Summary: Voltas at present levels is a good buy, irrespective of the present macroeconomic situation. I believe that the stock has taken a good hammering in the last one year because the market has been too emotional about it. In other words, the market was probably expecting too much and so thought it eventually got too little. I don’t believe that to be the case. The company looked overvalued at higher prices and looks just about correctly valued now. In fact, if the stock price dips any further, it should be treated an as additional invitation to buy.

My Holdings

None

About Voltas

I thought Voltas makes ACs. It does, but that’s not what it does all the time. In fact, if it were a man, it will make ACs only 1/3^rd of its time. For over half the time, it will execute Mechanical, Electrical and Plumbing projects in various large projects (like F1/Commonwealth Games/Hospitals etc). 10% of the time will be spent in actually making big machines and selling to other business. These include selling Textile Spinning Machinery to Textile Industries, selling Mining and Construction equipments to Mining companies and Material Handling Equipments to warehouse management companies. As mentioned earlier, for the remaining 1/3^rd time, it will  make ACs and Refrigerators. In whatever time that is left, however miniscule it may be, it will involve itself in performing horticulture, water management and purification work in Oman.

The company, thus, is not a company that sells to retail customers. It is a B2B company and has a profile right from small ACs to big Machines and a service profile that involves project management in all aspects. The company does so all across the world and enters into JV or Subsidiary engagement in geographies where such an option is available or needed.

Voltas’ Ecosystem

As mentioned earlier, Voltas makes products ad executes projects. That means its cash flows in any one line of business are very different from any of the others lines of business. When it makes small products, the ecosystem involves it to project demands on a seasonal basis, plan for the production, manage inventory and quality and eventually sell to customers. In that ways, it works like a normal manufacturing company. Cash is obtained when the product is eventually sold. Also an AC produced in one year can be sold the next year.

When Voltas makes big machines, it projects demand on the basis of economic conditions and government policies that impact its customers and then plans for production. The purchase decision for the customers are dependent on their own cash flows and so there are chances that these machines, if not sold on time, may have to be carried as inventory for a larger period of time. The cash is obtained when the machines are sold, but is blocked for a larger amount of time during the production. The inventory can be converted to cash, in worst of the situations.

When it executes projects, the company takes over a project site, brings in its resources and then starts executing work. Its cash flows come in the proportion of the work executed. The project timeline can be delayed for a myriad set of reasons, from incompetence to government interference to economic condition. If there are delays, the costs incur and these costs cannot be diverted to any other location for a different use.

As one can see, the three businesses that the company operates in are as different as chalk and cheese. That the company operates in these simultaneously is only because it chooses to, and not because it sees much natural synergy between these businesse.

Voltas’ position in its ecosystem

This question is tricky. It is tricky because it is not one ecosystem we are talking about.

One needs to look at how big the company is in its respective businesses. In ACs, the company controls 18% of Indian market (as per its own Annual Report). Apart from this, the company made about 3000 Cr. Rs. in the last FY on its Electro-mechanical projects and services division. Punj Lloyd, the 2^nd biggest project construction company, did about 8200 Cr. Rs. last year. Even though this is not a apples to apples comparison, this indicates that in the business of managing projects too Voltas is one of the bigger players. In its machinery division, the company made more than 550 Cr. Rs, which makes it amongst the top 25 engineering companies in the country (a list that includes totally heavy engineering companies, like BHEL). Purely amongst the industrial/general purpose machinery companies, Voltas ranks in Top 5.

So when we look at this way, Voltas looks like a significant player in all its ecosystems.

For the analysis below, I am using Consolidated Financial Statements

Reported Financial Performance:

The in the last FY2010-11, the company’s total revenue increased and PAT decreased on a YoY basis.

Below is a high level view of the company’s finances as reported in its annual report. It can be seen that the profits have fluctuated rapidly in the last 3 years (consolidated).

Since the last annual report was 9 months old, I have indicated the rolling 4 quarters net profit of the company. It can be seen that the company has reported almost the same amount of net profit in its last 4 quarters, as it did in the last FY.

The PAT and Net Worth exclude minority interest.

FY	2008-09	2009-10	2010-11
Net Sales (Rs. Cr)	4325.94	4759.63	5179.01
Reported pat (Rs. Cr)	257.67	388.13	345.92
Average Net Worth (Rs. Cr)	667.6	923.61	1201.65
Rolling 4 Quarters Net Profit as of now (Rs. Cr.)			339.1

Reported Free Cash Flows to Equity Owners

 Along with the above finances, one can look at the below measures from the company’s annual financial statements (consolidated).

FY	2008-09	2009-10	2010-11
Cap Ex	81.26	-6.89	-5.77
Dep + Amortization	20.96	21.41	21.02
Absolute change in Non-Cash W/C	-183.13	-34.77	-332.03
Total Increase in Debt	107.7	-146.27	102.96
Total Increase in Deferred Tax Liability	-3.47	2.17	5.02

 One can see that the company had one round of Capital Expenditures 2 years ago but has not done so recently. Looking earlier into its history as well, it looks like the company takes up capital expenditures in phases, and so to even out the impact of such exercise, one has to normalize these numbers.

The company has financed the Capex using Debt as there has been a similar increase in debt in 2 years ago as well. The company paid back the debt the next year, but then again took some more debt in the last year. As per company’s annual report, this additional debt was due to some local issues in some of its international markets.

The company’s Working Capital change has been negative consistently but fluctuates in magnitude on a year to year basis.

When I normalized the above factors and calculated the FCFE, I get the following data (all amounts in Rs. Cr.):

Average last 3 FY Sales	4754.86
Net Profit (latest)	345.92
Cash Value + Marketable Securities	738.88
Latest FCFE after Normalization of Debt and Capex	326.81
Latest FCFE before Normalization of Debt and Capex	176.67
Average FCFE after normalization for the past 3 years	249.43
Average FCFE before normalization for the past 3 years	174.95

One can see that the company’s last 3 year’s Average Free Cash flows on a normalized basis are less than the latest reported profit or the training 4 quarters profit.

So why has the share price dipped?

Despite reporting the same amount of total net profit in the last 4 rolling quarters as in last FY (indicating stable performance), the share price of the company is hovering around its yearly lows. This is because:

• In Q2 FY 12, the company reported 40 Cr as profit, which was less than ½ of what it made in Q2 FY 11. This indicated to the market that the company is not going to make the same amount of money in the coming days.
• Companies like Voltas command a lot of their share price due to their growth prospects. Since the growth prospects of the company look dim (due to low profit) the company’s share prices took a big hit.

So, share price is where it is now… Will it go up or go down?

If someone is interested in investing in this stock, he/she will want the answer to this question.  However, instead of answering this question, I am trying to make a case on why it makes sense to invest in this stock.

Following are the reasons I am gung-ho about this stock:

1. Prospect of Dividend: Last financial year, the company payd 2Rs per share of Dividend. As mentioned in the above sections, the company is still a consistently-high-free-cash-flow company and that has not changed. Given this, I believe we can be confident that the company will continue a period of good performance in absolute terms. I am reasonably confident that the company should return dividend in the coming year as well. Whether it will still be Rs. 2 or will it be lesser is a matter of speculation. In the last recessionary environment in 2008, the company stil paid Rs. 1.35 Rs per share of dividend and paid 1.6 Rs. per share in 2009. Even if the company pays 1.6 Rs per share, we are getting 2% fixed return on for sure.

For those who say 2% is not enough, I am only saying that this surety is not there with many companies in this FY. Also, this surety of a dividend is not the complete case in favor of the company.

1. Prospects of Capital Appreciation: Since April/May 2011, nothing materially has changed with the financials of the company. Yet, the company’s shares dropped by over 55%. Since Jan 2011, when the prices were about 3 times of their current prices, nothing materially has changed. Except 2 things. One, the recent profits have dipped. That we have covered above. And two, the company took about Rs. 100 Cr. worth debt. Even after this additional debt, the company’s total debt is at a measly  138Cr. 3 years ago, the company had over 180 Cr. debt and the company paid a lot of it back in 2009-10 and the prices were still double of present value. Since then, both absolute revenue and absolute profits have improved.

 

With the argument above, I believe that the company’s recent negative returns on share price are more attributable to the emotional nature of the market, and less with the actual performance. Remember, the company is still55% project management company and hence heavily dependent on economy and that is weighing more on the mind of the market. In other words, the same reasons that brought the prices down may bring the prices up later on.

1. Better hedged company: This point is again to underline why market may have been too emotional with this stock. The economic situation is not great for the immediate term, but the retail consumption story esp. the consumptions drive by Indian middle class is still intact. If we look, the business segment composition of Voltas has chaged in the last 3 years. In 2007-08, the company’s AC unit was 25% of its size and in FY 2009-10 it was 30% of its size. Clearly, the company is looking at its cooling products unit as its growth driver and this segment is propelled by retail or office consumption. Even if the company does not make 30% of its sales in Cooling products segment in FY 2011-12, it is still better hedged than in 2007-08 and hence its performance has a degree of stability to it.

1. Ratios look attractive: At present share levels, the company is selling at about 8 times its average free cash flows of the last 3 years, 11 times the latest year’s free cash flows and about 2.25 times the book value. For the same performance, when the share price was 135 Rs 6 months ago, then numbers were 15, 21 and 3.7 respectively. From what I have learnt from books and from my own experience, any time the P/E times P/BV exceed 25, the stock has to be really good to justify the multipliers. For me, no matter how I look at the free cash flows (point in time or averaged out), the numbers are attractive. The same numbers were NOT ATTRACTIVE at levels above 100.

The numbers are mentioned in the below section.

As a bottom line, instead of answering whether the share price will go up or down, I am contending that the share price is attractive now. Tomorrow, if the share prices go up you will gain. If the share prices will go down, then it will be even better as you can buy more to gain still more later! The company is extremely fit right now and should not lose the battle with bad economic situation.

 

Ownership Structure and Fit vs Flab:

30.32% of the company is in the hands of its promoters. The promoters are from Tata group. They are running a manufacturing cum project management organization with minimum debt and the company had an interest coverage of over 30 times in the last year.

I believe the company’s ownership and its fiscal condition are not in any doubt.

Return on Net Worth:

The PBIT/Avg. Net Worth for VOLTAS was 23.3% 6 years ago. It was 40.85% in the last FY. In this time, the lowest it got to was 52% in 2009. No matter how we slice this or dice this, the company is running on supreme operational efficiency. The premium that the market is giving to its share price is justified.

Value Judgment:

Removing the amount of cash the company carries from the share price, I arrive at the following conclusions. These are the same numbers I had referred to above.

Company	Voltas
Latest BSE closing Price	82.05
P/E Reported	7.8
P/FCFE Updated (After Normalization – Latest)	6.0
P/FCFE Updated (Before Normalization – Latest)	11.2
P/FCFE Updated (After Normalization – Last 3 FY Avg)	7.9
P/FCFE Updated (Before Normalization – Last 3 FY Avg)	11.3
P/Trailing 4 Qtr Earnings	6.6
P/Bv	2.26
Current Assets > Total Liabilities	TRUE
Interest Coverage	30.22

In my earlier analysis of other companies, I made a case for a company when the P/FCFE was in single digits and P/BV was around or below 1. Those numbers make sense for companies that have a lot going for them but also a lot going against them. Those companies were small and had a history of good performance in terms of free cash flows and returns on net worth (good things) but were small in their industry or were in industries that were matured and not expected to be star performers like other sectors (bad things). For such companies, it makes sense to buy a company when the share price to a shareholder is worth the same as the owner of the company.

For Voltas, this is not true. Based on the analysis above, I believe that the company has more things going good for it (financials, business mix, history) and very little (namely economic situation) going against it. In such a case, it is a ‘dream comes true’ situation if you and I can get the share at the same cost as it is worth to the owners. The closer we get to that the better it is. With that belief, it makes sense to enter the share at levels that makes sense. If the share drops below those levels, it is actually better for us as we can buy more of them. For Voltas, I believe those levels of good entry point are reached now.

Verdict:

Investing in Voltas is relatively less risky at present levels. For a patient investor who is willing to look longer term, this is a great opportunity. The stock looks just about rightly valued from its reported performance. For a new investor looking for 1-2 yrs timeframe, I would recommend look at this stock as an “accumulator” which means I suggest keeping on accumulating this stock on these levels and below with hope of a very good payback later.

Personally, I am going to buy the Scrip now.