>SIEMENS INDIA: De-rating likely as earnings growth moderates

■ A long-term strategy with near-term headwinds: We recently attended Siemens’ analyst meet where management reiterated their long-term strategy of 1) high-tech product innovation with focus on environmental solutions; 2) launch of value-priced SMART products catering to specific needs of emerging markets like India & China; and 3) expansion of local manufacturing & indigenization of products. With these initiatives, Siemens aim to gain market share & drive productivity improvements to support margins. While this long-term strategy appears promising, several headwinds should prevail in the near term, such as weakening demand, pricing pressure, forex fluctuations, commodity prices, & delays in delivery pickups. Siemens remains cautious on the near-term outlook.

■ Earnings growth likely to taper off further: Given decline in order intake and muted growth in order backlog (c2%) due to the non-repetition of large Energy orders, we believe sales growth is likely to moderate to low double digits going into FY12-13e. In addition, the visibility on growth remains low as Siemens derives c50-55% of its sales from short-cycle orders driven by Industrial and Institutional capex, which is under pressure due to rising interest rates and weakening business sentiment. Also, Siemens’s strong EPS growth in two of the past three years has been driven primarily by improvement in margins, which we believe will moderate going forward, driven largely by the normalization of margins in Power Transmission (c33% of group EBIT). Hence, we expect earnings growth to moderate further to c8.5% in FY12e and c14.4% in FY13e.

■ Currency fluctuations a key short-term risk: Margins in the Q4 results were negatively impacted (c440bps) due to a forex loss of INR1.6bn, which included both actual losses on imports & mark-to-market on currency hedging contracts. As Siemens is a net importer (imports c40% of components; exports c25% of sales), an exchange loss on rupee depreciation implies that either the company has unhedged exposure to imports or has different forward contracts on imports & exports. In either case, we believe that continuing weakness in the INR is likely to impact margins further in Q1.

■ Lower our FY12/13e EPS by c7%/10%; maintain Neutral rating, cut TP to INR765 from INR940: We are lowing our FY12/13e EPS by c7.4%/c10.2%, driven largely by our reduced revenue expectations (as we were already cautious on margins). On our new estimates, valuation remains rich with the stock trading at c25.7x FY12e PE. We believe the stock is likely to de-rate further as earnings quality has declined, business outlook has deteriorated, and the likelihood of further open offers has diminished. Our target price is derived from our preferred EVA valuation model and implies a 12m fwd target multiple of c24.4x on 24m fwd estimated EPS of INR31.4.

To read the full report: SIEMENS INDIA

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