A well-diversified and relatively unique business in the engineering sector distinguishes Voltas from other listed companies. A strong position in the electro-mechanical products business, attractive margins from the engineering and agency segment and expected turnaround in the unitary cooling products division augur well for Voltas' earnings growth.
With a sound footing in West Asia, the company is well-poised to capitalise on the construction boom and the resultant cooling systems demand in the region. Voltas appears to be a good investment option in the engineering segment from a three-year perspective. At the current market price, the stock trades at about 18 times its likely earnings for FY-08, based on an expected 30 per cent annual growth in earnings from FY06-08. The marginal premium vis-à-vis other players appears justified, given the diversified nature of the business and the few listed players.
Business
Voltas is an air-conditioning and engineering solutions provider. While the company's primary business is providing comfort air-conditioning requirements for homes and offices, malls, airports homes and multiplexes, it also operates in areas which require monitoring of temperature, humidity, or treatment of air. The users in this segment include steel and power plants, petrochemicals facilities and laboratories. The company is also into manufacturing of material handling equipment and provides agency services for selling textile machines and construction and mining equipment. This diversification should provide cushion for the company against any slowdown in any one segment.
Electro-mechanical segment, the driver
The Indian heating ventilation and air-conditioning (HVAC) market is dominated by Voltas, Blue Star and Carrier. The demand for office space, largely driven by the IT and IT-enabled service companies, has led to huge potential for the HVAC players. With few organised players in this sector, the above-mentioned companies should, among them, share the business opportunities. This apart, the increasing number of malls and multiplexes and the upcoming Special Economic Zones offer much scope for the HVAC business. Voltas has already executed projects in these segments. While Voltas appears evenly poised with competitors in making gains from the above-mentioned prospects, the company has an edge in the following areas of its business:
International strength: In the overseas market, Voltas is better known as a mechanical, electrical and public works contractor, including HVAC services. Of the total current order-book of Rs 2,400 crore, about Rs 1,300 crore is derived from international markets. Among its overseas markets, Voltas can be expected to benefit from the construction boom in West Asia. This region accounted for 27 per cent of the company's FY-06 revenues. The company's ability to compete with top players in the region such as the Emirates Trading Company has enabled it to become a sub-contractor for Bechtel.
Potential in airports: Voltas won projects of the value of Rs 160 crore in electro mechanical projects for the Hyderabad airport and appears keen to participate in the bidding for Mumbai and Delhi airports as well. With the upgradation and modernisation of airports in India gathering pace, Voltas may see increased bidding opportunities in this area. The company's earlier airport projects such as the Bahrain International airport and the new airport in Hong Kong, are likely to serve as reference points and give it the edge.
Key role in the retail story: India's success in the retail space may well depend on the availability of cold storage and warehousing solutions. Since a chunk of the investments in this area is in fresh food, this would require support in terms of cold chains, refrigerated transport and industrial refrigeration. Voltas, which is already an established player in this field, has further strengthened its position through a tie-up with Netherlands-based Besseling Group. The latter is a turnkey solutions provider for storage of horticulture. Voltas has secured an order from Adani Agri-Fresh for refrigeration systems. We expect Voltas to benefit from this segment, which may also offer slightly better margins than regular HVAC projects.
Improvements in other divisions
The engineering agency division of Voltas has over the last three quarters shown a propensity to make an increasing contribution to revenues. For the quarter ended December, 20 per cent of the revenue came from this division. Increased demand for construction and mining equipment and in-house manufactured forklifts are likely to drive revenues.
We view this as a positive, as the operating margins from this division are far superior to the 6-7 per cent OPM in the electro-mechanical segment. The company's unitary division, which consisted of room air-conditioners and refrigerators, was a drag on the company's margins.
Now, with the shutting down of this unit in Hyderabad and its relocation in tax-friendly Uttaranchal and the closing of the unprofitable refrigeration section, may see some improvement in margins. The company, among the top players in the room air-conditioning systems, has seen a 30 per cent growth over FY-07 in this area. We expect the increasing purchasing power of consumers to create robust demand for the product.
Voltas is a low-debt company with large cash coffers. Any growth through the inorganic route could be earnings accretive without much equity expansion. Further, any plan for liquidating real estate, after it shut down the Hyderabad unit, may unlock further value. We have not factored these positives in our valuation.
Risks: The OPM of Voltas, which is at less than 6 per cent, may take a hit if there is a hike in the price of raw material such as copper and aluminium, given that a number of its international contracts operate on a fixed price basis.
The company faces stiff competition in the room air-conditioning segment from Chinese products and the unorganised market. This may cause pressure in pricing and, consequently, margins. Any political unrest in West Asia or slowdown in construction in the region would affect revenue flow for Voltas.