatives (022) 30433218 [email protected]

Rahil Shah Banking / Financial Services (022) 30433217 [email protected]

Rakshit Ranjan, CFA Consumer (022) 30433201 [email protected]

Ravi Singh Banking / Financial Services (022) 30433181 [email protected]

Ritesh Gupta, CFA Oil & Gas / Chemicals / Agri Inputs (022) 30433242 [email protected]

Ritesh Vaidya, CFA Consumer (022) 30433246 [email protected] Ritika Mankar Mukherjee, CFA Economy / Strategy (022) 30433175 [email protected]

Ritu Modi Automobile (022) 30433292 [email protected]

Sagar Rastogi Technology (022) 30433291 [email protected]

Sumit Shekhar Economy / Strategy (022) 30433229 [email protected]

Utsav Mehta, CFA E&C / Industrials (022) 30433209 [email protected]

Vivekanand Subbaraman, CFA Media (022) 30433261 [email protected]

Sales

Name Regions Desk-Phone E-mail

Sarojini Ramachandran - Head of Sales UK +44 (0) 20 7614 8374 [email protected]

Dharmen Shah India / Asia (022) 30433289 [email protected]

Dipti Mehta India / USA (022) 30433053 [email protected]

Hitakshi Mehra India (022) 30433204 [email protected]

Krishnan V India / Asia (022) 30433295 [email protected]

Nityam Shah, CFA USA / Europe (022) 30433259 [email protected]

Parees Purohit, CFA UK / USA (022) 30433169 [email protected]

Praveena Pattabiraman India / Asia (022) 30433268 [email protected]

Shaleen Silori India (022) 30433256 [email protected]

Singapore

Pramod Gubbi, CFA – Director Singapore +65 8606 6476 [email protected]

Shashank Abhisheik Singapore +65 6536 1935 [email protected]

USA / Canada

Ravilochan Pola - CEO Americas +1(646) 361 3107 [email protected]

Production

Sajid Merchant Production (022) 30433247 [email protected]

Sharoz G Hussain Production (022) 30433183 [email protected]

Jestin George Editor (022) 30433272 [email protected]

Nikhil Pillai Database (022) 30433265 [email protected]















































Crompton Consumer


Explanation of Investment Rating

Investment Rating Expected return (over 12-month)

BUY >10%

SELL <10%

NO STANCE We have forward looking estimates for the stock but we refrain from assigning valuation and recommendation

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