25 Nov 2012
Update |Sector: Capital Goods
Crompton Greaves
CMP: INR
TP: INR
CROMPTON GREAVES (In‐Sites – Visit to Spain and Hungary):
Multiple Journeys, and strong pace of Urgency
‐
We visited i) Tapioszele (Hungary) which manufactures Power Transformers,
Rotating Machines and GIS substations ii) Bilbao (Spain) which includes
recently acquired ZIV and also the Global Head Quarters of newly formed
fourth business unit
‐
Power Automation. We also interacted with senior
management team including Mr Laurent Demortier (MD and CEO), business
heads and operating management across divisions.
We noticed an increased pace of urgency towards emerging as a ‘Global
Corporation’ from India. Several steps in terms of enhancing product
portfolios, geography reach, correcting cost structure, etc are being
accelerated. While the reported financials have continued to disappoint, the
operating management demonstrated a strong commitment to execute the
long term plan.
The transition phase has led to several moving parts, which are challenging to
monitor and stock reaction to any slippages has been significant. In our view,
the stock's performance would largely be driven by an improvement in
overseas business, though standalone performance would protect downsides.
We model overseas business EPS loss of INR4.7/sh in FY13 (led by the
restructuring costs in Belgium / Hungary) and breakeven in FY14 (as benefits
of several of the initiatives start showing initial results). Standalone business
performance is expected to be steady with EPS at INR8.2/sh in FY13 (up 4%
YoY) and INR9.2/sh in FY14 (up 12% YoY). We maintain Buy, with a target price
of INR131.
‐
‐
On the road from Spain: Leading the technology curve, businesses at an inflexion
point
‐
Bilbao (Spain) included the recent acquisition ZIV (for Euro150m) and also the
Global Head Quarters of recently formed fourth business unit
‐
Power
Automation. As we understood, Sub‐station automation and metering are at the
cusp of an inflexion point over the next 1‐2 years; while distribution automation
presents a longer‐term potential given the evolving markets and industry
protocols for smart grids.
‐
The profitability in sub‐station automation is dependent on scale economies;
while technological dominance and R&D are critical parameters in metering and
distribution automation. Profitability improvement in ZIV from 4‐6% EBIDTA
margin in CY09/10 to 16% in CY11 and ~20‐21% in CY12 was driven by metering
business.
‐
Going forward, 2013 quotation in Spain for smart meters is likely to be up 50%
YoY, while other countries like UK, Poland, Rumania, Portugal, France, etc are
showing promising trends. This business has a large operating leverage, given
R&D efforts and technology know‐how. Sub‐station automation has also
witnessed initial traction with pre‐qualifications from PGCIL and the attempt will
be to leverage on CG’s overseas network. Given this, the management stated
that the Power Automation business is on course to achieve revenues of
Euro200m in next 3 years, from Euro110m now.
1

Crompton Greaves
On the road from Hungary: Key part of the EMEA strategy, successful stabilization
to be an important game‐changer
‐
Ganz, the Hungary facility acquired by CG in 2006, is a 160years old company.
Tapioszele facility manufactures Power Transformers (PT), Rotating Machines
and GIS substations. While several of the businesses and manufacturing
surrounding Rotating Machines and GIS had been curtailed by the previous
owners, CG has made successful attempts to consolidate and meaningfully
expand presence in these segments as well.
‐
The restructuring entails right sizing of capacity in Belgium and expansion in
Hungary by 10000MVA; and thus CG’s operational capacity in Europe will
expand. Hungary contributed 10% of the overseas revenues of CG Global, and
attempt is to make Hungary the manufacturing hub for Europe, Middle East and
Africa (EMEA) region. Manufacturing capacities are being doubled in PT, by 2.5x
in GIS etc; and in 1HFY13 order intake from EMEA region is already up ~70% YoY
largely driven by Middle East (new office started in Dec 2011).
‐
The key risk to profitability in Hungary is that most of the 31 PT projects
transferred from Belgium have peak execution / delivery in Jan 2013. Any delays
can lead to damages being payable to the clients. While management team at
the plant believes that they are on track and there were ~23 transformers on
the shop floor being manufactured, there could be possibilities of contingencies
/ re‐works given the sudden increase in activity levels.
‐
Over past 2 years, Hungary has received pre‐qualifications (PQs) from several
utilities in Europe; and priority is towards increased penetration in Middle East
and Africa. Order intake in consolidated overseas business of CG is up ~60% YoY
in trailing 12 months and in FY13 should grow 20% YoY (while revenue growth in
FY13 in overseas business will be stagnant given the impact of restructuring and
stabilization period). We believe that the operating leverage to any possible
revenue increase is meaningful given that staff costs contributes 23% of the
overseas business revenues.
Interactions with management: Focused growth strategies
‐
Management is not looking for any acquisitions in the medium term and the
technology gaps in terms of GIS, etc are planned to be fulfilled through
technology partnerships
‐
The organization structure has been revamped and effective from Oct 15
th
,
entailing that marketing heads have been formed on the basis of regions to
present a unified face to the customer. Also, as per the revised structure,
business heads will focus on the respective segments in terms of unified product
offerings across geographies.
‐
Industrial business is being revamped as Rotating Machines, and the attempt is
to move up the curve in HT motors and also Turbo‐generators. Consumer
business is being rejuvenated and a new management team has been appointed
and the attempt is for a very meaningful increase in market share of fans.
‐
The management outlined a 450bps EBIDTA margin expansion program in May
2012, and it entailed accretion of 300bps from ‘improved sourcing’ and
‘increased offerings’. The inflexion point in terms of sourcing is expected in
4QFY13, and thus effective roll out can lead to consolidated margin expansion of
~100bp+ in FY14 consolidated for CG, in our opinion.
25 Nov 2012
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Crompton Greaves
Comparative Financials and Valuations
* Consolidated
On the road from Spain
‐
Bilbao (Spain) included the recent acquisition ZIV (for Euro150m) and also the
Global Head Quarters of recently formed fourth business unit
‐
Power
Automation. As we understood, Sub‐station automation and metering are at the
cusp of an inflexion point over the next 1‐2 years; while distribution automation
presents a longer‐term potential given the evolving markets and industry
protocols for smart grids.
The profitability in sub‐station automation is dependent on scale economies;
while technological dominance and R&D are critical parameters in metering and
distribution automation. Profitability improvement in ZIV from 4‐6% EBIDTA
margin in CY09/10 to 16% in CY11 and ~20‐21% in CY12 is driven by metering
business.
Going forward, the management stated that 2013 quotation in Spain for smart
meters is likely to be up 50% YoY, while other countries like UK, Poland,
Rumania, Portugal, France, etc are showing promising trends. This business has
a large operating leverage, given the R&D efforts and technology know‐how.
Sub‐station automation has also witnessed initial traction with pre‐qualifications
from PGCIL and the attempt will be to leverage on the CG’s overseas network.
Given this, the management stated that the Power Automation business is on
course to achieve revenues of Euro200m in next 3 years, from Euro110m
currently.
‐
‐
Post ZIV acquisition; Power Automation is now a separate business unit
‐
Post the acquisition of ZIV, CG has formed a 4
th
business unit
‐
Power
Automation. This business encompasses the past acquisitions of QEI, Microsal,
Nelco and ZIV. During CY2012, this business is expected to contribute Euro110m
in revenues and the target is to increase the same to Euro 200m over the next 3
years.
‐
The activities have been reorganized across three functional areas: Substation
automation, Distribution automation and Metering. CG, along with ZIV, is
possibly amongst the few 3‐4 players globally that is integrated in the entire
chain.
‐
ZIV was formed in 1993 around the key activities of ‘Protection and Control’ and
then expanded to encompass ‘Communications’. ‘Metering’ was started in 1998,
in response to the shift in market towards digital meters. Structure of ZIV is
asset light and extensively involves sub‐contractors. The key activity is R&D and
key focus is application support. A large part of the manufacturing is
outsourced, and assembly / sub‐assembly and testing is being done in‐house.
Thus, ZIV entails a very lean manufacturing set up with ~400 employees.
25 Nov 2012
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Crompton Greaves
Power Automation: Key Acquisitions
Compa
ny
Microso
l
Nelco
QEI
ZIV
Acquisiti
on
May
2007
April
2010
May
2011
July 2012
Locati
on
Ireland
India
USA
Spain
Cost
(EV)
€10.5m
Rs920
m
US$30
m
€150m
Portfolio
Automation products and systems for sub-stations
Acquired traction electronics, SCADA and Industrial drives
businesses
Automation for Electric utilities and Electrified Transit
(Railways)
Smart Grids, Grid Automation
Integration with CG provides growth opportunities in Substation automation;
‘Smart Meters’ an interesting growth driver
The newly formed ‘Power Automation’ business segment has been organized
around: Substation Automation, Distribution Automation and Metering. As we
understood, Sub‐station automation and metering are at the cusp of an inflexion
point over the next 1‐2 years; while distribution automation presents a longer‐term
potential given the evolving markets and industry protocols for smart grids. The
profitability in sub‐station automation is dependant on scale economies; while
technological dominance and R&D are critical parameters in metering and
distribution automation.
‐
The integration with CG will enable ZIV to improve in the key markets of
substation automation; and will be an important synergy driver. For instance, in
India PGCIL has already pre‐qualified based on ZIVs track record in sub‐station
automation and the PQs in segments like Power Line Communication are under
validation stages. Attempts are similarly being made to leverage the overseas
presence of CG in several geographies for these products, particularly in the
European markets. The market currently is being largely catered by established
European players like Siemens, Alstom, etc. Thus, given the competitive
intensity, we believe that the profitability will be a function of economies of
scale and hence the challenge will be to quickly scale‐up.
‐
In Metering, the market for Smart Meters is evolving quickly given the European
Regulations which mandates 20% energy efficiency improvement by 2020. Also,
demand management is becoming an important priority given increased focus
on renewables, with targets to generate 20% of electricity by 2020. Smart
Meters is an important opportunity in countries like France, UK, Poland, USA,
Brazil, India, etc. While ZIV is the ‘first to market’ and very few manufacturers
can offer integrated solutions, the challenge is technology dominance and scale
economics. This business has high entry barriers as pre‐qualifications are critical,
given that any faulty metering will entail a large financial implication and thus
ZIV is uniquely positioned to capitalize on the opportunity.
‐
Distribution automation is also an interesting long term market, with products
like Smart Grids, etc which basically entail communication between the meter
and the various equipments on the network. However the medium term
challenge is that the market is still evolving and there are no established
protocols even in the EU. Another challenge is weak financial position of the
distribution utilities and hence there are possibilities of this business being
required to be supported on BOT model, by the equipment manufacturers.
Another challenge is that the priorities across countries are also different, and
thus in Europe while the focus is on influencing the energy consumption and
demand side to drive energy efficiency; the focus in countries like India is
towards T&D loss reduction.
‐
Integration with CG will also enable ‘Product Pull’ through EPC portfolio of CG,
MV Transformer substations and Post delivery service agreements. The
25 Nov 2012
4

Crompton Greaves
‐
integration will also enable to create an image of ‘Product Support’ rather than
‘Local Knowledge Centre’.
Iberdrola is the largest customer for ZIV contributing ~35‐40% of the revenues
for ZIV. Given the acquisitions Scotland, USA, Brazil, etc, there are opportunities
to leverage the pre‐qualifications.
Smart Meters: Approaching an Inflexion point; ZIV advantage is ‘First to the
market’ and ‘Integration of Meters and Communication’
‐
ZIV manufactures most of the categories of meters and concentrators; and this
is an advantageous position as there are very few integrated players.
Concentrators provide ‘Power Line Communication’ and utilities prefer this
mode of communication, given the ownership of the network and need to
control the confidentiality of the data.
‐
ZIV had introduced the first smart meter in Europe. By 2020, all meters in
Europe have to be smart meters and this is a potential market size of 220m
meters; till date ZIV has delivered 1m smart meters with a pre‐dominant market
share in EU. We believe that given the initiatives in Spain, Poland, Rumania,
Portugal, France, UK, etc the inflexion point will be ~2014 for smart meters
business.
‐
Spain continues to be an important driver of demand within EU, and the
management believes that 2013 quotation will be atleast 50% higher YoY (2012
was 1m pieces). Market share of ZIV in 2012 in Spain was 40%, and the order
was split between three players in ratio of: 40/40/20.
ZIV: Financial Summary (stated as at July 2012)
€
M
Sales
EBIDTA
EBIDTA %
Dec-09
35.8
2.2
6%
Dec-10
34.0
1.5
4%
Dec-11
52.0
8.4
16%
TTM, Jul 12
75.0
15.6
21%
Dec 12 Est
85.0
17.85
21%
Capacity can triple with minimal capex, Metering business has a large operating
leverage
‐
Over the past 3 years, the revenues of ZIV increased from USD36m in
CY2009/CY2010 to Euro75m in ttm July 2012 and expected at Euro85m in
CY2012. Also, margins have increased from ~4‐6% in CY09/10 to 16% in CY11
and the target is EBIDTA margins at ~24% in CY12. A large part of the revenue
increase is being driven by smart meters program in Spain.
‐
The metering business has a large operating leverage, as it involves a technology
software and knowhow. Also, the management stated that the current capacity
of 3000 meters / day can be easily ramped up to 10000 meters / day with three
shift operations.
‐
ZIV has a tax shelter of Euro18m, with no time limits to be set off in future. As
per the norms, R&D spending enjoys subsidy of 25% from the government; and
of the balance 75%, the company enjoys a tax break of 25%. The management
believes that the accumulated tax shelter will witness an increasing trend in
CY12.
On the road from Hungary
‐
Ganz, the Hungary facility acquired by CG in 2006, is a 160years old company.
Tapioszele facility manufactures Power Transformers (PT), Rotating Machines
and GIS substations. While several of the businesses and manufacturing
surrounding Rotating Machines and GIS had been curtailed by the previous
25 Nov 2012
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Crompton Greaves
‐
‐
‐
owners, CG has made successful attempts to consolidate and meaningfully
expand presence in these segments as well.
The restructuring entails right sizing of capacity in Belgium and expansion in
Hungary by 10000MVA; and thus post the process, CG’s operational capacity in
Europe will expand. Hungary contributed 10% of the overseas revenues of CG
Global, and the attempt is to make Hungary the manufacturing hub for
Europe, Middle East and Africa (EMEA) region. Manufacturing capacities are
being doubled in PT, by 2.5x in GIS etc; and in 1HFY13 order intake from EMEA
region is already up ~70% YoY largely driven by Middle East (new office started
in Dec 2011).
The key risk to profitability in Hungary is that most of the 31 PT projects
transferred from Belgium have the peak execution / delivery in Jan 2013. Any
delays can lead to damages being payable to the clients. While the
management team at the plant believes that they are on track and there were
~23 transformers on the shop floor being manufactured, there could be
possibilities of contingencies / re‐works given the sudden increase in activity
levels.
Over the past 2 years, Hungary has received pre‐qualifications (PQs) from
several utilities in Europe; and the priority is towards increased penetration in
Middle East and Africa. Order intake in consolidated overseas business of CG is
up ~60% YoY in trailing 12 months and in FY13 is expected to be up 20% YoY
(while revenue growth in FY13 in overseas business is expected to be stagnant
given the impact of restructuring and stabilization period). We believe that the
operating leverage to any possible revenue increase is meaningful given that
staff costs contributes 23% of the overseas business revenues.
Hungary facility: The inventor of transformer in the world
‐
Ganz, the Hungary facility acquired by CG in 2006, is a 160years old company
and was the inventor of the transformer in the world. CG Hungary is amongst
the Top 300 companies operating in Hungary. Tapioszele
‐
facility in Hungary, manufactures PT, Rotating Machines and GIS substations.
While several of the businesses and manufacturing surrounding Rotating
Machines and GIS had been curtailed by the previous owners, CG has made
successful attempts to consolidate and meaningfully expand presence in these
segments as well.
‐
Hungary contributed 10% of the overseas revenues of CG Global, and the
attempt is to make Hungary the manufacturing hub for Europe, Middle East and
Africa (EMEA) region. Manufacturing capacities are being doubled in PT, by 2.5x
in GIS etc; and in 1HFY13 order intake from EMEA region is already up ~70% YoY
largely driven by Middle East (new office started in Dec 2011).
‐
There are 800 employees currently, of which 67% are Blue collar (vs 50% in the
past); and this shift has led to improved efficiencies. In contrast, Belgium plant
has ~60‐65% of the employees as white collar leading to duplication of key
functions in the CG network. The management highlighted that most of the
employees are from nearby locality, vs a large number of employees from
Budapest in past. CG has created local training institutes and developed skill
sets.
Hungary operating at 100% capacity utilization, given the transfer projects from
Belgium
‐
Hungary PT facility is now operating at ~100% capacity utilization (for the first
time ever post acquisition by CG), vs ~50‐60% capacity utilization in the past.
25 Nov 2012
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Crompton Greaves
‐
‐
Restructuring costs over next 2 quarters needs close monitoring; operating
leverage in FY14 could be meaningful
‐
The key risk to profitability in Hungary is that most of the 31 PT projects
transferred from Belgium have peak execution / delivery in Jan 2013. Any delays
can lead to damages being payable to clients. While management team at the
plant believes that they are on track and there were ~23 transformers on the
shop floor being manufactured, there could be possibilities of contingencies /
re‐works given the sudden increase in activity levels.
‐
Belgium restructuring, in terms of downsizing the employee base by 240, will be
completed most probably by mid December. This will be an important event to
monitor, and also the associated costs.
Capacity in Hungary is being expanded for GIS (by 2.5x), for PT (by 2x) and in
Rotating Machines the Capacity utilization has increased to 60% (vs 40% ~2 years
back) and target is 100% in FY14. The orders have largely been received (intake in
1HFY13 in EMEA is up 70% YoY), and thus FY14 will possibly see a very meaningful
ramp in execution. Order intake in consolidated overseas business of CG is up
~60% YoY in trailing 12 months and in FY13 is expected to be up 20% YoY (while
revenue growth in FY13 in overseas business is expected to be stagnant given the
impact of restructuring and stabilization period). We believe that the operating
leverage to any possible revenue increase is meaningful given that staff costs
contributes 23% of the overseas business revenues.
Given better absorption of overheads, Hungary should be profitable in 3QFY13,
excluding the impact of restructuring costs of projects transferred from Belgium.
Hungary PT capacity is being expanded from 7500MVA now to 10000MVA by
end Dec 2012, 12500MVA by March 2013 and 15000MVA in Dec 2013. This is a
phased expansion program, and entails new purchase of machinery (and not
transfer from Belgium). Belgium restructuring is about right sizing of capacities
(to 8000MVA from 12500MVA), and not downsizing in the first phase. Post the
capacity expansion by ~100% in Hungary, the employee addition is just expected
at 30% in PT given the expected productivity improvement of ~30% with use of
vertical winding machines.
Also, we understand that the salary levels in Budapest at Euro1000/ employee
for 3 months compares with Euro500/employee in Tapioszele for an entry level
engineer. Also, the fully loaded employee cost in Hungary is Euro7/hour vs
Euro50/hour for a winder in Belgium; and thus there is a meaningful arbitrage.
This has led to definite cost advantages and successful implementation of the
manufacturing strategy in Hungary will be the key success factor for CG’s
overseas ambitions.
25 Nov 2012
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Crompton Greaves
Overseas subsidiaries: EBIDTA margins (ttm, %) and EPS (INR/sh)
Key subsidiaries reported large losses in FY12 (INR M)
Staff cost differential meaningful between standalone and subsidiaries (% of revenues) Staff cost differential between Belgium /
Hungarystands at ~350%
Successful PQs for Hungary will lead to improved order intake; manufacturing hub
for EMEA region
‐
Over the past 2 years, Hungary has received pre‐qualifications (PQs) from
several utilities including Edf (France), Saudi Generation, Western Power (UK),
Air Products (UK), SNCF France Railways, E.ON (Hungary / France / Germany),
etc. There are also ongoing PQs processes and thus this is emerging as an
important hub for CG’s manufacturing footprint in Europe. The PQs have been
obtained for both the PT and Rotating Machines and, going forward, the priority
is towards increased penetration in Middle East and Africa.
‐
Obtaining PQ is a long process and requires Board approval of the utility to
initiate the process with the new supplier. This is followed by a very detailed
audit, given that equipment failures are unacceptable. The existing successes
entail that CG largely covers the Western Europe.
For the GIS switchgear, the key target markets are Far East, Europe and India.
CG completed the testing of GIS in 2009 and this has been largely developed
in‐house, based on the past technical competence at Ganz. In rotating
machines, the capacity range is 250kw – 25MW and the attempt is to
penetrate turbo generators market as well.
25 Nov 2012
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Crompton Greaves
CG’s Order Intake has improved meaningfully
Order intake composition
Sourcing from LCCs to be an important margin lever
‐
Sourcing from Low Cost Countries is expected to be an important driver of
margins on a consolidated level, and the inflexion point is expected in 4QFY13.
The management in Hungary stated that they now interact with Commodity
Managers in CG (vs direct negotiations with vendors in past), have witnessed
few initial samples of castings from China (vs Poland in past), etc.
‐
Effective roll out can lead to consolidated margin expansion of ~100bp+ in FY14
consolidated for CG, in our opinion. For Hungary, sourcing from LCCs stands at
just 25% and this quantum will increase significantly in FY14.
25 Nov 2012
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Crompton Greaves
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Crompton Greaves
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25 Nov 2012
10