>IMPROVING OUTLOOK: VOLTAS

■ Highest-ever EBITDA margins; EPS division the only drag
Voltas’ (VOLT) Q2FY10 earnings, at INR 807 mn (up 37% Y-o-Y), were ahead of our estimates as the company reported its highest-ever EBITDA margin. EBITDA margins improved 245bps Y-o-Y to 11.1% on improvement in operating metrics across segments. Even as the electro-mechanical project (EMPS, order book driven) business reported steady revenue growth (up 16% Y-o-Y to INR 6.8 bn) concerns continue on engineering products & services (EPS, short-cycle industrial demand/economic activity driven). EPS revenues were down 28% Y-o-Y to INR 1.1 bn.

■ Order intake remains weak; likely to improve in H2
INR 4 bn accretion in Q2FY10 was way below our estimate and continued to remain weak for fifth quarter in a row. Even as intake numbers disappointed, on the positive side, enquiry levels picked up considerably in both domestic and international markets. In our view, with improvement in oil prices and faster ordering of domestic projects (with elections out of the way), accretion is likely to pick up in H2FY10. However, on extremely weak accretion in H1FY10, we are cutting our order intake assumption for full year to INR 25 bn against INR 36 bn earlier. Management indicated that it is hopeful on closure of a few large orders in international markets by Q4FY10.

■ Revising up earnings on better margins; likely to sustain going forward
We have revised up our earnings estimates by 18% for both FY10 and FY11 on better than-expected operating metrics in Q1FY10. We believe EBITDA margins will sustain at 8% levels in the medium term as UCL margins stabilise at 7.5%, while EPS margins, which have taken a knock in the past few quarters, will settle around 17-18% as the business outlook and working capital improves.

■ Outlook and valuations: Recovery in sight; maintain ‘BUY’
Even as accretion disappointed in H1FY10, enquiry pick up in domestic and international markets is a positive in our view, indicating an early sign of revival. Given the 18-month coverage on international business and improving domestic economic landscape, we see no risk to our earnings estimates in FY10, while intake pick up (H2) will improve FY11 visibility. Current valuations of 14.0x FY11E and 12.1x FY12E, with focus on new areas of growth (water management, specialty healthcare centers, HVAC opportunity in oil & gas and power), light balance sheet, and initial signs of business recovery (likely to play out in next 12- 18 months) lead us to maintain ‘BUY’ recommendation and relative ‘Sector Outperformer’ rating.

To read the full report: VOLTAS