Shock Laga? ??

NIFTY 50: 19,428 (0%)

NIFTY 10Y Benchmark G-Sec Index: 2,176 (0%)

Founder’s Recap

No Room for Error? ?

The Indian markets have been trading at premium valuations given India’s structural growth story, long-term fiscal boost, growing domestic consumption, and a rising preference for India amongst global investors.

And while there has been increasing consensus on the Indian narrative, valuations haven’t been finding uniform comfort. The MSCI India index was trading at a 25% premium to MSCI World, and a 75% premium to MSCI Emerging Markets - valuations that made many think about risk-reward more often.

Typically, high valuations imply high expectations. And when high expectations aren’t met, there is bound to be a downward reset. With stocks, this simply results in a combination of earnings downgrade and valuation de-rating, which leads to sharp falls in the stock price. And that’s exactly what has been happening this earnings season.

Just over the last week, there have been multiple stocks that have seen a 5-10% correction, led by poor/missed earnings. The long list includes the likes of Apollo Tyres, Mazagon Docks, Sanofi India, Concor, Hero Motocorp, MTAR Technologies, Torrent Power, Lemon Tree, Biocon, Granules, BSE, GMR Power, IRCTC, Bata, and many more.

The low tolerance for error seems to have been exacerbated by a not-so-bright backdrop, which has been putting additional pressure on the markets, dragging the Nifty down by 3% last week. While the RBI’s status-quo on rate hikes was in line with expectations, there was a hawkish bend to the commentary, coupled with a reflection of near-term inflation concerns on forecasts.

There has been a spike in inflation for several commodities recently - tomatoes, cereal, pulses, which could result in a near-term spike in inflation. The RBI upped its inflation forecast for the year by 30 bps to 5.4%, and for the coming quarter by 100 bps to 6.2%. The upping of inflation forecasts have pushed many to shift rate cut expectations from end of FY24 earlier, to FY25 now.

Even with the tweaking of inflation forecasts, the grave worries from last year of (i) uncontrollable inflation, and (ii) hardcore rate hikes and its likely impact on the economy have receded. But the entire near-two-year episode has its set of ripples which are now seen in earnings.

There has been a series of disappointment this earnings season across sectors like technology services, chemicals, commodities, and export-heavy sectors. With valuations at an all-time high, sharp negative reactions haven’t been a surprise. India’s growth story may be intact over the long run, but is definitely not immune to interim shocks.

Market Stories

Havells: Khushiyon Ki Guarantee? ??

Do you remember the “Shock Laga” ad campaign, where a kid’s hair spikes up because of an electric shock? It has been nearly 15 years since those epic ads made Havells a household name. The company managed to make things like MCBs and switches, which are seemingly uninteresting and reserved for your local electrician, a subject of consumer awareness and choice.

Success in building and creating a consumer brand in residential switchgear, cables and wires was quite pivotal for Havells. Given Havells’ humble beginning as an electrical goods trading company in the old part of Delhi back in the 1950s, its success in building a consumer-facing brand for switchgears, cables and wires is nothing short of pivotal - and doing it over the span of 50 years? No wonder it got the title of “Bijli Baba”!

But recently, Havells has been moving from behind the wall to in front of it and all across the house, with switches and an array of household appliances like fans, lights, water heaters and air coolers. A monumental step in its industrial-to-consumer journey was the acquisition of Lloyd in 2017, which helped Havells expand its product portfolio into electronic appliances like ACs, televisions, refrigerators, and washing machines - engraving in its fate the “khushiyon ki guarantee”

But this ‘switch’ hasn’t been easy for Havells. While the acquisition expanded its addressable market multi-fold, losses from Lloyd mounted to more than Rs. 200 crore last year. Six years on, will the move to premium consumer electronics make or break Havells?

From Electricals to Electronics ?

The move for Havells from industrial electricals to consumer electricals and then to consumer electronics has been bold, and full of promise:

• The consumer market opened up doors for Havells to a huge market of Rs. 1.25 lakh crore in electricals and Rs. 1 lakh crore in electronics
• Its expertise in industrial cables and switchgears resulted in a right-to-win for the same products in a consumer setting
• Its product portfolio, which ranges from switches to ACs and refrigerators gives Havells a wide spread across price points and market segments

The move has resulted in a significant shift in Havells’ revenue towards electronics, from just 20% 10 years ago, to 40% now.

It has managed to seed and scale multiple Rs. 1,000 crore+ categories across consumer cables, wires, switches, fans, lighting and ACs.

These factors resulted in stellar financial and market performance for Havells over the last 10 years:

But its not as easy as it sounds. Just introducing products into the market doesn’t ensure success for a consumer electronics company. There have been several factors that have led to the astounding success that Havells has seen over the last 10 years:

1. Building a strong brand through innovative brand and ad campaigns
2. Focus on strengthening distribution and reach, by tapping old and emerging channels
3. Focusing on premiumisation to increase the revenue and margin profile of the business

With a strong base built through these moves, over the next 5 years, with both the consumer electricals and electronics markets set to see a 10-12% CAGR, Havells can potentially grow at 1.5x market.

Lloyd Turning Around ??

However rosy the story sounds so far, entering a new business comes with its own perils. Havells gained entry into the premium consumer electronics market through its acquisition of Lloyd.

But, the acquisition has been in a phase of transformation since then. Over the three years from its acquisition in FY18 to FY21:

• Revenue for Lloyd grew at a 6% CAGR, compared to 9% for the rest of the business
• Operating margins for Lloyd deteriorated from 19% in FY18 to 4% in FY21

This was led by several factors including:

1. Broader events like GST implementation, the pandemic, and an increase in customs duty and the weakening of the rupee impacting the import-dependent Lloyd
2. Dumping in the LED TV market by foreign entities, resulting in price erosion in nearly a quarter of Lloyd’s business
3. Loss of market share to competitors like Blue Star, LG and Voltas in ACs (70% of business) because of a slim retail reach, which didn’t include large retailers like Croma and Reliance Retail

To turn things around, Havells has been investing heavily in the business to build a more formidable brand in the consumer electronics space by diversifying from its AC and TV-heavy portfolio and launching new products (refrigerators and washing machines) to become a holistic brand.

Tepid revenue growth, the lack of profitability, and a drain on cash flows for Lloyd have been a confluence of broad misfortunes, a deeper strategic direction for Lloyd’s, and long-term investments in brand, product and distribution.

With 34% revenue growth in FY23; while the topline has picked up for Lloyd, its (-7%) operating margin is yet to see the benefits of growth, scale and back-ended benefits of investing.

?? But, Havells is no noob at acquisitions

• Between 1997 and 2001, Havells acquired 5 companies. Its claim to fame has been its acquisition of a European electrical manufacturer called Sylvania in 2007, which was, at that time, 1.5x the size of Havells itself
• After Havells acquired it, Sylvania got into bad shape as it got hit by the global financial crisis and breached covenants on its debt, leading it near bankruptcy
• Havells turned it around by changing the leadership, cutting manpower, closing factories, lowering costs by sourcing from India and China, and a pricing revision, among other things - while its India business was running in full swing, turning from electricals to electronics
• The result was a complete turnaround of Sylvania, which Havells sold off in 2016 for Rs. 1,100 crore. It then utilised these proceeds to double down on India, by acquiring Lloyd in 2017

The Road Ahead ??

Havells now operates in three distinct spaces:

In the future, growth for Havells is expected to be driven by:

1. A sharp increase in the addressable market post its foray into consumer electronics, and full product coverage across electricals and electronics
2. Industry growth of 10-15% CAGR over the next 5 years expected in consumer electronics, with higher growth for refrigerators, washing machines and ACs
3. Higher market share for Lloyd, led by strengthening of the brand, product expansion, and building stronger distribution

Additionally, profitability also has potential for improvement given:

1. Receding raw material prices in the near term
2. Movement towards higher value products, and higher premiumisation across product categories
3. Normalisation of the current aggressive expenditure on advertising and R&D

Historically, Havells has traded at a premium compared to its peers in both electricals and electronics - Polycab, KEI, Voltas, Blue Star, Whirlpool, Crompton Greaves and Bajaj Electricals.

Havells has absorbed several of its own “shocks” in the past, and is on its way to pull off a turnaround in Lloyd as well, resulting in a potential sustenance of its growth and valuation premium in the future.

We’ve discussed this and more on the latest episode of Common Cents by Rupeeting so do check it out:

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