Consumer durables - It's a question of demand

Is the cloud over the macro economic environment and the slowdown in manufacturing beginning to take a toll on consumption? The numbers from the listed consumer durable makers presents a mixed picture.

In the June quarter, while small appliance makers such as TTK Prestige, Hawkins Cookers, V Guard Industries and Bajaj Electricals managed very strong sales growth in their consumer appliance business, makers of air-conditioners and refrigerators reported lacklustre sales in this period. It is, however, too early to infer if the declining sales in home appliances is due to slowing demand or merely a milder summer.

The coming festival season is likely to give clues on whether all is well with demand for durables. The Consumer Electronics and Appliance Manufacturers Association (CEAMA) has put its growth estimates for the home appliances industry at 20 per cent for 2011-12. Now, what does the big picture say?

IIP doesn't give the full picture

The Consumer Durable Goods section of the IIP (Index of Industrial Production) reported a growth of 3.3 per cent in the June quarter (compared with 19.7 per cent in the same period last year), slowing down from a 15 per cent growth in the March quarter.

Wait, before you jump to a conclusion; the Consumer Durable Goods index of IIP is skewed in favour of two items — passenger cars and jewellery. While weight of passenger cars is 23.3 per cent, the gems-and-jewellery category has been given a weight of 20.9 per cent. So, it is obvious that the index will largely follow the trend in these two items.

Home appliances as a category has a weight of only 13.3 per cent in the Consumer Durable Goods index of IIP. So, growth, however strong in this segment, may not have significant impact on the index.

Performance track record good

Over the last five years, most companies in the home appliances basket have seen sales grow at a compounded rate of 25-30 per cent annually. Only a handful of Sensex companies have managed this kind of a growth in the five-year period. So, what has helped sales grow so dramatically?

Changing demographics in society, with more nuclear families and increasing percentage of floating population is one key reason for the growing demand for home appliances. Branded players in the kitchen appliance space such as TTK Prestige and Bajaj Electricals have benefited immensely. Higher aspiration levels that result in a shift to branded products from unbranded items in recent years has also aided sales growth.

The growing rural demand is another factor that is helping home appliance makers grow sales. The CEAMA opines that over the next five years, rural India will consume 20 per cent of the consumer durable industry's production. However, despite having grown at a high double-digit rate for the last few years, products such as air-conditioners and washing machines still have very low penetration.

On the profit side too, the picture has been quite good for home appliance makers.

Whirlpool of India has turned around its business into profits and has grown strongly in the last five years. Bajaj Electricals managed close to 40 per cent growth in PAT on an annualised basis in this period.

The rate of profit growth managed by companies, however, varied widely, depending on how best the player managed to contain costs and improve margins.

Small ticket items score

Rising interest rates and the spiralling food inflation will see people cutting down on discretionary expenses, eventually.

But, what one needs to note is that the home appliances industry is made of many small-ticket items (kitchen appliances, low-end models in washing machines, air-coolers, and so on) too, where financing doesn't play a major role in a consumer's purchase decision.

Industry observers say that less than 10 per cent of the home appliance industry's sales happen via the financing route. Kitchen appliance makers such as TTK Prestige, Hawkins Cookers and Bajaj Electricals would be last in the line to be impacted in an economic downturn.

In 2008-09, when the whole economy was grappling with issues such as rising interest rates and slowdown in demand, TTK Prestige reported sales growth of 23 per cent and Bajaj Electricals' consumer business reported 26 per cent sales growth.

The listed arm of Panasonic India — Panasonic Home Appliances — which is in the business of selling electric rice cookers and mixer-grinders too recorded an over 25 per cent growth in the top-line in that period.

The Centre for Monitoring Indian Economy has estimated that the wage expenses of the Centre and corporate sectors will increase by around 15-20 per cent in 2011-13. This too is conducive for sustained demand for these products.

How are profit margins?

Rising cost of inputs such as steel, aluminium, copper, etc. have added to the production cost significantly over the last one year.

Maintaining profit margins has been a tough job for consumer durable players. Despite price increases to pass on rise in raw material prices, these hikes were not large enough to contain margin erosion.

There has been a clear one-two percentage point dip in operating margins to around 9 per cent in 2010-11. But, now, the question is, if metal prices rally further, will Indian consumers be able to absorb further price increases?

Firstly, there are signs of commodity prices cooling with fears over slowdown in demand in the US and Europe. Copper, for instance, has come down from a high of $9999/tonne to $8850/tonne now, a drop of 10 per cent. Aluminium is at $2280/tonne now, down 9 per cent from the year high. If this trend continues, the price increases already made will place these companies in an advantageous position.

On the other hand, if input prices go up and players choose to pass it on, demand, especially on big-ticket items such as air-conditioners, will feel the pinch.

Stock Valuations

Home appliance stocks continue to be good bets for the long term, but, short term investors may pick-up kitchen appliance stocks now as there is good demand visibility.

From a price-earnings multiple of 30-35 times in recent times, broader market correction has brought down valuation of most stocks in this space to reasonable levels. Air-conditioner manufacturers — Voltas, Hitachi Home & Life Solutions and Blue Star — are in the valuation band of 9-16 times on trailing earnings now.

Whirlpool of India, which derives almost 65 per cent of its top-line from air-conditioner and refrigerator sales, trades at a valuation of 17 times. However, with the peak season for air-conditioners gone now, these companies may see a lacklustre growth this year unless demand catches up strongly in the festival season.

In electrical appliances, Havells, V-Guard Industries and Bajaj Electricals are trading in a PE band of 12-16 times (on trailing earnings) now. If copper prices subside, these companies will have some margin relief.

In small home appliances space, our preferred bet is TTK Prestige. Though the stock is at premium to all players now (at valuation of 31 times), it can be a good buy at around the Rs 2,400 levels.