V-Guard Industries Limited (532953) Earnings Call Transcript & Summary

Ladies and gentlemen, good day, and welcome to V-Guard Q3 FY '20 Earnings Conference Call hosted by AMBIT Capital. [Operator Instructions] Please note that this conference is being recorded. I now hand the conference over to Mr. Ashish Kanodia from AMBIT Capital. Thank you. And over to you, sir.

Thank you. Hello, everyone. Welcome to 3Q FY '20 Results Conference Call of V-Guard Industries Limited. Today, we have from the management, Mr. Mithun, Managing Director; Mr. Ram, Director and Chief Operating Officer; and Mr. Sudarshan, Senior VP and Chief Financial Officer. Now I would like to hand over the call to the management for opening remarks, post which we can open the floor for question and answers. Thank you. And over to you, sir.

Thank you, Ashish, and thank you, AMBIT, for hosting this call. A very warm welcome to everyone present, and thank you very much for joining us today to discuss the operating and financial performance of our company for the third quarter ended 31st December 2019. During the third quarter, which included the annual festive season, consumer sentiment continued to be sluggish and demand outlook remained challenging across most of our product categories. Under these circumstances, products such as fans and water heaters delivered double-digit growth, while other products where the demand can be potentially subject to postponement, delivered weaker growth. We continued to diversify the revenue profile by expanding contribution from a wider range of products as well as growing non-South markets by leveraging existing investments in brand marketing and distribution. We have also been moving towards premiumization of the portfolio and are seeing the benefits from this exercise starting to accrue in our brand positioning and improving our margins profile. Overall, our strategy has been to consolidate presence in the established markets, expand market share in new markets, while at the same time increasing our engagement with modern retail and e-commerce channels in specific product categories. While these distribution channels currently make a small contribution to revenues, at present we believe there is potential to expand it further over time. We maintain strict organizational discipline across functions, including control over working capital in tight liquidity conditions and containing operation cost inflation. Resultantly, revenue growth of 5.4% in Q3 delivered year-on-year EBITDA margin expansion of 190 basis points to 9.5%, while profit after tax increased by 27% to INR 42.9 crore. We continue to see margin expansion across all our key product categories, which will be a function of volume, growth, premiumization and cost effectiveness. During the quarter, net cash position improved further to INR 323 crores despite the annual dividend payout based on higher operating margins and stable cash conversion metrics. As a result, the company's operations continue to develop superior returns to stakeholders. ROE and ROCE were at 21.0% and 25.5%, respectively, at the end of Q3 FY '20, calculated on trailing 12-month basis. Going forward, in the near term, we expect to see a gradual pickup in demand growth. However, over the long term, we are confident of achieving top line growth trajectory of 15%, driven by expansion into new -- expansion into non-South markets and introduction of new product categories. We have undertaken several business strengthening initiatives, and we'll continue to add 3,000 to 5,000 retailers across the country every year with higher addition in the non-South region. We have put in place the best-in-class processes and systems to create the bandwidth for the company to transition from a leading -- to a leading nationwide brand with high-quality products in the consumer Electricals, Electronics and Consumer Durable space that have a strong sales in the minds of consumers. Overall, we see V-Guard brand being well positioned to benefit from the turnaround in the macroeconomic sentiment in the country. On that note, I would like to thank you once again for your participation and would like to hand over the floor to the moderator for questions and answers. Thank you.

[Operator Instructions] The first question is from the line of Aditya Bhartia from Investec.

Mithun, my first question is on the demand environment. Just want to understand from you, is it getting better or is it getting worse? And within the last quarter, how did you see, were the exit run rates better than what we saw maybe in October? A related question, are you also seeing dealers in the channel reducing their inventory levels? And has that situation stabilized?

So I think the environment continues to be challenging. Having said that, maybe December and January, we have seen a little bit better pickup in numbers than the earlier months. I think we'll have to wait and see because I think 1 or 2 months is not enough for us to read how the environment is going to behave. We will have to wait for a few more months to see whether a consistent growth will happen. Yes, retailers are not willing to take any risks, so they are also ensuring that they are working with minimal inventory. They are also -- become risk of us. And they are also not having access to capital in terms of loans, et cetera. So they are constrained in that sense of working capital. And that's not a new issue, but it's continuing, and there is no change in that sentiment as of now.

In this kind of a scenario, Mithun, how's that channel financing schemes working? Are you seeing banks curtailing their excitement towards channel financing?

No, channel financing, the banks are ready to give because on the basis of the company's assurances. But channel financing cannot be the only means of finance. Channel financing could be maybe -- cater to maybe 30% or 40% of the -- that firm's capital requirements. The rest has to be raised by the firm itself. So what we are seeing is, many banks are not willing to increase limits to customers and thereby it's getting affected. So channel financing, we are not seeing much change. Banks are still ready to give and all that. But other sources of finance, of course, is impacted. And many of them are also having other businesses, like some of them are into -- many of them -- many of the trade partners, they dabble in real estate and all that. So they also have money stuck up in various things like that.

Understood. And lastly, Mithun, how's been the competitive intensity in the last few months? And have you seen your peers resorting to price cuts or higher dealer incentives in order to boost their growth?

Yes. So definitely, the -- we are going through a hypercompetitive environment. We have seen several brands slashing prices so that they can boost up their volume growth, and that's continuing. We have seen that significantly in the water heating category. We are seeing that in the fan category as well. And we are also seeing it in the switchgear category. So these 3 categories, we are seeing price cut and hyper competition across.

And despite that, in fans and water heaters category, we managed to deliver double digit revenue growth?

Yes. So I think in the case of water heaters, we had some new launches. We also -- there were some softening of raw material prices, which helped us to pass on some of these benefits to the trade partners, which helps to drive volumes. The winter season was pretty good. So I think all these factors helped us to achieve the water heater numbers. In the other cases, also, I mean, like, see, what is happening is from 5 to 6 brands in a category, today, we are having 15 to 25 brands in each category. So there is really no shelf space for all of them to exist in the market. So many are getting the spread and cutting price. So the top 2 or 3 brands in a category may not do that, but the rest of them will do. So it's something that we have to live with, but we have actually would have forgone some sales because we have not participated or responded to some of these things. So we definitely have lost sales in water heaters in the first 6 months of the year. We have definitely lost sales in the switchgear category because we have not resorted to this kind of aggressive price cuts. Even in fans, we have not resorted to any cuts. So I think you will see that even with only a 5% volume growth, our margins, both gross and EBITDA margins, have actually improved. That's because we have not responded too aggressively to some of these actions.

The next question is from the line of Prashant Kutty from Sundaram Mutual Fund.

Just on this gross margin part, while you said that obviously the stabilizers part of the business usually helps in improving your gross margin profile, that has not really grown that much. So going into the season, are we probably hopeful of a relative improvement in gross margins from here on?

So gross margins have gone up not only in the stabilizer category, there's -- gross margin increase has been across. So only in the month of December, I would say, towards the fag end of December, we started to see some increase in raw material prices. But now after the recent news and recent gloom in the market, even raw material prices have started to correct again. So I think, definitely, this kind of gross margin should be maintainable for us going forward because the increase in gross margins is not only in stabilizers, but across all categories.

Just an extension to this. So when you're saying that in -- even in a quarter when gross -- stabilizers doesn't do well, we almost report a 33% gross margin. I understand the materials have been benign. But on a full year basis, is that 30% to 33% kind of a sustainable number incrementally?

So I think if you look at the...

No, the quarter mix can be different quarter-to-quarter, so you can't look at it as an absolute, but the improvement over last year will sustain.

Okay. Okay. Is it also do with the fact that non-South, the gap is completely reduced now? I mean, is any of that factor also playing?

That hasn't changed much in the last 1 year. I mean, it's like -- the 2 have been fairly close, so...

I think there are few things. One is the product mix itself is changing. So we have launched categories in the last 4 years, which are having significantly higher gross margin than the company average or having gross margins higher than the traditional categories, barring maybe our stabilizers. So I think, definitely, as those categories become larger, you will see that effect playing out in the product mix. So that is one reason. The second is some reduction in the RM prices that happened. This is the other reason.

Okay. Sure. The second question is on the -- you just spoke about there is hypercompetitive environment and you said that there is lot of undercutting which is happening in the trade. Suffice to say, we would have lost market share in the categories which you're highlighting, despite seeing good growth?

See, if you look at us in water heaters, definitely in the first 6 months, we would have lost some share. I think that we have come back strongly in the third quarter helped by some new launches and some response to price cuts also we have done, but not to the kind of extent. For example, something like water heaters, I don't want to name any brand, but there is a well-known brand which has cut prices by 10% to 15%. So there is like almost a 20% price difference between us and some brands. So I think those kind of discounts are unsustainable for anyone. And so we are not -- we have resisted. So some trade partners who are opportunistic and wants to make a quick buck have all jumped and moved to these kind of brands. So this has been going on. It's not a new thing, but it has aggravated more in the third quarter.

Is it because of the fact that since you said there are a lot of players now coming up in all of these categories, the raw material cycle is benign and pretty much everything has been passed on to the consumer? Is that becoming a new trend right now? Because we've been hearing it for a while now.

No, no. I think it has nothing to do with raw material prices. I think fundamentally, companies have made a call to broaden and expand their portfolio. The shelf space is limited and the fight to acquire shelf space sometimes gets bloodied, particularly when you are looking in categories which are seasonal, because otherwise then you have to carry the inventory longer. But in this instance, for example, the kind of price cuts we have seen in fan or water heater, it has even been before the season has begun. So I think some -- I would say, some brands are feeling the pressure and the need to build some threshold size. I think it's not sustainable. And I think that maybe it will be difficult to stay there. In the short term, of course, we have lost, and that's where our loss was in the first half. But of course, we are quite capable to protect our turf, and we will respond to do that if it is necessary, but that means then all of us lose money in the market, right?

There's also one more thing. So what happens is, most companies have a dominant category. So the dominant category, because of benign raw material prices may be supporting the kind of aggressive price cuts which are taken. So if I'm having 90% of my business coming from a dominant category, my 20% price cut on the balance 10% of the business may not affect too much on the overall number. So that's also -- is masking some of these things.

Lastly, any one-off in employee costs?

We don't have any one-off this quarter. Only last quarter, in Q2, we had a one-off write-back.

Okay. So this is a more sustainable employee cost number?

Yes.

The next question is from the line of Renu Baid from IIFL.

Sir, my first question is just to understand a bit more in terms of the growth outlook and the weakness that we have seen. It's been a couple of quarters that we have been in that mid-low single-digit range. And your commentary on demand offtake also is not as encouraging. So, a, do we see growth coming back, not just because of structural pickup in demand offtake from consumers, but also we have now 2 quarters where seasonal products will probably kick in and there the demand elasticity is slightly different when compared to the typical demand elasticity which we have from Housing and Building Material segments. So what would be your view in terms of growth as we look in terms of the next 6 to 12 months? Should growth rate improve optically from the lows that we have seen in the second, third quarter?

So I think, yes, Q4 should be better. Q4 and Q1 are typically stronger quarters for us. So if we don't have any untoward weather-related issues, we have a reasonably warm summer, I think Q4 and Q1 should do well. Yes, the Building Material segment, especially wires and cables, which is the bigger product category in that bucket, there, the demand is not weather-related but more of structural. So there, we are continuing to see pressure because of lack of demand for construction-related products.

So then should one expect that growth could be inching back to double digits because of the seasonal products? Or it will still hover the way it has been in high single...

So I think at this point, it's very difficult for us to make a comment on forward-looking statements, but I think if Jan is an indication, things are looking better. And the contribution of seasonal products, especially the summer categories, are higher in Q4. And last Q4 -- and last year Q4 and this year Q1 has been quite strong. We are hoping to repeat that kind of a performance.

Sure, which is interesting. Second point is, as we saw in the budget, import duty across Consumer Durables segment, especially the Appliances have been increased from 10% to 20% level. So if you can help us elaborate what is the kind of import content that we have within the Durables business portfolio? And do you think in the current competitive environment where pricing has been pretty tight, this could further put pressures on gross margins or market share?

If we look at the entire company, the total import component especially in the categories you have mentioned is about 8%. So around 8% is the import component in that...

To the Appliances segment, which...

And the Consumer Durable segment...

It's 8% of total company.

Sorry, it's 8% of the total company. How does that...

And for Consumer Durable segment, how large would it be?

So on Durables, it will be higher. Definitely, it will be like something like 25% to 30%.

25% to 30%.

So for example, 30% of fans, 25% of water heaters and maybe 25%, 30% of kitchen appliances, they're all imported.

Yes.

Okay. So would you think there would be a probability to do more of local sourcing or overall market will see the pricing level itself getting adjusted to the new environment of...

So in some categories like water heaters, we've already taken a call to replace imports with local sourcing. So as we speak, we are in the process of transitioning a lot of the imported models to India-made models. And by next financial year, the transition will be complete. So -- but there are certain categories where we don't have scale in the country. So for example, pedestal fan in some case where we have to, again, reevaluate in the current like. It was not making sense earlier, but if it makes sense, so we'll have to do an evaluation and see depending on our volumes, our size of the business, our ability to have the right ecosystem in the country. Because there is no point in simply importing spare parts and just assembling them in India, it'll not make any sense. So if the ecosystem is there in the country, yes, and with the current taxation structure, if it's making sense, definitely. So in the case of water heaters, definitely, we have taken the call last year. And even without this tax, we were planning to move it into the country. Kitchen appliances, partly it's made in India, partly imported. Again, now we'll reevaluate. So I think each of the categories, we will reevaluate depending upon the availability of the right supply source, availability of components. We'll reevaluate whether there is -- it is -- whether it is making sense to make in the country. In some cases, it will and in some cases, it may not. And I guess, in the smaller categories, it probably will not because we'll be subscale.

Correct. To that extent the impact will not be there. And overall, on the margin side, if we, as in -- going forward, if volumes are to be at the levels which we are anticipating just teens, what could be the levers to improve margins? Probably gross margin sustained improvement might not be feasible given the market is competitive and one might have to pass it on to the market. So you think margins that we are looking at the current levels are broadly where they should be sustainable or they could be levered because of improving product mix or other elements as well?

So I think there are 2 parts to this. There is gross margin and there is EBITDA. I think gross margin, whatever levels we have reached, we can maintain. We have an internal long-term program to improve our gross margins. And that, as we have been doing over the last, I think, 5 years, we have improved our gross margin by 5, 6 percentage points. And similarly, we will continue working on it. As Mithun was saying, on the basis of our change in product mix and also initiatives from the cost improvement side, mainly through procurement, moving to manufacturing and all those things. So I think the gross margin improvement is a long-term journey, right? We'll continue, maybe one or the other year like last year, we were stressed and our gross margin was flat as the commodity and currency impact traveled to market more slowly. So that is something which is a function of market dynamics. But I think broadly, the -- I don't think there is a concern on the gross margin side. The EBITDA side, yes, since the top line is uncertain, right? So of course, there is -- there can be some fluctuations in EBITDA. But the -- my sense is, I think, last year has also been -- that is the year that we are running, has also been challenging for us and others in the market. So I would assume that companies will tend towards passing on the pricing challenges -- sorry, the challenge arising from lower growth by trying to correct the fixed cost through pricing. So maybe I think the probability that there will be a drag, maybe not as strong as it would have been for the current year actually.

The next question is from the line of Sonali Salgaonkar from Jefferies.

Sir, my first question is in view of the situation in China right now, do you foresee any impact on the supply chain of procurement from the industry perspective or be it your end users?

So I think, fundamentally, there are some full value items, which are finished goods which we source from China. There, I think, as far as we are concerned, we are kind of almost protected until March. As you all may already be aware, China manufacturing has been closed for festive period and that closure has been prolonged for another 15 days now. I think certainly, in summer categories, I think there is likelihood that there will be pressure if the system doesn't open on 15th, you can expect that there would be some pressure. There would definitely be pressure in my view because it's unlikely that people are carrying inventories for April and beyond and probably even some of the inventories are on sea and since the documents are negotiated through banks, it's even possible sometimes that clearing this may be an issue. So I think we will get a better picture by around -- in another 15 days on this aspect. Component, again, there are lot of electronic components, which are imported from China. There are some chemicals also which are imported from China. I think where they have global scale, I think these can get disrupted. Right now, I think most companies are -- at least we are covered, as I said, till March. And there may be some component inventories with distributors of global -- or Chinese companies or global companies in India, so these should allow us to cover maybe till about April. But definitely, if things don't get better by 15th of February, I think some disruption will come.

Sir, which particular categories, summer categories, are we mentioning here right now?

See, if we look at full value items, table, wall and pedestal fans mostly are imported into the country. If you look at kitchen appliances like induction cooktops, rice cookers, if you look at the glass for the glass cooktops, they're all coming from China. And in the case of components, it's primarily electronic components like Ram mentioned, and maybe some things like chemicals, plastics, et cetera, are also coming from China. Electronics, I think, mostly without China, I think -- the China -- supply -- the entire world will have issues because many key components are only made there today.

Got it, sir. My second question is, would you be able to give us an approximate absolute market share in the key appliance segments that we are in?

Okay. We'll try and do it off-line. We don't have it right now with us.

Sure. Sir, and my last question is how should we look at the steady state ad spend to net sales? Because this quarter, we are at 5%. Should we expect the year to close at somewhere between 4.5% to 5% or lower than that?

Yes, full year will be about 5%.

Yes.

5%. All right, sir.

The next question is from the line of Nitin Arora from Axis Mutual Fund.

Mithun, just one clarification. When you said that Jan is somewhat seeing some signs of growth, is it something growing faster than this quarter's growth? Or is it some indications you are getting? I just got confused, you said higher growth, I thought, from the quarter, this quarter average. You were saying you're seeing some growth. And if you're seeing that, say eventually, this would be higher than this quarter's growth? How should we take it?

So I think -- see, I think we can't talk about Jan right now because we're yet to complete the quarter. But what I can say is that, yes, both December and Jan has been more positive compared to October and November.

The question -- the specific previous question was, are things getting better. So our answer to that was that probably we felt most challenged in October and November, okay? In fact, I think it was September, October, November were these 2 -- these 3 months were the most challenging months, yes. In relation to that, December was a bit better, and January was similar. But I think -- so that's the limited observation.

Yes, it's just very difficult to present...