SUMMARY:V-Guard: The future blue chip!Sustained strong growth with immense potential: V-Guard has been able to grow at a strong48% CAGR (vs. 8% industry CAGR) in FY2008-12. The company is expected to grow its profitsat c30% consistently in the next 3-4 years as a result of its exposure to new growth sectors,increase in market share from existing local fragmented players, expansion into newergeographies and margin expansion. Having started out as a pure stabilizer company, V-Guardnow caters to a wide panorama of products in the Indian electric and electronics space (like PVCCables, Pumps & Motors, Electric/Solar Water Heaters, Digital UPS, Fans, Power Cable,Switchgears and Induction Cook-tops) where each of these markets has a total long termpotential size of USD20-40bn!Focus on quality & after service sales in a fragmented industry: The Company has theadvantage of being an established brand in South India for years and expects to leverage thisbrand equity to newer products and geographies by cross/up selling. The USP of V-guard hasbeen its quality & after service sales, which is setting V-Guard apart from the other local players.The risk of competition from local/Chinese players(in some product lines) is overrated as theirproduct quality is much below required standards and consumers would avoid them as this is anindustry where there is not much compromise on safety and durability (eg. Inverter, Stabilizer,PVC cables etc.)Long term vision with excellent corporate governance: The Company is known for itstransparency, excellent corporate governance and honest management team. The company hasbeen investing holistically into technology, manufacturing, branding and distribution channels witha long term vision for the company rather than just short term profits - the perfect sign for a bluechip! Company also plans to list its entities V-Star and Wonderla in the future.Valuation & Risks: The Company currently trades at a forward P/E (FY13) of 14-15x, howeverthe company is in its high growth phase currently and assuming a consistent bottom-line growthrate of 30% for next 3 years, current price would imply a paltry PE of 6x by FY15, thushighlighting the long-term upside in the stock. Company is focusing on cutting its costs too with -more value re-engineering which is reflected in its increasing RoE / RoA. RoE is increasing everyyear consistently and is now at 28% (FY12) from less than 13% (4-5 years back).The company’s main downside risks are - a) lower profitability with higher commodity prices (asCopper is the chief input material), mainly if the company is unable to pass the price hikes on tocustomers b)seasonal nature of sales of some of its products c)dependence on macro andindustry growth rate for some of its products d) Entry of a large player with deep pockets, growinginorganically and cutting prices to gain market share e) Underinvestment in branding would be abig negative for the stockDETAILED NOTE:Broadly, the below sections address the following issues: 1) What is the potential for growth in the long term? 2) Can the company win market share and exploit this growth? If yes, how? 3) A look at the financial highlights, stock catalysts, valuation & risks
Company Overview:V-Guard is not just a pure electrical industrials player (as was considered a few years ago), butover the years has managed to gain substantial exposures to agriculture, housing, consumerdurables, electrical & many other related industrial sectors. The key highlight is that each of thesectors is growing at a rapid pace (minimum 20%) Also, geographically there is much to cover ascurrently only c25% of group revenue comes from North India. SegmentExisting Rev wt Sector growth inProducts in FY12 Driver FY12 Major risks Future Company strategy Entry to sub-urban and rural markets, Realty/ measures for improved profitability, better PVC 28% 36% Slowdown in realty Construction inventory management, doubling production capacity in Kashipur Introduction of newer models, reducing cost of ConsumerStabilizer 20% 20% Macro, inflation production, storage space expansion in Kochi, electronics Bangalore, Palakkad Ad campaigns, increased number of dealers, Stiff competition, Pump 14% Agriculture 25% improved rating of models, value engineering unfavorable climate activities, increased number of Models Special pricing strategy, aim to improve ranking Power tariffs, power from 4th largest brand in India, focus on Water 7% Industrial 44% failures, load immersion heaters, strengthening of heaters shedding, Late winters production unit of Electric Water Heater and Fan at Kala Amb Realty/ Increasing network branches, quicker Digital Uninterrupted Power 7% Consumer/I 236% expansion before power situation improves, UPS Supply in India T Infra own manufacturing units, tier 2 + 3 city focus Const./ Differential pricing strategy – premium, Power 6% Power 39% Industry growth Increasing installed capacity, presence in cable industries newer markets Electric Rural 6% 20% - - fan demand Solar road shows, increased direct dealer network, Realty/ water 3% 21% High installation costs timely subsidy to the customer, Govt proposal Demand heater to make it mandatory would also help them Others 9%Growth is happening in 3 dimensions:a) From Current Portfolio: Company is able to gain market shares rapidly from local players,leveraging on its brand and better quality products. For example – improved models ofagricultural pump and stabilizers are continually being introduced, keeping in track the customer’sspecific requirements, helping V-Guard to increase penetration and win market share.b) From Current portfolio in newer geographies: Geographically, only 25% of revenues come fromNorth India (from less than 10% a few years back). It is only a matter of time before V-Guard’sproducts become a trusted household name in the North as its products have already been testedand proven in the South. Apart from expanding to the North, the company also has plans toexport to foreign markets.c) From Newer products: It has consistently and quickly been able to increase the number ofproducts in its portfolio based on the need of the market. Only recently did V-Guard begin to
produce PVC cables but now it has started to contribute 28% of top-line! Similarly realizingdemand for Digital UPS, the company has accelerated production of Digital UPS thus ultimatelyincreasing its contribution to topline to 7% from 2% over past two years. This shows thecompany’s ability to dynamically realign based on the “demands/needs” of the sectors it operatesin.Recent/ New Products launched/expected inFY13Solar Photovoltaic ChargeInduction Cook-topDomestic Switch GearsWith further investments in capacity, we expect higher profits as the company has been able toincrease its RoCE every year for more than past 5 years!Immense Potential – A look at the potential market sizes for a few product lines:Each of above tabled sectors is rapidly beginning to expand in India, with the Govt’s focus oninfrastructure, power and solar energy in India.Stabilizer: (c20% of top line)-Regular electricity in India has always and will be a problem(at leastfor another 10-15 years) with demand exceeding supply by 20-30%. Just a back of the envelopecalculation of 200m households using 3 voltage stabilizers, for 3 basic electrical appliances of TV,Fridge, A/C of average price INR3000 per household shared by 5 competitors with a small 30%margin would create value worth cUSD2.2bn for V-Guard alone (market size USD36bn).According to the company the strategy is to capitalize on the stabilizer market for LCD/LED TVs,refrigerators, air conditioners, tread mill and washing machine.Digital UPS/Inverters (c7% of top line):-While inverters in a mid income household are common inKerala, it is only gradually picking up in other states and is yet to attain such mass usage. Thecompany has been able to aggressively advertise and capitalize on the recent power shortage.Taking a rough estimate of the total market as just half of the Indian households & calculatingdemand for inverters of a modest 15k, the total available market size to exploit comes atUSD45bn, which is far below the current sales.Solar heaters(3% top line) - As a result of power shortage and high costs of power, Govt ofIndia(GoI) is incentivizing companies to utilize renewable sources of energy like solar energy. GoIhas unveiled an USD19b (till 2020) investment plan in the sector thus helping companies in thisspace. The product is gaining mass acceptance gradually partly due to mandatory installment ofSolar devices and subsidies. According to vikapla, current market size for agricultural pumps isUSD0.5bn and is expected to grow to USD20bn by 2025. Similarly, current market size for thesolar heater space is north of USD25m and is expected to grow by 500-600% by 2022!All of these above numbers signify the immense potential in the sector.Why is V-Guard a player for the long term?Fundamentally strong: Most of the small caps are linked to its “one path breaking” productwhich is both vulnerable in terms of the growth of its specific industry and breakthrough in thattechnology by its competitors. V-Guard was no exception, and this risk phase is over as V-Guardhas already established its brand “V-Guard”, in the South and plans to paint its name in the Northin a big way too. It also does not rely on any single product to carry them into the next phase. V-Guard rightly has identified focus on advertising on “quality of a very trusted reliable householdbrand” across all their products and not just one specific product. Thus the company is able tospread its branding costs across its products and at the same time able to increase the number ofrevenue drivers.
Excellent Corporate governance: One of the key attributes for a small cap company is itscorporate governance and the whole management team runs by this vision of honesty andtransparency.Holistic investment into branding, distribution channel, and technology: This is the attribute of acompany which is eyeing for becoming a mass player. Every investment is kept taking into longterm focus into account. In an industry which is highly fragmented with small competitors acrossvarious locations, the company is perfectly poised on its way to create a Pan-India player withone trustable brand called “V-Guard”. The company invests in technology, which is not a commontrait among its peers and ultimately it is able to develop new products and market them really fast,helping them to gain rapid market share.Where are its levers / stock catalysts? Improvement in net margins as a result of the rapid cost cutting measures introduced by thecompany As the global economy slows down, commodity prices are expected to go softer enabling themto save on the costs A successful addition/launch of a new product to its portfolio of products would push the stockup. Past history tells us that every new venture has been immensely successful and the companyhas been able to eat into the market share of the leader The company plans to spread its wings both in terms of increasing production capacity andalso dealer/distributor presence, each of which should also start generating a new stream ofrevenues. Any successful launch would be a boost to the stock Cutting dividends to grow: Any focus on cutting dividends to increase spends (on mainlybranding ) would be a catalyst as the value created by its FCF would be more if the company re-invests than distributing to the company shareholders as the dividend yield is only 1-2% Listing of V-Star, Wonder-laFinancial highlights-> RoE has been increasing every year consistently to 28% (FY2012) from less than 13% (5years back)-> The top-line has seen 48% CAGR in past 4 years-> The margins (both net and importantly cash margins) have been increasing despite theincreasing commodity prices-> Company operates with a debt to equity ratio of only 9%-> Currently the company boasts of 28 branches, 200 service centres, 2700 channel partnersand10000 dealers (from even less than 50% of what was available a few years back)-> Having been in the industry for many years, the company is beginning to look much healthierwith leaner inventories & working capital management (reflected in its recent quarterlyperformance) (Annual basis) FY09 FY10 FY11 FY12
Op margin 9.4% 10.7% 9.7% 9.5% RoE 13.7% 18.0% 22.8% 24.3% Current Ratio 1.1 0.9 0.9 1.1 Interest Cover 6.6 8.8 6.0 5.1 Topline growth 13.7% 43.7% 59.9% 37.7%Valuation:Recently the stock saw a steep increase of 100% based on the stellar quarterly results (+67% y/ynet profits in 1QFY13), and currently the company currently trades at a forward P/E (FY13) of 14-15x (below some of its peers like TTK, Havells). Also, the company is in its high growth phaseand is expected to see 30% bottom line growth in the next few years (helped by organic growthand margin expansion). Assuming a consistent growth rate in net profit of 30% for next 3 years,current price would imply a paltry 6x by FY15, thus highlighting the long-term upside in the stock.Company is focusing on its costs too with value re-engineering in its operations and is reflected inthe increasing RoA & RoE. RoE has been increasing every year consistently to 28% (FY12) fromless than 13% (5 years back). P/B is not a correct measure as the company has asset-lightoperating model, where only 40% of sales are manufactured in-house vs. rest being outsourced.Downside RisksThe company has the risks ofa) Lower profitability with higher commodity prices (chief input material- Copper), if the companyis unable to pass them on to customersb) Seasonal nature of sales of some of its productsc) Dependence on macro and industry growth rate for some of its productsd) Entry of a large player with deep pockets, growing inorganically and cutting prices to gainmarket sharee) Underinvestment in branding would be a big negative for the stock