Charged for strong growth

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1 Equity Research October 16, 2017 BSE Sensex: Limited is the author and distributor of this report Consumer Electricals Crompton Consumer (Rs211 BUY) Target price Rs270 V-Guard (Rs192 ADD) Target price Rs208 Research Analyst: Ansuman Deb INDIA Consumer Electricals Charged for strong growth Reason for report: Initiating coverage The consumer electricals (CE) sector in India is on a strong growth footing driven by better outlook of housing, electrification and economic affordability. Housing schemes and energy efficiency drives by the government and reforms like GST are helping organised players gain market share and overall premiumisation is aiding margins. We initiate coverage on Crompton Consumer (BUY, TP Rs270) and V-Guard (ADD, TP Rs208), both suitably placed to benefit from this theme. While Crompton, with a renewed vigor post demerger, is set to actualise its complete brand potential, V-Guard is set to further consolidate its position among the big consumer electrical companies of India. Consumer Electricals (CE) has 15% growth potential in India. This is evident from the past where total revenue CAGR for the sector has been ~12% since Diversified CE companies have outperformed and ex Bajaj Electricals revenue CAGR for diversified CE has been 16% since Each CE segment has its own strengths. One of the cornerstones of Indian consumer electricals is the relative strength of each segment. We find that each segment has its own merits; be it the relative high market share of incumbents in fans or the high growth rate of lighting, coolers and appliances or the high unorganised share in lights, pumps and wires.we remain confident on growth potential of various categories in the sector. The leading growth is expected in lighting followed by appliances which are expected to grow at 12-15%, followed by fans, pumps, switchgear expected to grow at 8-10% and the last is the wires and cables which is estimated to grow at ~6-7%. Transition to higher organised share and premiumisation will offer additional growth for incumbent players. Abundant levers of growth put Indian CE sector in a sweet spot. A state-wise analysis of growth in housing number, housing quality, average number of people in household and the electricity penetration indicates a wide asymmetry between many states. As development catches up in the laggard states, additional 60bps growth to consumer electricals can arise through housing growth, while further 40 bps growth can be generated through overall improvement in housing quality. Similar comparison of residential electricity consumption in various states indicates additional 25bps of growth achievable through higher electricity consumption as India attains a more uniform and improved appetite for electricity which has remained abysmally low relative to global comparable. The plethora of government schemes in housing and electrification will assist in realising this growth. Yet, the theme of energy efficiency has just started to deliver results in India through the works of EESL and schemes like UJALA. As India bolsters energy efficiency efforts, we believe additional push to consumption can happen through rebound effect as some savings are channelized to higher direct consumption of electricity. Similar rebound effect in other countries indicates possible 75bps of additional growth possible to the consumer electrical sector. Valuation summary Company Rating TP PE (x) EV/EBITDA (x) EPS (Rs) FY18E FY19E FY20E FY18E FY19E FY20E FY18E FY19E FY20E Crompton BUY V-Guard ADD Source: Company data, I-Sec research Please refer to important disclosures at the end of this report

2 Consumer Electricals sector, October 16, 2017 TABLE OF CONTENTS 15% growth potential is the key underlying investment thesis... 3 Consumer electrical industry Ranking categories... 4 Lower organised share offers higher opportunity for incumbents... 4 Growth potential of categories range from 8 to 15%... 4 Market size of categories total current size ~Rs1000bn... 5 Unbundling growth levers for electrical equipment... 6 Housing growth there is room for improvement... 6 Average person per household is on the decline... 9 Quality of housing is another trigger Increasing electricity penetration to increase the housing base Saubhagya scheme to give another push to electrification Electricity consumption set to improve Residential electricity consumption can improve in many states Comparison of electricity consumption per capita with China Rebound effect How potent are the implications There is a rebound effect under an energy efficiency scenario Illustration of rebound effect as seen in other countries What is the potential energy saving that India can realise? Energy efficiency programs, role of EESL and prospects for electrical industry.. 18 Impact of the program on industry Energy Efficiency Services Limited (EESL) On a role with plans of its own Takeaways from tenders under EESL in UJALA Indian flagship energy efficiency program, EESL the torchbearer UJALA s working model Price trajectory of LEDs has bottomed out Industry response to UJALA Prospect of pumps under EESL Case Study of AgDSM scheme in Andhra Pradesh LED like price erosion is unlikely in case of fans Valuations Index of Tables and Charts COMPANIES Crompton Greaves Consumer Electricals V-Guard Prices as on October 13,

3 Consumer Electricals sector, October 16, % growth potential is the key underlying investment thesis The key investment thesis to our analysis of Indian consumer electrical sector is the potential for 15% growth for diversified companies in the space. This 15% revenue growth rate, based on an asset light model and ideally negative working capital requirement will render a FCF growth rate of ~16-17% and justify our target 35x earnings multiple for Crompton Consumer and V-Guard. We believe that based on past performance and the potential for the sector, 15% revenue growth rate is perfectly achievable. The aggregate revenue CAGR for Indian consumer electrical companies has been ~12% over the past 7 years. However, the diversified electrical companies have fared even better. The aggregate revenue CAGR for the diversified electricals, namely Havells, Bajaj Electricals, Crompton Consumer, V-Guard and Orient Electricals has been 14% between 2010 and Without Bajaj Electricals, the revenue CAGR for the similar period has been ~16%. Chart 1: Revenue CAGR for consumer electrical companies between 2010 and Havells Bajaj Electricals Crompton Consumer V-Guard Surya Roshni Anchor Electricals Usha International Orient Electric (%) HPL Electric Philips India-lighting Going ahead, consumer electrical sector faces multiple tailwinds for its growth. Source: Company Data, I-Sec research Table 1: Multiple levers for consumer electricals sector to better its past growth rate Volume levers Value levers Government Push -Increasing number of households -Improving quality of housing -Housing Schemes like Pradhan Mantri Awaas Yojana -Increasing electricity penetration -Premiumisation -Electrification scheme like Saubhagya -Change in technology like CFL to LED -Acceptance of segments like appliances, luminaires and coolers -Energy efficiency drives like UJALA -Increasing rural income resulting in overall increase in electricity consumption Source: I-Sec research We have detailed discussion on each of these levers in sections ahead. 3

4 Consumer Electricals sector, October 16, 2017 Consumer electrical industry Ranking categories When ranking the various categories of the electrical equipment industry, the basic parameters are share of organised market, market size and projected growth rate. Lower organised share offers higher opportunity for incumbents A slow but steady shift from the unorganized to organized sector is certain. Higher the unorganized share, higher is the attractiveness of a consumer electrical category as it offers higher upside to organized incumbents. The shift from organized to unorganized industry is evident from more than market growth of organized leaders in the past 5 years. The overall unorganized market share is high in most of the categories of electrical equipment from a minimum of 25% in fans to high of 75% in coolers. Higher organized share in lighting, coolers and appliances indicate higher growth potential for organized players in these segments. Chart 2: Unorganised market share of electrical equipment 80% 70% 60% 50% 40% 30% 20% 10% 0% Source: Market Data Fans Domesic Pumps Switches Electric lighting Wires and Cables Air Coolers Growth potential of categories range from 8 to 15% Appliances The market of various categories in the electrical equipment industry is set to grow at 1x- 2x of the GDP growth rate of India. The leader is lighting and appliances which are expected to grow at 12-15%, followed by fans, pumps and switchgear which are expected to grow at 8-10% and wires and cables which are estimated to grow at ~6-7%. The lower growth rate segments are also attractive because they present the least risk of technological disruptions. So, while there is the LED revolution in lights, IoT in appliances, fans or pumps or switchgears have minimal prospects of disruptive technology but high premiumisation can always happen. As such, incumbents with maximum exposure to these mid growth segments are best poised in the industry. Even a low growth segment like wires/cables has been extremely profitable for players like V-Guard and Havells. The main reason is that wires and cables have become a branded commodity while facing little technological risks. 4

5 Consumer Electricals sector, October 16, 2017 Forecasted growth is also higher for lighting, appliances and coolers. Chart 3: Forecasted 5 year CAGR of various categories 16% 14% 12% 10% 8% 6% 4% 2% 0% Source: Market data Fans Domesic Pumps Switches Electric lighting Wires and Cables Air Coolers Appliances Market size of categories total current size ~Rs1000bn The market size is highest for wires and cables. This makes Havells and V-Guard well poised among the major electrical equipment players. Over the years, wires and cables have become a branded commodity product and these players have benefitted from the same. Switches and lighting are big markets where a big transition from unorganised to organised will play out over the next few years. Pumps and fans are mid-size markets with deep entrenched players. Appliance is a high growth yet big market and is a category where a large number of players have entered. Chart 4: Market size of various categories (Rs bn) Fans Domesic Pumps Switches Electric lighting Wires and Cables Air Coolers Appliances Source: Market Data 5

6 Consumer Electricals sector, October 16, 2017 Unbundling growth levers for electrical equipment Electricity sector and its end use in India are at crossroads when the country is witnessing growth in multiple accounts, both demand as well as supply side. As ingenious it may seem, there is premiumisation, there is increasing penetration, and there is government push as well as technical evolution which are shaping the electrical appliances industry. The common resultant of these levers is a long term growth story which is compelling. We analyzed individual growth triggers based on the trend seen in the past. The idea is that a lot of growth achievements which India has already witnessed can be a building block for estimating the future growth. Obviously, there are possible upsides to that which can happen on account of better Governance or improved economic growth of the country and there are possible downsides from a slowdown or economic disruption. Consumer electricals demand triggers can be broadly split between housing and spending. We begin with housing. Housing growth there is room for improvement The occupied residential house in India has clocked 3.2% CAGR and cumulative 36% growth between 2001 and However, this growth is not uniform and has several leaders and laggards across the Indian geography. The growth in housing has not only been vastly different in the various states but has also varied in the urban/rural background. Urban trend in occupied residential houses Urban CAGR in occupied residential houses has been 4.6% between 2001 and Kerala registered best growth at 8.4%. While being almost double the national average, the high urban housing growth in Kerala underlines the strength of that market for consumer electricals and would have benefited companies like V-Guard. Apart from Kerala, the top performing states are Bihar, Chhattisgarh, Gujarat, Haryana and Uttarakhand. The states that have lagged growth are Maharashtra, Odisha, Karnataka, Rajasthan, Assam, Himachal Pradesh, Jharkhand, Madhya Pradesh and West Bengal. Table 2: Categorising states on the basis of urban housing growth Strong (more than 60% growth in a decade) In-line (50-60% growth in a decade) Weak (lower than 50% growth in a decade) Source: Government of India Andhra Pradesh, Bihar, Chhattisgarh, Gujarat, Haryana, Kerala, Uttarakhand Karnataka, Punjab, Tamil Nadu, Uttar Pradesh Assam, Himachal Pradesh, J&K, Jharkhand, Madhya Pradesh, Maharashtra, Odisha, Rajasthan, West Bengal We find that many states that have performed poorly on the urban housing growth parameter have room to grow. The table shows the urban housing growth map of India. We have categorised states with more than 60% growth in occupied residential houses between 2001 and 2011 as high growth states, below 50% as laggard states and between 50%-60% as in-line performing states. 6

7 Consumer Electricals sector, October 16, 2017 Chart 5: Urban housing CAGR between 2001 and All India AP Assam Bihar Chattisgarh Gujarat Haryana Himachal J&K Jharkhand Karnataka (%) Kerala MP Maharashtra Odisha Punjab Rajasthan TN UP Uttarakhand West Bengal Source: Government data The blue sky scenario would suggest that the overall urban Indian residential housing volumes can grow at par with some of the more successful big states like Gujarat which is almost 160bs higher than the national average. Rural trend in occupied residential houses Overall rural India has witnessed average CAGR of 2.6% in occupied residential houses between 2001 and The best growth was registered by Bihar, Gujarat, Haryana and J&K. which witnessed ~3.5% CAGR. The laggard states are Andhra Pradesh, Kerala, Maharashtra, Tamil Nadu and Himachal Pradesh. The key to note is that rural housing growth has been much more uniform than urban housing. Additionally, there are states like Kerala and Andhra Pradesh which have been leaders in urban housing growth but laggards in rural sector. Table 3: Categorising states on the basis of rural housing growth Strong (more than 35% growth in a decade) In-line (25-35% growth in a decade) Weak (lower than 25% growth in a decade) Source: Government of India Bihar, Chhattisgarh, Gujarat, Haryana, J&K, Jharkhand, Madhya Pradesh, Rajasthan Assam, Karnataka, Odisha, Punjab, Uttar Pradesh, Uttarakhand, West Bengal Andhra Pradesh, Himachal Pradesh, Kerala, Maharashtra, Tamil Nadu The blue sky scenario would suggest that overall rural housing has a precedence of growth in the range of % CAGR, as seen in the case of Bihar, Haryana and Gujarat, 60bps growth rate over the national rural average of 2.6%. 7

8 Consumer Electricals sector, October 16, 2017 Chart 6: Rural housing CAGR between 2001 and 2011 (%) (1) (2) (3) (1.7) All India Andhra Pradesh Assam Bihar Chattisgarh Gujarat Haryana Himachal J&K Jharkhand Karnataka Kerala Madhya Pradesh Maharashtra Odisha Punjab Rajasthan Tamil Nadu Uttar Pradesh Uttarakhand West Bengal Source: Government Data Overall trend in occupied residential houses Overall India has witnessed average CAGR of 3.2% in occupied residential houses between 2001 and The best growth was registered by Gujarat, Bihar, Haryana and J&K. which clocked ~4% CAGR. The laggard states are Kerala, Maharashtra, Odisha and Himachal Pradesh. Table 4: Categorising states on basis of total housing growth Strong (more than 40% growth in a decade) In-line (30-40% growth in a decade) Weak (lower than 30% growth in a decade) Source: Government Data Bihar, Chhattisgarh, Gujarat, Haryana, J&K, Madhya Pradesh, Rajasthan Andhra Pradesh, Assam, Jharkhand, Karnataka, Punjab, Tamil Nadu, Uttar Pradesh, Uttarakhand, West Bengal Himachal Pradesh, Kerala, Maharashtra, Odisha The blue sky scenario suggests that the overall housing has a precedence of growth in the range of 4% CAGR as seen in case of Bihar, Haryana and Gujarat, 80bps higher than the national average of 3.2% seen in the past. Chart 7: Overall housing CAGR between 2001 and 2011 (%) All India Andhra Assam Bihar Chattisgarh 4.5 Gujarat 4.1 Haryana 2.1 Himachal 3.8 J&K Jharkhand Karnataka 1.7 Kerala 4.1 Madhya Maharashtra Odisha Punjab Rajasthan Tamil Nadu Uttar Pradesh Uttarakhand West Bengal Source: Government Data 8

9 Consumer Electricals sector, October 16, 2017 Average person per household is on the decline The growth in households also has the element of incrementally fewer people per house. This trend has increased over the years with the growth in overall economy. In urban India, the overall number of people per household has reduced from 5.34 in 1991 to 5.12 in 2001 and 4.78 in The highest reduction took place in states like Andhra Pradesh (1.3% decline annually) and Bihar (1.1% decline annually) compared to the average annual reduction of 0.7% per annum for aggregate urban India. Chart 8: Trend of declining household strength has picked momentum Urban household size Rural household size Overall household size Source: Government of India In rural India, the maximum decline is seen in Madhya Pradesh, West Bengal, Rajasthan and Chhattisgarh where the average household strength has declined by ~1.2% annually, which is 0.8% annually for overall India. Overall average person per household has declined for India by 0.8% between 2001 and 2011, whereas it declined by 0.4% between 1991 and The blue sky scenario will suggest that the rate of decline in average strength of households can increase in some of the states which lie below the national average. 9

10 Consumer Electricals sector, October 16, 2017 Chart 9: CAGR decline in number of people in average household 0.0 (0.2) (0.4) (0.6) (0.8) (1.0) (1.2) (1.4) All India Andhra Pradesh Assam Bihar Chattisgarh Gujarat Haryana Himachal Pradesh J&K Jharkhand Karnataka Kerala Madhya Pradesh Maharashtra (%) Odisha Punjab Rajasthan Tamil Nadu Uttar Pradesh Uttarakhand West Bengal Source: Government Data Quality of housing is another trigger Not only the number, but also the quality of housing is on the rise in India. This will clearly indicate that growth in quality housing is also more than the aggregate numbers that we have discussed. Better quality house will result in higher consumption of household related items like electrical equipment. There are two aspects of quality: The material of roof, wall and floor where we have seen high premiumisation The number of rooms in a house, where we have seen increase in number of rooms in a house. Between 2001 and 2011, we have seen increase in share of two/three room household. There has also been an increase in share of households with no exclusive room as more people have gained houses. Chart 10: The housing quality of India is improving continuously Material of roof Material of wall Material of floor Others Concrete GI/Metal/Asbestos sheets Tiles Grass, etc Grass etc Mud/Unburnt bricks Stone Burnt brick Others Mud Stone Cement Mosaic/floor tiles Rest Source: Government Data 10

11 Consumer Electricals sector, October 16, 2017 Table 5: Households having electricity as main Source of lighting India Electricity Change (pts) Total Rural Urban R-U Diff Source: Government Data Chart 11: Room distribution of houses in 2001 Chart 12: Room distribution of houses in Total Rural Urban Total Rural Urban No One room exclusive room Two rooms Three rooms Four rooms Five rooms & above 0 No One room exclusive room Two rooms Three rooms Four rooms Five rooms & above Source: Government Data Increasing electricity penetration to increase the housing base There is a lot to achieve in electrification in India and electrical equipment is the best sector to play this opportunity. Pending electrification in rural households: Going by the available data, there are ~25% households which are yet to be electrified. There is lot to be achieved in states like Uttar Pradesh, Bihar, Odisha, Assam, Rajasthan and Jharkhand. Chart 13: Status of rural electrification 120% 100% 80% 60% 40% 20% 0% Andhra Pradesh Assam Bihar Chhattisgarh Gujarat Haryana Himachal Pradesh Jammu & Kashmir Jharkhand Karnataka Kerala Madhya Pradesh Maharashtra Odisha Punjab Rajasthan Tamil Nadu Telangana Uttar Pradesh Uttarakhand West Bengal India Source: Garv dashboard 11

12 Consumer Electricals sector, October 16, 2017 Saubhagya scheme to give another push to electrification The Saubhagya scheme is a step in accelerating the electrification drive in India Government launched a new scheme Pradhan Mantri Sahaj Bijli Har Ghar Yojana Saubhagya to ensure electrification of all willing households in the country in rural as well as urban areas. The total outlay of the project is Rs163bn while the Gross Budgetary Support (GBS) is Rs123bn. The outlay for the rural households is Rs140bn while the GBS is Rs106bn. For the urban households, the outlay is Rs23bn while GBS is Rs17bn. The Government of India will provide largely funds for the Scheme to all States/UTs. The States and Union Territories are required to complete the works of household electrification by the 31 st December The beneficiaries for free electricity connections would be identified using Socio Economic and Caste Census (SECC) 2011 data. However, un-electrified households not covered under the SECC data would also be provided electricity connections under the scheme on payment of Rs500 which shall be recovered by DISCOMs in 10 instalments through electricity bill. The solar power packs of 200 to 300 Wp with battery bank for un-electrified households located in remote and inaccessible areas, comprises five LED lights, one DC fan, one DC power plug. It also includes the Repair and Maintenance (R&M) for 5 years. For easy & accelerated implementation of the scheme, modern technology will be used for household survey by using Mobile App. Beneficiaries will be identified and their application for electricity connection along with applicant photograph and identity proof will be registered on spot. The Gram Panchayat/Public institutions in the rural areas may be authorised to collect application forms along with complete documentation, distribute bills and collect revenue in consultation with the Panchayat Raj Institutions and Urban Local Bodies. The Rural Electrification Corporation Limited (REC) will remain the nodal agency for the operationalisation of the scheme throughout the country. 12

13 Consumer Electricals sector, October 16, 2017 Electricity consumption set to improve To assess the demand for consumer electricals, one must gauge the electricity usage of India and residential consumption of electricity is a good parameter for the same. Residential electricity consumption can improve in many states A look at the recent trend of state wise residential electricity consumption shows tremendous disparity in the growth of the various states. Chart 14: Residential electricity consumption pattern Statewise CAGR electricity demand growth (%) 25.0 National CAGR electricity demand CAGR AndhraPradesh Assam Bihar Chhatisgarh Gujarat Haryana HimachalPradesh JammuandKashmir Jharkhand Karnataka Kerala MadhyaPradesh Maharashtra Orissa Punjab Rajasthan TamilNadu Uttrakhand Source: Government of India UttarPradesh WestBengal Thus, on an average, the residential electricity consumption growth has been 7% for India between 2009 and Key takeaways are: Gujarat, a leading state in all parameters, has had sub-par residential electricity growth of only 2.8% compared to the national average of 7%. Maharashtra, another leading state has had negative residential electricity growth of 2.7%. Thus, the residential electricity consumption of Maharashtra has declined from 16,946GwH in 2009 to 14,763GwH in The residential electricity consumption has also declined in West Bengal by average 1.1% There is an actual growth in residential electricity consumption in some of the states who have been able to catch up to leading states. For example, the residential electricity consumption in Haryana has actually increased by ~15% CAGR between 2009 and 2014 to reach 7,550 GwH in 2014, and can exceed that of Gujarat in some time if not already. The relative weaker states have performed better in terms of residential electricity consumption like Jharkhand (highest at 21.7% CAGR) and Bihar (18% CAGR). We do sense that electricity consumption has improved significantly India. Blue sky scenario will suggest that the residential electricity consumption can improve ahead with national average rate being 7% and actually achieved rates of 15% plus in some states. Therefore, there is ample scope of increase in the range of 300bps to reach a growth rate of 10%. 13

14 Consumer Electricals sector, October 16, 2017 Comparison of electricity consumption per capita with China Electricity power consumption per capita of India reached kWh in ~2015. China had reached the same in Since 1996, Chinese electricity consumption has grown by 9% compared to 4.6% of India. India has already improved its electricity consumption in recent years. For example, since 1996, the average growth in electricity consumption per capita of India has been 4.6%, while the more recent 5 year growth rates have been 6-7%. Even by this angle we have a scope of improvement of India Chart 15: In 2014, India was where China stood in (KWh per capita) 4,500 4,000 3,500 3,000 2,500 2,000 1,500 1, China India Source: World Bank data 14

15 Consumer Electricals sector, October 16, 2017 Rebound effect How potent are the implications Over the past ten years, energy saving and consumption reduction have been the main ways to constrain energy consumption and the most effective way to conserve energy is, as always, to improve energy efficiency. Therefore, the cost for equal energy services may decrease, which in turn leads to a change in behavior, and residents increase the demand for buying or using the household appliances, thus electricity consumption increases. Theoretically, improving electricity utilisation efficiency has important positive influence on reducing electricity consumption, the share of coal consumption, and greenhouse gas emissions. However, there has been less than estimated electricity saving with increasing efficiency. China has seen residential electricity consumption increase rather than decrease with the improvement of electricity utilisation efficiency in the past decade. There is a rebound effect under an energy efficiency scenario Energy rebound effect always exists. The effectiveness of improving electricity efficiency for energy conservation is not as great as expected, whereas there will be some rebound energy consumption. Residential electricity consumption arises mainly from household appliances, such as air conditioners for controlling the temperature, refrigerators, rice cookers, washing machines, and home lighting for daily life, and computers and TVs for work or entertainment. When electricity utilisation efficiency improves, the power consumed doing the same work (lighting, heating, cooling, etc.) decreases. Therefore, the cost for equal energy services may decrease, which in turn leads to a change in behavior, and residents increase the demand for buying or using household appliances, thus increasing electricity consumption. On the other hand, electricity utilisation improves with technologic progress, which promotes economic growth to some degree. This will boost the buying power of residents, and they may increase their demand for using or buying household appliances, resulting in increased electricity consumption. Types of rebound effect: As for the mechanism underpinning the energy rebound effect, it can be classified as the direct effect and indirect effect. The direct energy rebound effect refers to the efficiency improvement of one certain energy service leading to increased demand for the energy because of the decreased cost of the energy service. The indirect energy rebound effect is related to the decreased cost of one certain energy service leading to increased demand for other energy services. For example, the money saved by efficiency improvements in air conditioning is spent on taking holidays thus more energy is consumed by tourism. Scale of rebound effect: The economy-wide energy rebound effect consists of the direct and indirect energy rebound effects. Different sizes of energy rebound effect have different implications: specifically, energy rebound effects between zero and one are partial energy rebound effects, which implies that real energy consumption is more than expected and less than the original, and a part of the energy conservation caused by energy efficiency improvement is offset by the extra energy consumption. A negative rebound effect called super conservation effect denotes that real energy savings are more than the expected from energy efficiency improvement. Rebound effect whose size is more than one, i.e. backfire effect, means energy efficiency improvement does not lead to any energy conservation, but increases energy consumption. The energy rebound effect has been extensively explored with its existence being confirmed, but its magnitude remains the core of the controversy. 15

16 Consumer Electricals sector, October 16, 2017 Illustration of rebound effect as seen in other countries Short-term direct rebound effect varies from 15% to 55% for Norway s household heating energy consumption. Long-term direct rebound effect ranges from 29% to 47% for Canada s household heating sector. Short- and long-term rebound effects for US household cooling are 4% and 26.5%, respectively. Rebound effect for US residential electricity consumption is 35%, while a study has shown that urban residential electricity consumption has a rebound effect of ~ %. Combined direct and indirect rebound effects from various types of energy efficiency improvement by UK households show that total rebound effects are 41% for measures that improve the efficiency of domestic gas use, 48% for electricity use and 78% for vehicle fuel use. Long- and short-term rebound effects of residential electricity use in South Korea in 2002 are 30% and 38%. Long-term rebound effect of Chinese urban residential electricity consumption is 74%, while the short-term rebound effect is 72%. Long-term direct and indirect rebound effects of residential electricity use in Beijing are 46 56%, and the short-term direct rebound effect is between 24% and 37%. Chart 16: Rebound effect in electricity consumption in various geographies 180% 160% 140% 120% 100% 80% 60% 40% 20% 0% Norway household heating Canada household heating US household heating US residential US Urban residential UK residential South Korea residential Chinese urban residential Beijing residential Source: Research Papers The average size of the direct rebound effect for China s residential electricity consumption is 72% during It indicates that, in the linear relationship between residential electricity consumption and its influencing factors, when electricity utilisation efficiency improves, 72% of the expected electricity savings are being offset by the extra electricity consumption due to efficiency improvements and the cheaper electricity service cost, and only 28% of the expected electricity savings are attained. It is likely that the energy rebound effect in developing countries appears more significant, and the unmet energy demand in developing countries may, more or less, lead to a larger electricity consumption. 16

17 Consumer Electricals sector, October 16, 2017 What is the potential energy saving that India can realise? EESL is the core element of potential energy saving that India will witness in the recent times. For example, LED distribution scheme has resulted in annual savings of 34,279 mn KWH per year achieved till date under the Ujala scheme. The tube light distribution scheme has saved 150mn kwh per year and the electric fan scheme is saving at a rate of 164mn KwH per year. Considering there are many states left to be brought under EESL effectively, electric fan scheme has just started and there will be Energy efficiency schemes in other equipments as well like pumps, AC and other similar schemes in streetlights, equipment, etc. the total annual saving in a steady state can easily be 50bn KWH per year. Considering that domestic sector is ~24% of total electricity consumption, even if 50% rebound effect is to happen, the energy saved is ~7bn KWH every year, which is ~2.5-3% of the current consumption. So, around 3% of additional energy consumption can happen from energy efficiency as per the rebound effect. In a blue sky scenario, the electrical energy efficiency drive can lead to increase in energy consumption by 300bps on account of rebound effect. Even if 25% of the same is used in new equipment, upgrade of existing equipment etc., the volume growth of electrical equipment could be ~75bps. We believe consumption volume of electrical equipment in India can increase by 200bps, split between housing growth, spending growth and rebound effect Chart 17: Unbundling growth levers of consumer electrical industry 75 bps from rebound effect 40 bps from quality 60bps from housing growth 25 bps from higher per capita Source: I-Sec research 17

18 Consumer Electricals sector, October 16, 2017 Energy efficiency programs, role of EESL and prospects for electrical industry Impact of the program on industry Continuing with our analysis of energy efficiency, there is a need to assess the impact of energy efficiency programs on consumer electrical industry as a whole. Till now, we have seen a hugely successful program of distribution of LED lights under UJALA. The total LED distributed under UJALA is 265mn. This number will go up significantly in coming years as penetration increases in all states and the program carries further momentum. The development under UJALA has had the effect of exponential increase in LED bulbs volumes while the prices have crashed. We have explained the impact of UJALA with exhibits in the following section. The debate remains on the long term impact of such program on the industry. Can similar energy efficiency programs be implemented in the case of fans and pumps? We pick these two products for argument since energy efficiency programs have already started for them. We believe a similar scale like UJALA may not be possible for fans and pump. In case of fans, it is not possible since higher air span and lower voltage is not a natural combination like higher lumen and low voltage in the case of LEDs. Additionally, with 75% market share being organised, the proliferation of fan manufacturing is limited unlike LEDs apart from the fact that there is a technological prowess required in making energy efficient fans. We have detailed the same in following sections. In pumps, there is little economic dynamics to support energy efficiency. The electricity given to farmers is already subsidised and the wide range of voltage under which pumps operate is difficult to bring under single energy efficiency program. Additionally, there have been objections to additional capex in energy efficient pump programs when there was pressing requirement of funds. We have detailed the series of objections that energy efficient pump distribution scheme faced in Andhra Pradesh later in this report. Is lighting industry doomed because of energy efficiency since prices of LED under UJALA have fallen from Rs310 in Sep 14 to Rs38 in Sep 16? While there is no definitive answer to this question, we believe pricing will improve gradually in LED and in the long term UJALA can create a replacement market big enough to create enough economies of scale such that marginal value increase can give overall positive value to industry. Our interaction with some UJALA tender participants also highlight that there are many fringe participants in the UJALA scheme who are there to benefit from the free distribution network which is currently offered by EESL. There is limited margin objective of these fringe players. Currently the margins these fringe players seek are as little as being the proportion of LED buyers who do not come for any replacement even when the bulb is under warranty. Clearly, these fringe players will not be there for a steady state replacement market. Additionally, EESL will not have a sustained dedicated distribution network for electrical equipment in the long term that can replace a professional company who has dedicated incentivised target based workers. 18

19 Consumer Electricals sector, October 16, 2017 Energy Efficiency Services Limited (EESL) On a role with plans of its own Self-sustaining model of EESL is another crucial parameter for success of the schemes. EESL s revenues increased 40 times from to about Rs7bn in , with the profit before tax increasing 10 times in the same period. Energy Efficiency Services Limited (EESL) was established in 2009 by the Ministry of Power as a joint venture between four public sector companies, National Thermal Power Corporation (NTPC) Limited, the Power Finance Corporation (PFC) Limited, the Rural Electrification Corporation (REC) Limited and POWERGRID. EESL was set up to assist central and state governments in implementing the Bureau of Energy Efficiency s programs, such as Standards and Labeling (S&L), Bachat Lamp Yojana (BLY), and Perform, Achieve and Trade (PAT). EESL is also involved in capacity building of the State Designated Agencies (SDAs) identified for the implementation of BEE s programs in the various states. With programs like UJALA, EESL has accentuated its role as an Energy Service Company (ESCO) which conducts audits and provides consultancy services for energy saving measures. EESL s revenues increased 40 times from to about Rs7bn in , with the profit before tax increasing 10 times in the same period. It has more than 400 employees housed in its corporate office in NOIDA and 14 regional offices all over India. It has secured long-term loans from Germany s KfW Development Bank and the Asian Development Bank. It is further raising money through debt using masala bonds, green bonds, as well as a loan from the World Bank. EESL s plans to expand globally have begun with a joint venture with a UK company and an office in London. It also plans to raise money through equity by going public in the next two to three years. Takeaways from tenders under EESL in 2017 We have enlisted the detailed tenders under EESL for the year Key takeaways are as follows: The orders for fans have started but largely along with LED in Uttar Pradesh and Maharashtra and remain few in number. There is limited scope to understand the share of fans in these combined tenders. The companies which have won exclusive fan tenders under EESL are the high profile organized players like Crompton, Surya Roshni, Orient Electric and Marc Enterprises. Though it is early times, we have seen limited small player participation in EESL under the fan category. LED luminaires are being distributed in markets abroad also through EESL. (Surya Roshni has won one such tender for UK) Streetlights take the dominant share among tenders issued by EESL. EESL has also issued tenders for replacement of defective lights. 19

20 Consumer Electricals sector, October 16, 2017 Table 6: Detailed tenders of EESL in 2017 Date Type Value (Rs) Company July'17 LED Luminaire in UK 182,820,750 Surya Roshni LED bulbs, BEE 5 Star Ceiling fans and Energy Efficient Tube Lights in Uttar Pradesh 37,702,200 Alankit Ltd -"- 37,702,200 Amar Construction -"- 37,702,200 Command Consultancy -"- 37,702,200 Itech mass Pvt. Ltd. -"- 37,702,200 Kishan Infrastructure -"- 37,702,200 Medas Consultancy -"- 109,860,000 Radiant Haroti -"- 37,702,200 RBS Multisolutions -"- 49,437,000 Shri Balaji Kripa Infosystems -"- 37,702,200 Sun Mega Ventures -"- 82,395,000 Vap Infosolutions -"- 4,691,100 Zephyr Limited LED in Jharkhand 16,018,200 Florida Electrical LED industrial lights and floodlights for PAN India and PSUs 21,164,648 HQ Lamps Manufacturing -"- 456,033,810 Phillips India -"- 587,254,525 Crompton Greaves -"- 46,071,491 Invetech Lighting 16,750 LED streetlights in Jaipur 82,911,998 Florida Electrical 7915 LED streetlights in J&K 30,886,765 Florida Electrical Event Management agency hiring to carry out awareness for UJALA-- LED Bulbs, tube lights, efficient fans in Uttar Pradesh 9,712,850 Shresta Communications LED streetlights in Kota, Rajasthan 61,316,736 Surya Roshni Solar Lamp kit in 5 states 19,669,500 Nvis Technologies 20 June'17 May'17 April'17 Mar'17 Solar Lamp kit in 5 states 16,400,000 Auro Power -"- 245,200,000 Jay Autocomponents -"- 310,400,000 Sun Aid Solar Energy -"- 400,200,000 Sirius Solar Energy Systems -"- 89,800,000 Odisha Small Industries Solar Street light in 5 states along with AMC for 5 years 1,349,325,000 Gautam Solar LED bulbs, BEE 5 Star Ceiling fans and Energy Efficient Tube Lights & Data Base Preparation in Maharashtra 15,940,000 Sun Mega Ventures Solar Street light in 5 states along with AMC for 5 years 1,079,460,000 Phillips India Solar Street light in 5 states along with AMC for 5 years 269,865,000 Madnani Engineers LED Industrial Lights & Flood Lights for PAN India & PSUs. 202,022,000 Orient Electric LED ' streetlights and other related works under all India SLNP 149,854,657 HQ Lamps Manufacturing -"- 93,844,513 Keonics Limited LED Industrial Lights & Flood Lights for PAN India & PSUs 60,682,325 Jaguar & Company LED in GHMC 425,206,408 Surya Roshni LED bulbs, BEE 5 Star Ceiling fans and Energy Efficient Tube Lights & Data Base Preparation in Delhi 11,242,000 Kishan Infrastructure LED in GHMC 400,134,018 Crompton Greaves LED in GHMC 364,049,280 HQ Lamps Manufacturing LED streetlight for Anand and Gandhinagar 42,551,652 Surya Roshni -"- 35,106,000 Phillips India -"- 39,878,000 Havells LED Industrial Lights & Flood Lights for PAN India & PSUs 100,000,000 Quadralumen LED Street light in GHMC 188,472,781 Wipro Replacing defective LED, setting up kiosks for EESL in Andhra Pradesh 5,506,200 Alankit Ltd -"- 4,428,900 Raminfo -"- 5,386,500 SNR Edatas 9 watt LED on Pan India basis 327,200,000 Phillips India 9 watt LED on Pan India basis 490,800,000 Crompton Greaves 9 watt LED on Pan India basis 818,000,000 Ledvance LED streetlights in Gujarat 91,147,291 Quadralumen BEE 5 star EE fans pan India 332,460,000 Marc Enterprise BEE 5 star EE fans pan India 169,924,000 Crompton Greaves BEE 5 star EE fans pan India 147,760,000 Surya Roshni BEE 5 star EE fans pan India 88,656,000 Orient Electric Heritage street lighting systems in Varanasi 151,602,000 K-Lite Off Grid Solar LED Street Lights in five states 164,259,520 EON Electric LED Streetlights in Andhra Pradesh 619,446 Havells LED streetlights in Vijayawada 1,013,886 Fugenic Computer Services

21 Consumer Electricals sector, October 16, 2017 Date Type Value (Rs) Company LED Streetlights in Gujarat 124,778,500 Crompton Greaves LED streelights/ floodlights in NTPC 84,748,976 Phillips India 12,500 LED streetlights in Kota 937,500 Balaji Sales Supply of 6,290 Nos. of LED Streetlights in NTPC 27,121,545 Phillips India LED streetlights in Ranchi, Dhanbad 158,649,370 Havells LED street lights in Gujarat 68,176,263 HQ Lamps Manufacturing LED streetlights in Jharkhand 101,174,998 Havells Feb'17 LED Street lighting Bangladesh 5,572,272 Phillips India Off Grid Solar LED Street Lights in five states 164,260,000 Orsus Agro Developers LED streetlights in Rajasthan 71,475,492 HQ Lamps Manufacturing 9 watt LED on Pan India basis 190,000,000 Rudai Lighting 9 watt LED on Pan India basis 190,000,000 Ledvance LED streetlights in Himachal Pradesh 56,949,193 Orient Electric LED streetlights in Himachal Pradesh 50,306,524 EON Electric LED streetlights in Anand 1,744,200 Parth Engimech LED streetlights in Gandhinagar 2,974,000 Shailee Electricals LED streetlights in Gandhinagar 4,461,000 Sun Trading LED streetlights in Gandhinagar 2,616,300 Sun Trading 732 LED streetlights in Coal India 2,458,400 Surya Roshni Lighting controls for LED streetlights in Gujarat 13,753,340 Karnataka Government by nomination 33,681 LED streetlights in Tripura 77,866,765 Karnataka Government by nomination LED streetlights in Rajasthan 82,142,073 Florida Electrical EE fans 1,768,000 Surya Roshni 4886 LED streetlights in Coal India 43,733,615 Havells Jan'17 Lighting controls for installed LED streetlights pan India 52,400,000 Florida Electricals -"- 424,408,460 Kakatiya Energy Systems -"- 382,760,970 Nav Shikha Polypack -"- 187,002,080 Salzer Electronics -"- 547,656,000 Schnell Energy Stand-alone OFF Grid Solar LED Street Lights in Uttar Pradesh 136,361,613 Gautam Solar Large-scale Distribution, storage, and inventory management of EE appliances & Data Base Preparation 10,560,000 Kishan Infrastructure LED lights for CGO buildings in Delhi 13,125,128 Alien Energy LED streetlights pan India 444,163,100 Havells LED streetlights pan India 390,838,100 HQ Lamps Manufacturing LED streetlights pan India 678,036,170 Surya Roshni LED streetlights pan India 1,172,111,150 Wipro Source: Government Data 21

22 Consumer Electricals sector, October 16, 2017 UJALA Indian flagship energy efficiency program, EESL the torchbearer UJALA under EESL has established that energy efficiency programs can succeed. We look at the reasons for its success and whether similar success can be established in other segments like fans and pumps. Government s Ujala program has been extremely successful, being arguably the world s largest no subsidy LED bulb programme for households. The UJALA programme has sold more than 264 million LED bulbs to Indian households in just the three years since its launch in These bulbs are claimed to be saving more than 34 billion units (kwh) of electricity annually, which is about 14% of the residential electricity consumption in India in The avoided peak demand is claimed to be ~7000 MW, which is more than the solar capacity added in India in UJALA s popularity has enthused Energy Efficiency Services Ltd. (EESL), its implementing agency, to use the programme model to sell energy efficient ceiling fans, pumps and air conditioners. EESL also plans to implement the UJALA model in other countries like the United Kingdom, Canada, Nepal, and Bangladesh. UJALA s working model Work model of UJALA underlined by limited role of discoms and no subsidy Under UJALA, EESL is the only implementing agency and procures LED bulbs on a national level through competitive bidding. This demand aggregation has enabled it to bargain for and obtain significant discounts from manufacturers. There is no subsidy from the government. EESL signs agreements with DISCOMs to distribute the LED bulbs in their territories. Like the Nashik programme, consumers can either buy the bulbs upfront or through monthly instalments via electricity bills. They are not required to submit their old incandescent bulbs. The distribution is handled by local agencies hired and supervised by EESL. DISCOMs have a limited role to play. Neither do they invest in the programme8, nor are they responsible for its administration. Their role is limited to providing space for the kiosks set up by the local distribution agencies, providing consumer details to EESL for those consumers who want to buy the LED bulbs through monthly instalments, and in some cases create awareness about the programme. CFL volume growth surprised Indian lighting industry, LED era started post 2013 India s lighting industry grew about 16% annually over the last six years and stood at about Rs 210bn at the end of The growth up to 2013 was dominated by CFLs. CFL sales had doubled in four years since the launch of the Bachat Lamp Yojana (BLY) in As CFLs got popular, it was expected that demand would grow to a billion lamps in Accordingly, manufacturers made significant investments and the annual production capacity of CFLs in India reached around a billion lamps in 2013, more than double the number of CFLs sold in that year. 22

23 Consumer Electricals sector, October 16, 2017 UJALA is still quite far from its objective of phasing out incandescent bulbs in India. Rather, it seems to be phasing out CFLs from the Indian market. This is corroborated by the consumer surveys, which indicate that about 60% of the UJALA bulbs were used to replace CFLs, while only 25% were used to replace incandescent bulbs. A key reason seems to be UJALA s lack of focus on low income as well as rural households, who are more likely to buy incandescent bulbs. Post 2013; the LED revolution took over CFL. Only 280 million CFLs were sold in 2016, which is about 60% of peak sales in LED lighting entered the Indian market around 2010, when it accounted for about 6% of the total market by value. LED bulbs started selling significantly only around Sales have increased 50 times, from around 5 million bulbs in 2014 to about 250 million bulbs in At the end of 2016, LED lighting accounted for 54% of the total lighting industry by value. The growth in the sale of LED bulbs has been huge since the launch of DELP in 2014, followed by that of UJALA. About 812 million incandescent bulbs were sold in 2016, and more than 770 million in 2013, before the launch of the UJALA programme. Sales have seen a steady annual decline of 5% for the last two years (2015 and 2016). But this decline is much less than that for CFLs. This indicates that UJALA is still quite far from its objective of phasing out incandescent bulbs in India. Rather, it seems to be phasing out CFLs from the Indian market. This is corroborated by the consumer surveys, which indicate that about 60% of the UJALA bulbs were used to replace CFLs, while only 25% were used to replace incandescent bulbs. A key reason seems to be UJALA s lack of focus on low income as well as rural households, who are more likely to buy incandescent bulbs. Price trajectory of LEDs has bottomed out Two factors contributed to the dramatic price drop of LED bulbs in India: LED chip prices have fallen by a factor of 10 every decade since the 1960s, as observed by Haitz s Law contributing to the reduction in the price of LED bulbs globally. LED bulbs, being a recent application of LEDs, presented a significant potential for reduction in the manufacturing cost, achieved through economies of scale. In India, UJALA driven demand provided the economies of scale that enabled manufacturers to bring down their prices. In 2014, a 7W LED bulb carried a maximum retail price of Rs 650 Rs 700, which shopkeepers sold for about Rs 400 Rs 450. Prayas survey of about 150 retailers and their online survey on three leading commerce websites revealed that a 7W LED bulb was available in the price range of Rs 100 Rs 150, while a 9W LED bulb was available at Rs 140 Rs 200. The actual price of the bulbs may be lower as the retailers often offer discounts on actual purchase. There are also expensive bulbs available for more than Rs 150 (7W) and Rs 200 (9W), as well as cheaper bulbs that are available for Rs 40 and Rs 50. Most bulbs come with a warranty of two years. The price of LED bulbs sold under the UJALA programme is almost half of the price of LED bulbs sold in retail outlets in India. A 9W LED bulb sold through UJALA is available at ~Rs 65 compared to Rs 140 Rs 200 in the retail market. This price difference is due to aggressive bidding by manufacturers and the exclusion of regular dealers and retailers from the programme. However, both are not sustainable in the long term. Interviews with industry stakeholders reveal that the retail market prices, after falling to a third of its value in 2014, have stabilised and may not go down further. As per Prayas, there is no possibility of the market price matching the UJALA price. UJALA prices acted as an external pressure point for a reduction in market prices, but this reduction seems to have bottomed now. The significant difference in the UJALA 23

24 Consumer Electricals sector, October 16, 2017 As per Prayas, there is no possibility of the market price matching the UJALA price. UJALA prices did act as an external pressure point for a reduction in market prices, but this reduction seems to have reached its limit now. price and the market price is also increasing the incentives for malpractices in the distribution of bulbs through UJALA. Our interactions with some UJALA tender participants also highlight that there are many fringe participants in the UJALA scheme who are there to benefit from the free distribution network which is currently offered by EESL. There is very little margin objective of these fringe players. Currently the margins that these fringe players seek are as little as the proportion of LED buyers who do not come for replacement even when the bulb is under warranty. Clearly, these fringe players will not be there for a steady state replacement market. How have LED prices corrected in other geographies? A similar trend of price reduction has been observed in other countries. The market price reduction in India is comparable to the price reduction observed in other parts of the world. Gerke, Ngo, and Fisseha (Gerke, Ngo, & Fisseha, 2015) conducted a regression analysis of the weekly prices of LED A-shaped bulbs (the most common variety of LED bulbs) sold in the USA between 2011 and They found that the prices reduced by about 28% per year after controlling for the effects of light output (lumens), retailers, and brands. A recent study (Scholand, 2016) compared the historical retail prices of mainstream LED bulbs in major European countries between 2011 and They observed that the prices reduced 32% annually in France, 28% in Germany, 33% in Italy, 32% in Spain, and 27% in the UK. Chart 18: Procurement data for the UJALA program Price (Rs.) Rs year warranty 5 year warranty January 2015 onwards: 3 year warranty Rs Jan Aug Nov Jan Mar Jun Nov Jan Apr Sep Quantity purchased (millions) Price Quantity Source: EESL 24

25 Consumer Electricals sector, October 16, 2017 UJALA statistics The UJALA programme has transformed the LED lighting industry in India. Its share by value in the total lighting industry grew from 6% in 2010 to 54% in Demand for LED bulbs has gone up 50 times in the three years since 2014, while the retail market price (for bulbs sold beyond UJALA) has dropped to a third of its value. India now has about 176 local manufacturing units and 300 registered companies selling LED bulbs. The number of accredited testing laboratories for LED bulbs in the country has increased from three to fifteen in the last three years. A thriving small-scale industry for LED lighting has emerged, albeit amidst concerns about the quality of its products. We checked the financial parameters of a large number of SME electricals. While they represent a varied group, from wire makers to bulb manufacturers, their profitability has remained healthy, registering return in the range of ~10%. Chart 19: Indian lighting trends by value Chart 20: Sales trend of lighting devices in Indiaqty (Rs mn) 120, ,000 80,000 60,000 40,000 20,000 Source: ELCOMA - LED Tube lights, CFLs and incandescent bulbs Other (Luminaires and Accessories) (mn) 1, LED Tube Lights CFL Incandescent Lamps Consumer behavior also indicates positive response to LED on its own merits Survey by Prayas among LED users indicates repeat purchase by consumers even without Ujala. The UJALA programme has notably increased consumer awareness about LED bulbs. Among the surveyed households in three cities, 47% to 73% reported that they would not have bought LED bulbs if it were not for the programme. Majority of the surveyed households were satisfied with the performance and quality of the LED bulbs. Following a similar trend, most households said that their next purchase would be LED bulb. Post the UJALA programme, LED lighting made up 37% to 63% of the total lighting points in the surveyed households. The chart below displays the range of responses to selected questions from the surveyed households in the different cities. 25

26 Consumer Electricals sector, October 16, 2017 Surveys undertaken by Prayas indicate positive response of most consumers towards LED light distributed under EESL. There is a big replacement market out of the Ujala program which most lighting companies will target. Chart 21: Survey response indicates positive feedback to UJALA Households that would not have bought LED bulbs if UJALA were not launched Households that were satisfied with bulb perforance LED lightings as a perceneage of the total lighing stock Households that will replace UJALa bulb with LED buld in the future (%) Source: ELCOMA Chart 22: Reason for purchase of UJALA bulbs given by surveyed households Pune Lucknow Puducherry 10% 14% 2% 1% 12% 6% 16% 52% 47% 24% 85% 31% Source: ELCOMA Cheaper than the bulbs Reduction in electricity bill Good for the environment Other Key constructs which made UJALA a success Programme design not based on subsidy: EESL designed the UJALA programme based on lessons learned from the Bachat Lamp Yojana (BLY) for CFLs and its own pilot programme for LED bulbs in Puducherry. UJALA was significantly different from the pilot and did not involve any subsidies or exchange of old bulbs. Each household was allowed to buy ten LED bulbs if paying upfront and four if paying through monthly instalments. Technical specifications of the procured LED bulbs were adopted from the prevalent standards by the Bureau of Indian Standards (BIS). Partnering with DISCOMs who had measured role: The role of DISCOMs in UJALA was limited; this resulted in their quick participation. EESL s uniform national level model for the programme resulted in quick approvals from the state regulatory commissions. A strong political ownership of the programme provided the final push for DISCOMs, most of which are susceptible to political influence, to participate in the programme. 26

27 Consumer Electricals sector, October 16, 2017 Bulk procurement resulting in further lowering of costs: All participating manufacturers commended EESL s efficient and transparent e-bidding process for procurement of LED bulbs. Successive bids saw significant price reductions as EESL s quantum of orders increased with more DISCOMs participating in the programme. However, manufacturers believe the latest bids are too aggressive to be sustainable. EESL s initial strategy preferred domestic manufacturing but did not mandate it, as its core objective was market transformation. Subsequently, manufacturers were required to assemble the LED bulbs in India. Aggressive marketing: EESL adopted innovative marketing initiatives. The #iledtheway campaign saw more than 75 million citizens committing to buy LED bulbs. The UJALA dashboard with its real time updating of the number of LED bulbs sold in India was periodically reported by media and politicians. EESL also conducted numerous local level campaigns like TV ads, newspaper ads, mobile advertising vans, and others. Distribution network to create on ground touchpoints: EESL hired vendors in each state to distribute the LED bulbs, record consumer data, collect defective bulbs for warranty, and advertise locally. EESL s small team effectively coordinated the supply chain with the vendors across the country, which at the peak of the programme sold six lakh LED bulbs per day. Monitoring and evaluation ensured quality: EESL has a three-tier approach to ensure that procured LED bulbs comply with the BIS standards for safety and performance. This approach includes compliance reports from certified laboratories submitted by manufacturers, testing of a random sample by EESL, and a call centre to receive complaints from consumers. Some of the shortcomings of UJALA Defects: Mos households preferred not to replace these bulbs under warranty due to procedural and perceptual reasons. Our interactions with some suppliers of UJALA indicate that the successive bidding took LED prices to a low where it was only based on the non-returning of bulbs under warranty. Lack of compliance: Prayas surveys show that the processes on the consumer end lacked compliance. Consumer data was not entirely recorded, the limit of ten LED bulbs per household was not strictly followed, and defective bulbs were not collected at all the centers, to be replaced under warranty. Benefits of LED Table 7: Comparison of key features of LED bulbs, CFLs, and incandescent bulbs LED bulbs CFLs Incandescent bulbs Life expectancy (hours) Power required (W) Cost of ownership (Rs) over the life of 1 LED bulb Hazardous materials None Mercury None Colour rendition Wide range of colors Restricted colour options Restricted colour options Source: Prayas Group 27

28 Consumer Electricals sector, October 16, 2017 Table 8: Comparison of features of different energy efficiency lighting programs in India Feature Nashik (2005) BLY (2009) DELP (2014) UJALA (2015) Target Incandescent bulbs Incandescent bulbs Incandescent bulbs Incandescent bulbs Replacement CFL CFL LED LED Investment by Bulb manufacturers 3 ESCOs across the country EESL EESL Paid back by Consumers Consumers (about 10% of price) and buyers of carbon credits (90%) Consumers (about 10% of price) and DISCOM (90%) Consumers Implementing agency Source: Prayas Group MSEDCL BEE/EESL as the nodal agency and 3 ESCOs across the country EESL EESL Industry response to UJALA Aggressive bidding has affected the profitability of enthusiastic players with the impact seen more on the intermediate manufacturers. EESL is also slowing its procurement of LED bulbs, adding to the woes. However, some enthusiastic global players with a strong financial position are probably using this opportunity to increase their market share in the Indian LED market, even if it means low or no profits today (case in hand being Philips). The bulk volumes of LED promised by UJALA led the industry to believe that it was economical to invest more in local assembly lines rather than import the bulbs. The manufactures also preferred dealing with one consumer, EESL, rather than thousands of distributors and retailers across the country. This brought down their transportation costs, as they could pack a larger quantity of bulbs in a single shipment to the EESL warehouses. EESL also paid upfront and fast, unlike retailers and dealers who preferred credit lines that resulted in recovery issues in some cases. One more contributing factor was that EESL took responsibility for the nation-wide advertising of LED bulbs. Although EESL did not advertise specific brands, the box of the LED bulb carried the brand name, giving the manufacturers much valued brand recognition. Finally, most participating manufacturers cited the transparent, simple, and fast processes of the UJALA programme as one of the key reasons for their participation. There is a wide spectrum of LED industry from ardent subscribe to non-subscribers of the UJALA program. Enthusiastic manufacturers installed large assembly lines for LED bulbs or converted their existing and idle CFL assembly lines into LED bulb assembly lines. Some also imported bulbs from China or bought them from other Indian manufacturers (those who only manufacture LED bulbs and do not sell them in the retail market). These intermediate manufacturers in turn made significant investments in LED assembly lines. As the price went down with successive bids, cautious manufacturers opted out, but enthusiastic ones continued to participate. Aggressive bidding has affected the profitability of enthusiastic players with the impact seen more on the intermediate manufacturers. EESL is also slowing its procurement of LED bulbs, adding to the woes. However, some enthusiastic global players with a strong financial position are probably using this opportunity to increase their market share in the Indian LED market, even if it means low or no profits today (case in hand being Philips). Some manufacturers were cautious about their participation in the programme. They adopted a mixed approach towards meeting the demand for LED bulbs from UJALA. They invested in building capacity to meet some of the demand from UJALA and bought the rest from intermediate suppliers. As the bid prices went down, these manufacturers stopped participating in the programme and consequently stopped buying from the intermediate suppliers. This probably added to the financial woes of the intermediate suppliers. The cautious manufacturers were still able to sell their in- 28

29 Consumer Electricals sector, October 16, 2017 house manufactured LED bulbs in the retail market because of the awareness created by the UJALA programme. Some big as well as small players did not participate in the UJALA Program. The big companies adopted a different business model. They decided to grow organically and increase their production capacity as per the market demand and not based on UJALA s demand. They also spent significantly on establishing their brand as a quality product and distinguishing themselves from the brands being sold under the UJALA programme. They benefitted from the rise in market demand for LED bulbs caused by increased awareness through UJALA. The prices of the branded LED bulbs offered by non-participating manufacturers are not very high compared to those offered by participating companies. The brand establishment may help these companies in the long term. The other non-participants were the small-scale manufacturers that have entered the market in significant numbers in the last two years. They benefitted significantly from the consumer awareness created by the UJALA programme. They had an opportunity to participate in the UJALA programme by creating a consortium. Most of them did not participate, however. A number of small-scale LED manufacturing hubs have come up in Maharashtra, Delhi, Uttar Pradesh and Haryana. Surveys revealed that some 7W/9W LED bulbs are available for as low as Rs 50 without any warranty. These may either be low quality bulbs imported from China or assembled by small-scale manufacturers in India. Distributors and retailers (both large and small shops) are important players in the lighting industry. They act as marketing and distribution agents, as well as collection agents in the warranty process. They have been kept out of the UJALA programme. One of the reasons for the low price of LED bulbs offered under the programme is that it does not include commission paid to dealers and retailers. There is a range of feedbacks which Prayas has shared through their dealer surveys on LED. There are some distributors who refuse to stock LED bulbs, some who claim to have been independently able to sell LEDs, some who continue to believe in the potential of incandescent bulbs, etc. Discussions with some retailers revealed that they sell LED bulbs by providing two reasons to buyers: (a) the quality of their bulbs is better than the government bulbs, and (b) claiming warranty for the government bulbs is tedious. There is some proof of the fact that the warranty claims are actually lower than expected. 29

30 Consumer Electricals sector, October 16, 2017 Prospect of pumps under EESL One of the concerns of the industry has been the feasibility and chances of extending UJALA type schemes to other electrical appliances like pumps and fans. In order to upscale the implementation of Agricultural Demand Side Management (AgDSM) scheme, EESL had devised distribution model similar to UJALA scheme wherein the farmers shall be handed over Energy Efficient Pump Sets (EEPS) over the counters. This shall help in upscaling the present replacement methodology of pump sets per year with 2-3 lac pump sets per year. Innovative concept of Smart Control Panels have been adopted wherein farmers could switch ON /OFF their pump sets using a mobile phone and the power consumption data shall be transmitted to EESL Dashboard for monitoring purposes. In this section we discuss why UJALA level implementation is difficult in case of pumps. Agricultural power consumption (22% of the total power consumption) is one very prominent avenue of improving efficiency. However, UJALA type success may not be achievable. Since most of the targeted user of the energy efficient pumps (EEPS) would be consumers under subsidy, the effective customer is the Government itself. Hence, the proposed AgDSM had several stumbling blocks. Through the process of approving AgDSM program, we could sense that there are several stumbling blocks to the program and UJALA like success and successive price erosion might not happen. Case Study of AgDSM scheme in Andhra Pradesh EESL has come into an agreement(s) with the DISCOMs of Andhra Pradesh for distribution of 2 lac EEPS and shall commence distribution in Eastern Power Distribution Company of Andhra Pradesh (APEPDCL) and Southern Power Distribution Company of Andhra Pradesh (APSPDCL) submitted petitions to the Andhra Pradesh Electricity Regulatory Commission (APERC) to approve a cumulative replacement of 1,00,000 5 HP in-efficient agriculture pumps with 5 star pumps in their respective territories at a combined cost of Rs4.5bn. DISCOMs will invest in the programs and Energy Efficiency Services Ltd. (EESL) will provide the project management consultancy. EESL prepared detailed project reports for both the programs including a baseline study conducted in Rajanagaram. APERC approved both the programs after conducting public hearings. We have highlighted some of the objections raised by various stakeholders in this AgDSM program. This highlights that Agriculture pumps are quite different from LED lamps or fans and similar DSM programs like UJALA can be difficult to replicate. Table 9: Assumptions of the deal between APEPDCL and APERC Particulars of required capital investment Amount (Rs mn) Number of Submersible pump sets 35,000 Total cost of EEPS with smart control panel with 5 years maintenance 37,676 1,319 EEPS installation Rs. 4600/ unit 161 Cost for awareness & Distribution (Inclusive of call centre agency & software agency) 26 EESL PMC charges over 5 years 5% 66 Total Project Cost 1,572 Source: Government Data Between APSPDCL and APERC APSPDCL to replace 65,000 old pump sets out of those existing in the eight districts that are connected to the grid, with BEE 5 star rated 5HP energy efficient submersible Pump 30

31 Consumer Electricals sector, October 16, 2017 Sets and Smart control panels. APSPDCL mentioned that the energy savings will be around MU per annum, resulting in reduction in power procurement cost of Rs944mn per annum. Table 10: Assumptions of the deal between APSPDCL and APERC Particulars Amount (Rs mn) Number of Submersible pump sets 65,000 Total cost of EEPS with smart control panel with five years maintenance (Inclusive of Tax) 37,676 2,449 EEPS installation Rs. 4600/ unit 299 EESL PMC charges over five years 5% 137 Cost for awareness & Distribution (Inclusive of call centre agency & software agency) 40 2,925 Source: Government Data Table 11: Key observations in case of pump distribution under AgDSM in Andhra Pradesh Objections of various stakeholders in the AgDSM program Objections raised by Peoples' Monitoring Group on Electricity Regulation Comments Cost of the project can be brought down as the pump sets along with the control panel are going to be procured in large scale. PMC charges should be reexamined. Installation cost of Rs. 4600/- per pump set needs to be brought down. Scrap value of the old pump sets needs to be deducted from the project cost and old pump sets need to be scraped and disposed of properly, so that old pump sets do not re-enter the market. Objections raised by Centre for Power Studies, Hyderabad Objections raised by Bharatiya Kissan Sangh Objections raised by Sri G. Muniratnam, Sri Ajanthy Foods Objections raised by Praja Energy Audit Cell Problems with Voltage Issue of bearing expenditure is to be examined and should not be passed on to consumers. The Government of Andhra Pradesh has to bear the expenditure, since the financial benefits would result in reduction of subsidy burden of the State Government. The agricultural consumers are now using ISI pump sets. Earlier, the DISCOMs have implemented energy efficiency programs like replacement of pump sets with star rated pump sets, replacement of normal fans with 5 star rated fans and replacement of bulbs with LED bulbs. In these schemes, it was mentioned that the investment made would be paid back with the accrued amount from energy savings. But the Commission allowed an amount of Rs1.4bn in the tariff order FY towards implementation of the above energy efficiency programs. At present, we have lot of surplus power and there will not be any financial benefit, if this type of energy efficiency scheme is implemented Consumers are using pump sets with the ISI marks. The state is having surplus power and there is no need for power saving. The power utilities are running under losses. The expenditure involved is very high and there is no return on investment as the DISCOMs have surplus power. The tariffs have to be increased to cover the losses due to implementation of this scheme. Replacement of old motor with new motor involves both manual labor and skilled mechanic and it is very difficult to ensure that the new motor is installed in place of old motor at a depth of 200 to 400 feet. Old motors have to be scraped which are working in good condition and this is not a good sign when 70% of people are below poverty line. He requested to not approve the project. Fixing of capacitors should be insisted first and then installation of ISI pump sets should be taken up as a second step. The voltage profile mentioned in the Detailed Project Report (DPR) indicates that only 11% of consumers are getting proper voltages i.e, between 400 V to 415 V. If, EEPS are installed at such locations where voltage profile is poor, Energy Efficient Pump Sets will burn out. 31

32 Consumer Electricals sector, October 16, 2017 Objections of various stakeholders in the AgDSM program Disputes in energy saving claim because of various HP ranges of pumps in use Source: Government Data Comments In the detailed project report, the petitioner furnished data pertaining to supply voltages and power consumption etc. A 5 HP motor consumes 7.06 HP (5.3 kw) power. Out of 91 numbers pump sets, 48 pump sets are consuming in the range between 7.16 HP (5.37 kw) to 15.5 HP (11.71 kw). Only 43 pump sets are consuming power in the range of 3.66 HP (2.75 kw) to 7.06 HP (5.3 kw), which indicates that these pump sets are of 5 HP capacity and are authorized. The pump sets that are consuming in the range of 8 HP (6 kw) to 15.5 HP (11.71 kw) are 31 in number and pump sets that are consuming between 7.06 HP (5.3 kw) to 8 HP (6 kw) are 17 in number. Pump sets that are consuming between 3.66 HP (2.75) kw to 7.02 HP (5.27 kw) are 43 in number. In the DPR, the average capacity of old pump sets considered is 7.61 HP (5.71kW). Since, the connected load of more than 50% consumers is between 8 HP to 15.5HP, the anticipated savings may not be realized as estimated in the DPR. If, higher capacity consuming pump sets which are in the range of 8 HP (6 kw) to 15.5 HP (11.71 kw) are replaced with 5 HP Energy Efficient Pump Sets, Energy Efficient Pump Sets may not work and may burn out. One of the objectors also stated that given the limitation of the evaluation of Rajanagaram project (as well as other pilots); a rigorous monitoring and evaluation should be conducted for the two proposed programs. APERC should commission an independent evaluation of both the programs after a year of their implementation. No further Ag-DSM programs should be approved till the effectiveness of the existing programs is substantially proved over a year. Additionally, the operation and life of pumps depends on many parameters, not all of them electrical. R&M and warranty process is crucial to ensure that farmers use EEPS in a manner that savings are realised in sustained manner. This is important since the pilot survey reported motor failures. 32

33 Consumer Electricals sector, October 16, 2017 LED like price erosion is unlikely in case of fans While super-fan is achievable, super-efficient fan is still not easy: The statement made regarding the Energy Efficiency target for fans was that A 70% market penetration of 35 W fans would be more desirable than a 1% penetration of 10 W fans. This means energy efficiency of fans normally brings lower air sweep and lower consumer acceptance. As such, singular focus on lower wattage for energy efficiency cannot be the sole objective for efficiency in case of fans. There is a sense that we get that it is not easy for a fan to offer expected air sweep while consuming lower power and maintaining aesthetics. The scale and technological edge will keep the power with market leaders like Crompton. In fact, while devising the specifications for energy efficient fans, it was considered that innovators and manufacturers could exercise their ingenuity to devise alternative ways to meet them. In the case of fans, performance can be dramatically improved in different ways: (1) improving the induction motor; (2) using a BLDC motor; and (3) improving the design of the blades. The specifications for super-efficient fans were developed to give designers and manufacturers freedom of how they chose to improve the performance relative to fans currently available in the market. Based on considerations, the initial set of proposed specifications was defined as follows: Higher air flow at full speed (~230 cmm versus 210 cmm in the labelling program) Low noise through the use of better quality blades In order to be more suitable for Indian conditions: - None or very low degradation in performance at lower voltages; reliable under even high ambient temperatures. Lowest power consumption reasonably possible. However, manufacturers were not supportive of the idea of a super-fan. They were also apprehensive about the availability of the technology required to meet the specifications of the super-fan, because according to them, there was no working model that consumed less than 40 W and met the current airflow requirement. Hence, there were several dilutions in the requirement for an energy efficient fan. This would get the programme rolling, and super-fans can be introduced later. However, in order to encourage the production of fans with higher air flow, it was decided to specify a minimum service value rather than the maximum power consumption by the fan. Hence, we believe energy efficient fans are likely to remain a competency of established players. Consumers prefer performance over power efficiency in case of fans. Several surveys have indicated that consumers were not interested in energy efficient fans. Pricing played a major role in their decisions to purchase fans. The very low sales levels of 5-Star fans support this observation. It appears that consumers are most interested in high air delivery. Further, some sources indicated that there was a greater drop in air delivery at lower voltages for 5-Star fans compared to regular fans, which may also be contributing to the low sales volumes for 5-Star fans. Given these features of the fan market in India, it seemed that a superior fan which was not only much more efficient but also addressed some of these concerns through superior performance would be optimal, i.e. a super-fan rather than just a super-efficient fan. 33

34 Consumer Electricals sector, October 16, 2017 This is one of the reasons of limited EESL activity in electric fans thus far despite the electricity savings potential offered by fans. To give a perspective, a regular (non-bee star rated) ceiling fan consumes 75 Watts as compared to a regular (most inefficient) tube light that consumes 55 Watts. Also a ceiling fan is used during the day as well as night whereas a light is used only during the night. In totality ceiling fans consume more than twice or thrice the amount of electricity as compared to lights. But most people ignore power consumption of ceiling fans while buying them. BEE or Bureau of Energy Efficiency in India started rating ceiling fans of 1200mm sweep (regular sized ceiling fans) a few years back and since then the manufacturers have started coming out with efficient ceiling fans. The top Energy saving fans in India, adopting the BDLC technology and giving the maximum saving as per BijliBachao are as follows: Atomberg GORILLA (28 watts, CMM) Orient ECOTECH (32 watts, CMM) Superfan SUPER A1 (35 watts, CMM) Usha TECHNIX (43 watts, CMM) Orient ENERGY STAR (48 watts, CMM) Havells ES 50 (50 watts, CMM) Crompton HS PLUS (53 watts, CMM) 34

35 Consumer Electricals sector, October 16, 2017 Valuations For Crompton, the main thesis of higher than trading multiple is to capture the better positioning of the company post demerger, and industry leading RoE of 50% and earnings CAGR of 20%. We value Crompton Greaves and V-Guard at 35x one year forward PE. Chart 23: EPS growth (%) in FY18-20E vs FY20E P/E (x) CAGR EPS growth (%) Arvind Bajaj Elec Eveready Finolex C IFB Ind Voltas CG Cons ITC Blue Star Whirlpool Dabur V-Guard Bata Titan Page Havells Trent Berger Kansai HUL GCPL Colgate Asian Paints Jubilant P/E (x) Source: I-Sec research For V-Guard, we assign it similar 35X PE multiple despite lower RoE (~25%) and lower earnings growth (~18%) compared to Crompton given that as the company grows, it has potential to improve both RoE and earnings growth, increasing turnover to Rs30bn by FY20. We also have a high conviction on the management to charter the requisite growth trajectory. Chart 24: Average RoE (%) in FY18-20E vs FY20E P/E (x) Avg RoE (%) CG Cons Colgate 45 Page Dabur ITC Blue Star 25 Eveready GCPL Berger Asian Paints Whirlpool V-Guard Titan 20 Bajaj Elec IFB Ind Havells Kansai 15 Finolex C Voltas Jubilant Bata 10 Arvind Trent P/E (x) Source: I-Sec research 35

36 Consumer Electricals sector, October 16, 2017 Index of Tables and Charts Tables Table 1: Multiple levers for consumer electricals sector to better its past growth rate... 3 Table 2: Categorising states on the basis of urban housing growth... 6 Table 3: Categorising states on the basis of rural housing growth... 7 Table 4: Categorising states on basis of total housing growth... 8 Table 5: Households having electricity as main Source of lighting India Table 6: Detailed tenders of EESL in Table 7: Comparison of key features of LED bulbs, CFLs, and incandescent bulbs Table 8: Comparison of features of different energy efficiency lighting programs in India Table 9: Assumptions of the deal between APEPDCL and APERC Table 10: Assumptions of the deal between APSPDCL and APERC Table 11: Key observations in case of pump distribution under AgDSM in Andhra Pradesh 31 Charts Chart 1: Revenue CAGR for consumer electrical companies between 2010 and Chart 2: Unorganised market share of electrical equipment... 4 Chart 3: Forecasted 5 year CAGR of various categories... 5 Chart 4: Market size of various categories... 5 Chart 5: Urban housing CAGR between 2001 and Chart 6: Rural housing CAGR between 2001 and Chart 7: Overall housing CAGR between 2001 and Chart 8: Trend of declining household strength has picked momentum... 9 Chart 9: CAGR decline in number of people in average household Chart 10: The housing quality of India is improving continuously Chart 11: Room distribution of houses in Chart 12: Room distribution of houses in Chart 13: Status of rural electrification Chart 14: Residential electricity consumption pattern Chart 15: In 2014, India was where China stood in Chart 16: Rebound effect in electricity consumption in various geographies Chart 17: Unbundling growth levers of consumer electrical industry Chart 18: Procurement data for the UJALA program Chart 19: Indian lighting trends by value Chart 20: Sales trend of lighting devices in India-qty Chart 21: Survey response indicates positive feedback to UJALA Chart 22: Reason for purchase of UJALA bulbs given by surveyed households Chart 23: EPS growth (%) in FY18-20E vs FY20E P/E (x) Chart 24: Average RoE (%) in FY18-20E vs FY20E P/E (x)

37 Equity Research October 16, 2017 BSE Sensex: Limited is the author and distributor of this report Consumer Electricals Target price Rs270 Shareholding pattern Dec 16 Mar 17 Jun 17 Promoters Institutional investors MFs and UTI FIs and Bank Insurance Co FIIs Others Price chart (Rs) May-16 Aug-16 Dec-16 Mar-17 Jun-17 Oct-17 Research Analyst: Ansuman Deb ansuman.deb@icicisecurities.com INDIA Crompton Greaves Consumer Electricals Winds of change ; set for self-actualisation BUY Rs211 Reason for report: Initiating coverage Crompton Greaves Consumer Electricals Limited (Crompton) is India s leading consumer electrical company with pole position in electrical fans and residential pumps apart from being a strong national player in electrical lighting and geysers. The company has clocked average revenue growth of ~15% in the past eight years. Going ahead, besides the Indian consumption growth story, we see levers of growth from premiumisation in fans (44% revenue share, or RS), increasing LED penetration in lighting (28% RS), foray into agricultural segment of pumps (19% RS) and growth in household appliances (9% RS). Structurally, we believe the company still has significant value unlocking potential left post demerger in 2015 and management has set key strategic initiatives rolling to attain the same, across the value chain of manufacturing, distribution and branding. This corporate transformation in the background of a high brand value and attractive market fundamentals makes Crompton set for self-actualisation. Value unlocking post demerger yet to achieve full potential: Crompton has been one of the traditional consumer super Brands in India. However, a significant landmark in the history of the company was the demerger of Crompton Consumer from erstwhile Crompton Greaves in We believe there are many levers available with the company which will be incrementally exploited to their complete potential under this new entity. Some of the initiatives under a new revitalised corporate strategy underline the potential of this transformation. These include the first major go to market initiative in a decade, major cost reduction drive across company under measurable deliverables, investing behind the brand and scouting for inorganic growth. We like this heightened entropy of the company and believe that it sets the ground for better earnings ahead. Expect 14% revenue CAGR, PAT margin to improve to ~9% by FY20. We expect revenue growth in fans to improve led by premiumisation, lighting driven by increase in value and penetration of LED and pumps, given the focus on agricultural segment. Frontloaded ESOP accounting and cost reduction programs will offer support to margins in FY18-20E. RoE/RoCE will sustain at more than 40% owing to asset light model. Recommend BUY with a Target price of Rs270 based on 35x PE multiple based on FY19-20 earnings. FCF yield at TP is ~3.9% for FY20E. Market Cap Rs132bn/US$2bn Year to March FY17 FY18E FY19E FY20E Reuters/Bloomberg CROP / CROMPTON IN Revenue (Rs mn) 39,759 43,179 48,992 55,890 Shares Outstanding (mn) Net Income (Rs mn) 2,932 3,270 4,325 5, week Range (Rs) 244/130 Recurring EPS (Rs) Free Float (%) 65.6 % Chg. YoY FII (%) 33.2 P/E (x) Daily Volume (US$'000) 3,060 CEPS (Rs) Absolute Return 3m (%) (4.2) EV/E (x) Absolute Return 12m (%) 17.7 Dividend Yield (%) Sensex Return 3m (%) 1.5 RoCE (%) Sensex Return 12m (%) 18.9 RoE (%)

38 Crompton Greaves Consumer Electricals, October 16, 2017 TABLE OF CONTENTS Corporate strategy winds of change Strategic Imperatives 1: Go-to-market first such program since demerger Strategic Imperatives 2: Cost reduction program across the company Strategic imperatives 3: Onboarding a strong management team Strategic imperative 4: Premiumisation of the portfolio and diversification Strategic imperative 5: Investing behind brands Crompton consumer at a glance Fans: Crown jewel of Crompton Crompton s fan strategy Crompton has consistently outgrown the overall fan market Fan business has structural positives Lighting: High on disruption, high on promise Peer Analysis 1: Philips Lighting India- Market leader struggling with margins Peer Analysis 2: Surya Roshni (SRN) Held fort despite decline in margins Peer Analysis 3: Eveready New player in the LED business Pumps: High growth potential Crompton has consistently outgrown the overall pump market Agricultural pump is a focus area: Can be a growth driver Growth drivers for agriculture pump sets Challenges for agricultural pumps Pump segment-peer analysis Case study: Kirloskar Brothers Case study: Shakti Pumps Appliance: High growth segment Scheme of arrangement of the demerger of Crompton Financials Annexure: Crompton fan category list Index of Tables and Charts

39 Crompton Greaves Consumer Electricals, October 16, 2017 Corporate strategy winds of change The structural positive thesis on Crompton is based on the new corporate identity of the company post demerger from erstwhile Crompton Greaves. The new management and independent corporate strategy is set to bring the winds of change which are already set rolling. Strategic Imperatives 1: Go-to-market first such program since demerger One of the standout features of Crompton has been the lack of material marketing strategy or realignment which is typically expected from a consumer facing company. There has been no discernable marketing strategy adopted by the company at least since Apart from efforts made to popularise the LED Lamps, we find no major marketing undertaken by the company. As such, the current go to market (GTM) campaign is a right step to vitalize the supply chain of the company. The key target for the company under this scheme is to increase the reach of the company in the supply chain. The company had till now limited retail presence among competitors but maintained high shelf share in its existing retail network. The target is to change that reality towards higher retail network, both in terms of volume and quality. Currently, Crompton has 3,500 dealers and 100,000 sale touchpoints mostly in urban areas. Now, they intend increasing reach by 50 per cent and adding 50,000 stores in the next three years. In FY17, the company started the GTM program to enhance shopper experience by improving product availability and visibility. A pilot program with focused approach was run in lighting segment in South India. This resulted in significant gains in top-line as well as positive feedback from the customers. In the coming year, management looks to replicate this success across all geographies and in other product lines. The company s main target under this scheme is to increase its reach in the supply chain. The company until now had limited retail presence among competitors but maintained high shelf share in its existing retail network. The target is to change that reality towards higher retail network, both in terms of volume and quality. Management has stated that the two main targets of Crompton s GTM campaign are: Improving quantity of coverage; servicing larger footprint and covering more retail coverage, towns. Enhancing the quality of coverage in terms of merchandising, visibility, servicing, and shelf space. Chart 1: Crompton targets 50% increase in reach by its Go to Market initiative 160, , , ,000 80,000 60,000 40,000 20,000 - Source: Company Data 100,000 FY17 150,000 FY20 39

40 Crompton Greaves Consumer Electricals, October 16, 2017 Chart 2: Crompton has highest per dealer revenue which indicate room to increase the touch points (Rs mn/dealer) Source: Company Data V-Guard Orient Electric Bajaj Electric Surya Roshni Havells Crompton Consumer There would be significant investment in distributors and sales force to align their business strategy with that of the company, ensure strengthening of the capability of channel partners and providing a far more transparent and consistent pricing. The benefits of the GTM in its entirety will be realized over two year period. Hence, we would see the benefits to accrue post FY19. Studies indicate that the benefits of an Effective Go to Market Strategy can lead to double digit growth in revenues and enhanced return on investments. Strategic Imperatives 2: Cost reduction program across the company The company has been able to maintain and/or better margins through the cost reduction initiatives. Management has mentioned that company s cost savings program is expected to continue over a two to three year period. Some projects will offer immediate results while others will take longer. It is a well-defined program across each category covering the entire gamut of operations from logistics, transportation, productivity as well as supply chain. The CEO and MD are personally regularly monitoring these projects on a consistent basis. Some measurable benefits which have already been reported include that in the lighting segment in FY17 where comprehensive cost reduction program has generated benefit of around 5% of sales. Even in the consumer durable segment, a significant share of the 150bps improvement in margins in FY17 was due to the focused cost reduction programs. 40

41 Crompton Greaves Consumer Electricals, October 16, 2017 Strategic imperatives 3: Onboarding a strong management team Another gust to the referred winds of change is the appointment of senior proven people in key management positions Table 1: Key managerial personnel of Crompton have rich strategic experience Key Managerial Personnel Designation Comments Mr. Shantanu Khosla Managing Director Mr. Shantanu Khosla joined the Company in January Prior to joining the Company, he served as the MD & CEO of Procter & Gamble India from July 2002 to June He is a Bachelor of Technology in Mechanical Engineering from the renowned Indian Institute of Technology, Mumbai. Mr. Shantanu Khosla has also completed his Master s in Business Administration from Indian Institute of Management, Calcutta. Mr. Mathew Job Mr. Sandeep Batra Source: Company Data Chief Executive Officer Chief Financial Officer Mr. Mathew Job joined the company in January Prior to that, Mr. Mathew Job was with Philips Electronics India Ltd from June 1994 to October 2009, where he held several key positions. From November 2009 till January 2012, Mr. Mathew Job was working with Grohe India Pvt Ltd as Vice President and Managing Director. He then moved on to Racold (Ariston) Thermo Ltd as Managing Director where he worked till September He has studied Bachelor in Technology (Electrical & Electronics). He is an alumnus of the Indian Institute of Management, Calcutta. Mr. Sandeep Batra joined Crompton in January Prior to that, he was with ICI Limited from January 1988 to January 2009, where he held various important responsibilities and eventually assumed the role of the Chief Financial Officer. He then joined Pidilite Industries Limited as their Chief Financial Officer in Jan He is an alumnus from the prestigious St. Xavier s College, Kolkata, a Chartered Accountant and Company Secretary, by profession. 41

42 Crompton Greaves Consumer Electricals, October 16, 2017 Strategic imperative 4: Premiumisation of the portfolio and diversification Crompton management believes that the premium fan segment is essentially a two player business and a relatively safe haven for the company. Premiumisation of fans: Crompton wants to increase its premium share of the fan portfolio which has steadily increased from single digits to mid-teens in last six quarters. Havells is the leader in the premium fan category (above~rs2,500). Crompton management believes that the premium fan segment is essentially a two player business between Havells and Crompton and a relatively safe haven for the company. Chart 2: Premium fan share of Crompton on the rise Premium share of Crompton (%) Q3FY16 Q4FY16 Q1FY17 Q2FY17 Q3FY17 Q4FY17 Source: Company Data What if scenario of premiumisation Crompton is a market leader of fans (26% market share) compared to Havells (13% market share). While the latter is a leader in premium segment above Rs2,500, Crompton has started to gain ground in this share. Similar attempts are being made by Orient Electric. 50% bridging of EBIT margins between Havells and Crompton can add Rs50 per share to Crompton s target price. Havells and Crompton clocked FY17 EBIT margins of 25% and 17% respectively in the consumer electric durable segment (ex-lighting, cable and switchgear). Considering that the difference is entirely due to premiumisation, if we assume that Crompton is able to reach 21% EBIT margins in the fan segment by 2019, at 33x multiple, there could be Rs50 per share addition to the target price. Incremental focus in agricultural pump segment: Crompton is a leader in the domestic residential pump category in India and has managed to increase its revenue from Rs2.6bn in FY08 to ~Rs7bn in FY17. Crompton has been able to perform relatively better with average 14% revenue growth in the pump segment between FY10 and FY17, maintaining its leadership position in the residential pump segment and trying to make headways into the agricultural market. The agricultural pump revenue grew in double digits in FY17. The agricultural market size is ~Rs23bn, which is around 28% of the total pump market. 42

43 Crompton Greaves Consumer Electricals, October 16, 2017 Strategic imperative 5: Investing behind brands We base our analyses on the sum of ad spend cash discounts, sales promotion and sales commission. The total of all these elements has increased from ~Rs500mn- Rs600mn to more than Rs1.8bn in FY16/17 since demerger. The Crompton brand has been under invested and had to be rejuvenated and the current management has been following an active policy on this expenditure as seen in the table below. Chart 3: Average ad related spend as a percentage of sales between 2010 and 2017 Crompton is lowest among comparable on average ad spend as a percentage of sales for the period Average ad spend as % of sales 0.0 Crompton Consumer Orient Electric Eveready V-Guard Finolex Surya Roshni Bajaj Electricals Havells Source: Company Data Let s hangout ghar pe Crompton is now focusing on building its brand to compete with other players across product categories. One of the strategies has been to address a younger audience with new campaigns. The company has realised that Crompton was a strong brand only with the older generation aged above 45 but with the new campaign, it is addressing the 25 to 45 age group. Crompton launched its marketing campaign Lets Hangout Ghar Pe in 2016 through the release of TVCs for its fans and LED range of products. As per the company, the campaign was well received and helped in improving consumer awareness significantly. Crompton was also associated with the cricket series between India and England in Conceptualised by BBDO India, let s hang out ghar pe was an integrated brand campaign that was executed across various touch points, aired across national as well as regional channels. As per media reports, the effectiveness of the campaign was measured by leading research agency, AC Nielsen, who found that the television commercials have been effective in delivering targeted results on various brand parameters. In line with the intention, the advertisements captured situations experienced by young couples in a modern and contemporary setting. 43

44 Crompton Greaves Consumer Electricals, October 16, 2017 Comparison of ad spend as a percent of sales Chart 4: Orient Electric Chart 5: Eveready 1,000 Ad spend % sales (RHS) Ad Spend % sales (RHS) 7 (Rs mn) (Rs mn) FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 0 Chart 6: Crompton Greaves Chart 7: V-Guard 1,400 Ad Spend % sales (RHS) 4.5 1,400 Ad Spend % sales (RHS) 12.0 (Rs mn) 1,200 1, (Rs mn) 1,200 1, FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY Source: Company Data Chart 8: Surya Roshni Chart 9: Bajaj Electricals 1,400 Ad Spend % sales (RHS) ,500 Ad Spend % sales (RHS) ,200 1, , (Rs mn) (Rs mn) 1,500 1, FY10 FY11 FY12 FY13 FY14 FY15 FY FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY Source: Company Data 44

45 Crompton Greaves Consumer Electricals, October 16, 2017 Chart 10: Havells (Rs mn) 4,500 4,000 3,500 3,000 2,500 2,000 1,500 1, Ad Spend % sales (RHS) FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY Source: Company data Tracking ad spend effectiveness If we leave aside other effects like increase in distribution network and enhancement of product offering and consider increase in revenue to be only driven through ad related expenditure, we find that Crompton has the best multiplier of revenue to ad expense. This is a simple corollary to the fact that Crompton has underinvested in ad and promotional expense in the past. Crompton has the best multiplier of Revenue to ad Chart 11: Change in revenue between 2017 and 2010 to the total ad spend in this period Revenue to ad multiplier Eveready Havells Bajaj Electricals Finolex Orient Electric Surya Roshni V-Guard Crompton Consumer Source: Company data 45

46 Crompton Greaves Consumer Electricals, October 16, 2017 Crompton consumer at a glance (All figures are in Rs mn) The numbers are not adjusted for post GST tax calculation, both for company and industry Source: I-Sec research Table 2: Segment wise growth and industry summary Growth (%) Industry Forecast Company estimate Company history (FY10-17) Drivers Fan Premiumisation, growth in market share Lights Both volume and value in LED and fixtures Pumps Inroads into agricultural pump segment Appliances Higher penetration Source: Company data 46

47 Crompton Greaves Consumer Electricals, October 16, 2017 Fans: Crown jewel of Crompton Chart 12: Fan revenue and revenue growth Chart 13: Fan revenue share of Crompton (%) 30,000 Fan Revenue (Rs mn) 30% Fans revenue share (%) 25,000 20,000 15,000 10,000 5,000 - FY10 FY11 Fan revenue Growth (%, RHS) FY12 FY13 FY14 FY15 FY16 FY17 FY18E FY19E FY20E 25% 20% 15% 10% 5% 0% 48% 47% 46% 45% 44% 43% 42% 41% 40% 39% 38% FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18E FY19E FY20E Source: Company data The Crompton brand is almost best known for the product category of fans. It is a super-brand identified with better life, durability and has high positive legacy attached to it. Crompton is the industry leader with a very strong recall among customers. The current fan market in India is ~Rs65bn with annual production of 60-65mn units with rural penetration of 65% and urban penetration of 90%. Fan as a business segment is dominated by select few strong players among organised players, as evident from the pie chart below. The fan market is attractive because the organised market is highly consolidated and premiumisation has started Chart 14: Fan market share of India: Concentrated market with ~75% held between 4 players. Others, 23% Crompton, 26% Havells, 13% Orient, 20% Source: Company data Usha, 18% 47

48 Crompton Greaves Consumer Electricals, October 16, 2017 Crompton s fan strategy Premiumisation: Crompton wants to increase its premium share of the fan portfolio which has steadily increased from single digits to mid-teens in last six quarters. Havells is the leader in the premium fan category (above~rs2,500). Crompton management believes that the premium fan segment is essentially a two player business between Havells and Crompton and a relatively safe haven for the company. Chart 15: Portfolio of Crompton already has higher share of premium fans (nos) Super Premium Premium Metallic/ Decorative Standard Plain Economy BEE Star Source: Company data Crompton management believes that the premium fan segment is essentially a two player business and is relatively safe haven for the company. What if scenario of premiumisation? 50% bridging of EBIT margins between Havells and Crompton can add Rs50 per share to Crompton s target price. Havells and Crompton clocked FY17 EBIT margins of 25% and 17% respectively in the consumer electric durable segment (ex-lighting, cable and switchgear). Considering the difference is entirely due to premiumisation, if we assume Crompton is able to reach 21% EBIT margins in the fan segment alone by 2019, at 33x multiple, there could be Rs50 per share addition to the target price. 48

49 Crompton Greaves Consumer Electricals, October 16, 2017 Chart 16: Premiumisation gap between Havells and Crompton apparent from respective EBIT margins (%) Havells Lighting Havells-Electric Consumer Durables Crompton Lighting Crompton-Electric Consumer Durables Source: Company data Increasing market share: Crompton also wants to increase its overall market share of fans from ~25-26% to near 27-28%. This is illustrated by the fact that despite 15% of portfolio being premium, the average fan price of Crompton remains ~Rs1,300. Participate in the EESL scheme. Crompton is keen to participate in the tendering programs of EESL to gain as much volume growth possible. The EESL tendering process for fans has just started. Table 3: EESL tenders for fans in 2017 Date Type Value (Rs) Company July'17 LED bulbs, BEE 5 Star Ceiling fans and Energy Efficient Tube Lights in Uttar Pradesh 37,702,200 Alankit Ltd -"- 37,702,200 Amar Construction -"- 37,702,200 Command Consultancy -"- 37,702,200 Itech mass Pvt. Ltd. -"- 37,702,200 Kishan Infrastructure -"- 37,702,200 Medas Consultancy -"- 109,860,000 Radiant Haroti -"- 37,702,200 RBS Multisolutions -"- 49,437,000 Shri Balaji Kripa Infosystems -"- 37,702,200 Sun Mega Ventures -"- 82,395,000 Vap Infosolutions -"- 4,691,100 Zephyr Limited June'17 April'17 LED bulbs, BEE 5 Star Ceiling fans and Energy Efficient Tube Lights & Data Base Preparation in Maharashtra LED bulbs, BEE 5 Star Ceiling fans and Energy Efficient Tube Lights & Data Base Preparation in Delhi 15,940,000 Sun Mega Ventures 11,242,000 Kishan Infrastructure BEE 5 star EE fans pan India 332,460,000 Marc Enterprise BEE 5 star EE fans pan India 169,924,000 Crompton Greaves BEE 5 star EE fans pan India 147,760,000 Surya Roshni BEE 5 star EE fans pan India 88,656,000 Orient Electric Feb'17 EE fans 1,768,000 Surya Roshni Source: EESL The orders for fans have started but largely along with LED in Uttar Pradesh and Maharashtra and remain few in number. There is limited scope to understand the share of fans in these combined tenders. 49

50 Crompton Greaves Consumer Electricals, October 16, 2017 The companies which have won exclusive fan tenders under EESL are the high profile organised players like Crompton, Surya Roshni, Orient Electric and Marc Enterprises. Though it is early times, we have seen limited small player participation in EESL under the fan category. Crompton has consistently outgrown the overall fan market Crompton has been able to grow its Fan business better than the industry. This has been a constant standard for the company. With revenue CAGR of 15%, market share of 26% and a fairly consolidated market with limited possible technological disruptions, the fan business of Crompton rank high on attractiveness. Chart 17: Crompton fan has consistently outperformed the broader fan market Growth in Fan market (%) 35 Crompton growth Industry growth Source: Company data FY11 FY12 FY13 FY14 How has fans revenue growth for Crompton been? The fan revenues of the company have increased from Rs6bn in to ~Rs18.2bn in FY17. Over the last eight years, fans CAGR has been a healthy ~15%. This however does not completely capture the effect of premiumisation which the company has started to focus as a more concerted strategy in last 1-2 years. The Indian electrical fan industry clocked a CAGR of ~10% from FY10 to FY17, split between volume CAGR of 6-8%, and average price increase of 3-3.5% annually due to a rise in raw-material prices. Demand for ceiling and exhaust fans increased due to a rise in housing construction activities, improvement in electric fan penetration rates, rural electrification and replacement demand in urban areas. Crompton however can add to the 10% growth through both increases in market share and premiumisation of portfolio. Crompton fan portfolio: Crompton has six broad categories in the fan segment clearly demarcating Super Premium, Premium, Metallic/Decorative, Standard/Plain, Economy and BEE Star rated. The premiumisation drive could also be seen in the portfolio. 50

51 Crompton Greaves Consumer Electricals, October 16, 2017 Fan business has structural positives. The organised market is dominated by only 4 players who have a cumulative share of 75%. Considering that the market is Rs65bn strong with double digit growth potential, this is unique and puts the incumbent in a very sweet spot. Some leaders in the fan market too have a weak underbelly. - Usha International: One of the strong players in the fan segment is Usha International which has a market share of 18%. The company has one of the strongest brands as a consumer durable product manufacturer in India, with a legacy of more than 80 years. It was recently ranked among the 100 most trusted brands in India by AC Nielsen. It has also grown its revenue tremendously from Rs7bn to over Rs20bn in the last 5 years. All of this has been done while the ad spend by the company has been high at ~3-4% of sales per annum. Yet, the company has not been able to maintain sustainable profits. From FY12 to FY15, EBITDA has declined from Rs700mn to Rs100mn, while EBITDA margins have declined from ~5% to ~0.5%. One of the leaders in the fan market, Usha International has seen its margins decline over the years and its market share has also stagnated compared to Crompton and Havells. We consider this as a soft competition which presents organic as well as inorganic growth opportunity for Crompton. Table 4: Financial highlights of Usha International (Rs mn) FY12 FY13 FY14 FY15 Electric Fans 8,271 8,894 Sewing Machines 4,153 4,029 Appliances 3,663 3,687 Auto products Engines, pump sets and motors 2,418 2,370 Revenue 19,403 19,917 Revenue from ops 15,604 18,902 18,540 19,144 -RM costs 10,206 12,485 12,759 13,129 -Employee costs 1,039 1,306 1,531 1,751 -Other Expenses 3,617 4,529 4,023 4,151 EBITDA Exceptional income (444) - Other Income Interest Depreciation Taxes (104) (6) PBT 244 1,033 (771) (455) PAT (667) (449) Adjusted PAT 169 (187) (222) (449) EBITDA Margin (%) Gross profit 5,244 5,869 5,353 5,528 Gross Margin (%) Advertisement Ad % of sales 2.9% 3.8% 4.0% 3.3% Net Worth 2,342 2,780 2,044 1,519 RoE (%) 7.2 (6.7) (11) (30) LT borrowing 1, ST borrowing 2,166 2,441 2,959 3,314 Cash Current Investments Net Debt 3,188 2,956 3,101 3,295 Capital Employed 3,980 4,030 2,911 2,105 RoCE (%) (4.7) Source: Company data Fans will come in EESL but not an easy walk for competition as LED. This is because a super-efficient fan should be be not only power efficient but also give enough air. While LED offered low power consumption along with higher lumen, the win-win situation is not easily available in fans. Voltage requirement and airflow 51

52 Crompton Greaves Consumer Electricals, October 16, 2017 remain directly proportional. We will discuss the same in greater details in section below. Chart 18: Rural penetration of fans ~65% Rural Penetration of fans Source: Company data, I-Sec research Chart 20: Categories within the overall fan market Table, Pedestal and wall fan, 20% Domestic exhaust and industrial fan, 8% Ceiling fan, 72% Chart 19: Urban penetration of fans~90% Urban Penetration of fans Chart 21: Premium fan share on the rise Premium share of Crompton (%) Q3FY16 Q4FY16 Q1FY17 Q2FY17 Q3FY17 Q4FY17 Source: Company data, I-Sec research Fans can be broadly classified into three product categories, namely ceiling fans, table pedestal and wall fans (TPW), and domestic exhaust/industrial fans. In terms of prices, fans have been categorised into three segments - entry level (sub-economy, Rs1,100-Rs1,500), economy (Rs1,500-Rs2,000) and decorative (premium, above Rs2,000). Ceiling fans (72% of total market) are most widely used. Table, pedestal and wall fans (20% of total market) are mobile and used in places which require localised cooling. Domestic exhaust fans are used in kitchen and washrooms while industrial fans are used for directing air flow in various industrial processes. Together, domestic exhaust and industrial fans form 8% of the total fan market. Crompton is present in all three categories of fans. Around 60% of the fans supplied by Crompton are manufactured in-house while the rest 40% are outsourced from local suppliers. For the entire fan industry, the demand is largely met locally, with imports accounting for 8%-10%, mainly from China. 52

53 Crompton Greaves Consumer Electricals, October 16, 2017 Lighting: High on disruption, high on promise Chart 22: Lighting revenue and revenue growth Chart 23: Lighting revenue share of Crompton (%) 18,000 16,000 14,000 12,000 10,000 8,000 6,000 4,000 2,000 - FY10 FY11 Lighting Revenue (Rs mn) Lighting revenue growth (%, RHS) FY12 FY13 FY14 FY15 FY16 FY17 FY18E FY19E FY20E 20% 18% 16% 14% 12% 10% 8% 6% 4% 2% 0% 40% 35% 30% 25% 20% 15% 10% 5% 0% FY09 FY10 Lighting revenue share (%) FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18E FY19E FY20E Source: Company data We like the high entropy business model that the company has shown in the lighting segment and falls in line with the right to win philosophy of the company. Lighting segment contributes around 30% to the total revenue of Crompton. What stands out is the treatment of lighting business by the company. The company has put lighting as one of its key growth areas and its involvement in this segment has been the highest among all product categories, notwithstanding putting lighting as a different segment of business. Highlights of lighting business of Crompton In FY10, the company was first to indigenously produce a highly energy efficient light emitting diode (LED) lamp consuming just 5 watts of power. In Aug 10, the company developed and commercialised smart LED street lighting solutions along with selling an integrated package of the same. FY12 saw Crompton pushing hard to make inroads with LED lamps and street lighting. It did that successfully by: (i) selling over 40,000 LED street lighting units; and (ii) winning LED street lighting contract from the Government of Punjab for 9,500 units and (iii) winning another special project of putting up 1,500 LED-based luminaires across the River Sabarmati in Ahmedabad, Gujarat. Crompton acquired CFL business of Karma Industries at Baddi, Himachal Pradesh for Rs145mn in FY13 to double the CFL capacity. This is one of the rare acquisitions by the company in its last 7 years of history. Crompton entered a technology licensing agreement with Bridgelux in USA, one of the top LED chip manufacturing companies in India in FY13. Throughout the years, Crompton has engaged consistently to improve its presence in streetlights, automated control algorithms to control lightings, use of high power chips on board street lights and high bay lights driven by technology help from overseas technology partner. 53

54 Crompton Greaves Consumer Electricals, October 16, 2017 In FY16/17, Crompton actively participated in EESL tenders. In FY16, Crompton was awarded orders for 14 million LED lamps and LED street lights from Energy Efficiency Services Limited. In FY17, EESL supply was Rs770mn. The level of entropy in the lighting business is very high. From innovations in energy efficiency to the LED revolution to being operated as a different segment, Crompton has kept the highest engagement possible in the lighting segment. Crompton has also entered technological partnership with LED chip manufacturing company, aggressively participated in the EESL scheme and been active in the streetlight segment. The LED portfolio now accounts for almost 70% of the total lighting sales and 60% of the LED sales are in fixtures. 54

55 Crompton Greaves Consumer Electricals, October 16, 2017 Table 5: Year wise highlights of lighting business FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 -Number 2 position in -Number 2 position in Lighting Lighting -The lighting division was the first to launch a series of High Power Factor direct fit compact fluorescent lamps (CFL- DF). - First to indigenously produce a highly energy efficient light emitting diode (LED) lamp consuming just 5 watts of power. -Leadership in high intensity discharge lamps used for public lighting. -Number 2 position in Lighting -In FY11, lighting grew by over 16% compared to the previous year. New products accounted for over 18% of total lighting sales. -Leadership in high intensity discharge lamps used for public lighting. -CG s lighting business grew by 17% in FY2012, compared to an overall market growth of 12% resulting in the company increasing its overall market share. -The company undertook street lighting projects in Punjab and Gujarat, replacing high wattage halide lights with LED. The company took leadership position in LED luminaires. -FY12 saw the company pushing hard to make inroads with LED lamps and street lighting. It did that successfully: (i) by selling over 40,000 LED street lighting units; and (ii) by winning an LED street lighting contract from the government of Punjab for 9,500 units. The business won another special project -Lighting business grew by 13% against industry growth of 12% -The company acquired CFL business of Karma industries at Baddi, Himachal Pradesh for Rs145mn. This will double the capacity of the company in the CFL division CGs growth in rapidly growing products such as Compact Fluorescent Lamps (CFL), indoor commercial lighting and high mast have been 26%, 30% and 42% versus market growth of 18%, 22% and 15% The business holds an overall No. 3 position in the Indian market and leadership in high intensity discharge lamps used for public lighting, industrial lighting and floodlighting The lighting division grew over 17% versus an overall industry growth of 12%. The company ventured further into LED space among streetlights, homes and public buildings with the help of its foreign partner Company had mentioned a marketing comment in their annual report: "from generator to light bulb" The business holds an overall No. 3 position in the Indian market and leadership in high intensity discharge lamps used for public lighting, industrial lighting and floodlighting Lighting division grew by 7.4%, which was higher than industry. A total of 207 stock keeping units (SKUs) were launched during FY2015, mostly in LED based fixtures. Exclusive LED experience centers inaugurated at three locations. New product sale was 18% of total lighting and 36% of luminaires First year of separate business, the company is well poised to grow from Government schemes of LED like IPDS, DDUGY, UJALA, SLNP. A total of 375 products were launched in the year, based largely on LED technology. Exclusive LED experience centers were set up at 2 locations. The company was awarded orders for 14 million LED lamps and LED street lights from Energy Efficiency Services Limited. New product sales were 18% of total sales. "Go to market" program to enhance shopper experience conducted in South India, run in the lighting segment. The "go to market" program is aimed at improving product availability and visibility and gave positive results The market has been witnessing an accelerated shift to LED. LED lighting has grown by 50% last year, replacing CFL and HID. This was enabled in a big way by government procurement, through EESL programs, in LED lamps and streetlights. The cost improvements resulting from increased volumes were passed on to the EESL routed consumers as well as in direct market routes. EESL programs have been extended to LED battens, with corresponding benefits of volume and cost improvement. Multiple government programs are relevant for growth of this segment, especially for residential and outdoor applications. These include IPDS, DDUGJY, Unnat Jyoti for Affordable LEDs for All UJALA and Streetlight National Program SLNP. 55

56 Crompton Greaves Consumer Electricals, October 16, 2017 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 that of putting up 1,500 LED-based luminaires across the River Sabarmati in Ahmedabad, Gujarat. -Lighting division achieved 11% growth in fluorescent tubular lamps (FTL) against an industry de-growth of 3%. -The division is making serious efforts at popularising LED lamps, for private and government-sector applications. Source: Company data -Developing and commercialising smart LED street lighting solutions, with the first integrated package being sold in August In FY12, CG continued to enjoy industry leadership in high intensity discharge lamps used for public lighting. This business has taken a leadership position in LED luminaires, with the introduction of full range of down lighters, office lighting tiles and industrial luminaires apart from the already introduced outdoor range. The green initiative has led to the business having achieved the lowest consumption of mercury in the manufacturing of lamps at its integrated unit at Baroda. The company entered a technology licensing agreement with Bridgelux in USA, one of the top LED chip manufacturing companies in India Introduced patented smart street panels to automatically control illumination levels. First of its kind in India with features to reduce energy bill like daylight sensing and LED dimming integrated via an automated control algorithm. The company has been able to grow its LED business by four times that of market and introduced 180 SKUs of LED in the market in FY14. The company launched an LED flat panel luminaire in the branded category and gained 25% market share within first quarter of introduction CFL grew by 24% against a market growth of 15% to 16% due to enhancement of Baddi capacity. New products accounted for 17% of total sale of lighting and 24% of luminaires. It secured two large scale orders from infrastructure companies for street lighting Continuous development and cost optimisation led to CG bagging 5 million LED lamps and LED street lights orders under the government s drive on energy efficiency. CG s growth in LED based lighting products was in excess of 100%, versus a market growth of 45%. This growth was on account of the launch of new products and a continuous revamp of entire product portfolio in LED. The lighting and luminaires business generated cash of Rs440mn in FY15, up by 19% compared to the previous year. The company introduced high performance, aesthetic and highly energy efficient products like the Hawk series of streetlights and Pluto/ Neptune/Jupiter series of area/industrial lights. A comprehensive cost reduction program resulted in benefits of around 5% of sales. However, bulk of this benefit was passed on to consumers in the form of lower prices. While volumes for lamps increased significantly, total revenue remains lower due to the steep reduction in selling price. This price reduction journey is largely complete for LED lamps and is mid-way for LED panels and battens. Total EESL supply was Rs770mn. R&D efforts helped Crompton win major orders for various prestigious projects like Delhi Metro, Bengaluru Airport, Chennai Municipal and Tirumala Tirupati. -Some of the new products were colour changing LED lamps and battens, dimmable battens, high performance, aesthetic and energy efficient products with higher lumen in streetlight, floodlight and high bay series. 56

57 Crompton Greaves Consumer Electricals, October 16, 2017 Chart 24: Lighting market share of India Koninklijke Philips, 20.20% Others, 46.20% Surya Roshni, 11.60% Source: Company data Havells India, 5.90% Bajaj Electricals, 9.50% Crompton Greaves, 6.60% 50% of the lighting market is held by the leaders in organised market. The lighting revenue of Crompton has increased from ~Rs4.5bn in FY09 to Rs11.6bn in FY17. EBIT of the lighting segment has grown to ~Rs1bn in FY17. The share of LED has reached almost 70% of the lighting portfolio with 60% of the same being in fixtures as of FY17. Peer Analysis 1: Philips Lighting India- Market leader struggling with margins The declining margin of Philips India stands a testimony to the pressure witnessed by lighting companies in lieu of the falling prices of LED. Market leader in the lighting segment, the financials of the company underlines the extreme environment in the lighting industry. The lighting revenue increased by 6.5% in FY15 followed by a decline of 3.5% in FY16 and almost flat in FY17. EBIT margins declined from ~10% in FY15 to ~6% in FY17. This apparent weakness or decline has been accompanied by tremendous growth in LED business. In three years, the LED share of lighting business has increased from 28% in FY15 to 55% in FY17. Table 6: Lighting business highlight of Phillips India (Rs mn) FY14 FY15 FY16 FY17 Sales 32,410 34,488 33,275 33,270 Sales Growth (%) 6.5% -3.5% 0.0% Gross Margin 12,899 12,841 12,537 GM (%) 37.4% 38.6% 37.7% EBIT 2,515 3,502 3,862 1,957 EBIT (%) 7.8% 10.2% 11.6% 5.9% Source: Company data The decline in EBIT margins of Philips reflects the high price erosion which took place as LED gained market share. Going ahead, we expect value recovery in LEDs. 57

58 Crompton Greaves Consumer Electricals, October 16, 2017 Table 7: Highlights of Phillips India lighting over the years Philips India Philips India Philips Lighting India Philips Lighting India Year of disruptive transformation at its peak. There was a rapid decline in conventional lighting for the "Go to market strategy was The Lighting Sector of Phillips India first time in recent history. The LED based sales grew by 17.9% announced for consumer lifestyle grew by 7.2 % for the FY15. conventional lamps business on a comparable basis. segment. has witnessed de-growth of % that was offset by a strong growth in LED lamps and drivers by 73.3%. The growth was driven mainly by aggressive LED penetration across business, increasing company s share of the lighting business to 27.6%, reach expansion in semi-urban market, increasing retail presence through Light Lounges and Light Shops and by driving LED installations in the Professional Segment. Professional Lighting Solutions witnessed growth of 14.2%. The LED growth has been significantly higher than projection and LED contribution in Professional Lighting Solutions business now stands at 64%. The Home lighting business continued the growth momentum during the financial with 11% growth. Growth in Light Sources business was driven by strong performance in LED lamps followed by Switches and LED Systems. The growth in LED business adversely impacted the conventional business, resulting in an overall growth of 4.6%. Lighting sector of the company grew by 1.0 % for the 10 month period ending January 31, 2016, over the corresponding period of the previous financial year. LED business share of Lighting business reached to 36%. Professional Lighting Solutions witnessed growth of 3.6%. The home lighting business continued the growth momentum during the financial year with 11.7% growth. The light sources business has witnessed slight de-growth of - 2.2%. Strong growth in LED lamps and drivers by 68% offset by faster decline in conventional Lamps business. This adverse impact is due to growing awareness on LED augmented by the drive by government to support the conversion to LED lamps through UJALA program. Demerger of Philips India Lighting. Entry of connected lighting systems for homes as well as professional customers. LED share increased from 27.5% to 38.4% Professional Lighting Solutions witnessed growth of 4.9 % driven by strong growth in LED across segments Company s LED contribution in Professional Lighting Solutions business now stands at 71.8% compared to 64% last year. -Introduction of new offerings in connected lighting and system & services, -The home lighting business continued the growth momentum during the financial year with 15.5% growth. This impressive growth was driven by strong LED penetration, continuous expansion of locally relevant portfolio, strong growth in sales of low cost downlights % growth in home lighting business; led by strong LED penetration, continuous expansion of locally relevant portfolio and significant growth in sales of low cost down lighter category across homes. The company also introduced a new range of Philips Hue White Ambiance, personalised smart lighting system for homes Innovative products like Stellar Bright 2-1 LED bulb, Linear LED bulb and Astrasleek LED batten. Conventional lamp business declined by 29.1%. LED share increased from 37.4% to 55.4%. Net promoter score improved in FY17. This is a metric for measuring the customer satisfaction. Established R&D in Noida, Bangalore continues to help innovation. Addition of 19 branded stores across India. Professional lighting grew by 14.3%, LED within professional segment increased from 69% to 74%. 79% growth in recently launched modular switches. Rs223mn impairment on account of faster than expected technology change affecting traditional lighting produced from Factories at Vadodara and Mohali. Source: Company data Gives 2.9% revenue to net parent company. 58

59 Crompton Greaves Consumer Electricals, October 16, 2017 Peer Analysis 2: Surya Roshni (SRN) Held fort despite decline in margins Lower LED share has led to SRN reporting lower decline in lighting margins The performance of SRN has been steady over the last 5-7 years, with lighting revenue and EBIT clocking 13%/10% CAGR. Like other players in the business, the company benefitted from foray into new businesses like fans and appliances. With the benefits of an existing distribution network, the company has gained entry into fans/appliances. That the company could not manage to improve margins, despite the entire LED saga being played out highlight the muted profitability of LED business, especially led by Government procurement programs. One of the noticeable trends of SRN has been the declining margins of lighting business, from ~11% in FY10 to ~9% in FY16/17. This is in fact similar to the point we discussed for Phillips. Yet, the decline in margins is lower for SRN because of relative lower share of LED (33%) in its lighting portfolio. Chart 25: Lighting margins have declined (Rs mn) Lighting Revenue -Lighting EBIT Margin (%) 16,000 14,000 12,000 10,000 8,000 6,000 4,000 2, Chart 26: Sharp increase in fan sales (Nos) 1,600,000 1,400,000 1,200,000 1,000, , , , ,000 0 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY FY14 FY15 FY16 Source: Company data SRN has been one of the first players in the India s lighting industry. Apart from lighting business, the company has a large steel tube business. The company has always highlighted that it is the only lighting company in India with 100% backward integration. The company has actively adapted to technology changes; be it the CFL in 2010 or LED in 2013 and has traditionally been involved in supplying orders for Luminaires / HID Lamps& High Masts to the government. The company also has a dedicated R&D center in Noida for carrying out research. The company had focus on manufacturing of High Mast Towers, Octagonal street lights and other innovative lamps. The company started LED product line in The company targets to achieve Rs2.6bn of fan revenues in FY17, out of which Rs600mn will be from Government orders The company ventured into fan business in This is an extremely relevant example which suggests the strength of a distribution network in consumer electricals. The company could generate Rs1300mn of business from fans within 2 years of operation and is targeting Rs4bn in four years. The company targets to achieve Rs2.6bn of fan revenues in FY17, out of which Rs600mn will be from Government orders. Also started in 2014, the company expects appliance business to generate Rs1bn revenue in FY17. The LED revenue of Surya despite increasing remains a minority, contributing only Rs3bn or 23% to the total revenue in the lighting business. 59

60 Crompton Greaves Consumer Electricals, October 16, 2017 Besides turning to fan/appliance segment for growth, one of the noticeable trends of the SRN has been the declining margins of lighting business, from ~11% in FY10 to ~9% in FY16/17. Government orders of LED have at best been margin neutral. LED business consisted of ~30% of total lighting revenue in CY15 and government orders contribute almost 50% to the same. Overall RoCEs have however improved with better working capital management. Table 8: Landmarks of SRN business Year Highlights 1973 Setting up a steel plant in Bahadurgarh 1980 Galvanizing plant 1984 Setting up of lighting plant at Kashipur 1989 HPSVL and energy-efficient 26mm FTL production began 1991 Production of CR Strips 1992 Setting up of second lighting plant at Gwalior (M.P), production of fluorescent powder filament for GLS and FTL commenced New modern glass plant 1998 Asia's largest ribbon glass plant started with annual capacity of 400 million GLS and 25 million FTL shell 2006 Installed capacity of CFL of 1 million units per month 2009 PVC plant New world class pipe unit in Associate Co. Bhuj, Gujarat 2010 Setting up of high mast plant at Gwalior (M.P) 2012 Technology & Innovation Centre at Noida 2014 Launch of fans and appliances 2015 Launch of Surya Home Appliances 2016 Commissioning of New Steel Pipe Plant at Hindupur (A.P.) Source: Company data Chart 27: LED share has grown steadily 30% 25% 20% 15% 10% 5% 0% CY11 CY12 CY13 CY14 CY15 Table 9: Highlights of SRN business trajectory over the years Industry--- CFL segment grew by 25%, GLS by 4% and FTL by 9%. Luminaire business group now had more than 500 dealers. Launch of fans in Jan'14. Strived to reach Rs5bn revenue in LED segment in next three years Scaling up LED, with turnover of Rs3bn. Company surpassed the same---cfl grew by 31%, GLS 10% and FTL 16%. Lighting industry was pegged at Rs80bn. Luminaire business group had a dealer count of 425. Source: Company data Products launched include----led Street Lights and LED tube-lights. -LED Tube Lights. -Induction Light for Petrol Pumps. -Induction Light and sensor controlled streetlights. Company becomes the second largest lighting company with 25% market share The Luminaire business flourished due to improvement in establishing industry & government business oriented dealers in SURYA branded products. LBG was on the threshold of taking a quantum leap in the non-trade business segment in the year Manufactures all its lighting components. Lighting market share > 25%. Strive to reach Rs4bn of fan revenue in four years. During the year, Surya also added home appliances business by introducing heating products like water heaters, heat convectors immersion rods in the month of October and subsequently added irons and mixers. These products were accepted with great enthusiasm by the trade and company set a target of Rs2bn sales in next 2 to 3 years. Fan revenue crossed Rs1.3bn. Home appliances grew to Rs300mn. Company expects LED business to grow at a CAGR of 17% till 2020 In FY16, SRN was awarded orders worth ~Rs1.55bn for supply of LED bulbs, street lights and other lighting products from EESL and other PSUs including NTPC & BPCL which includes orders for supply of 8.6 million LED Bulbs under DELP. 60

61 Crompton Greaves Consumer Electricals, October 16, 2017 Peer Analysis 3: Eveready New player in the LED business The operations started in India through import of dry cell batteries and then marketing the same across major cities. This led to setting up of manufacturing facilities and a distribution network across India. Subsequently, this manufacturing presence was integrated forward into the manufacture and marketing of flashlights, a device category consuming battery. Over time, the company evolved into the largest dry cell battery player in India with a market share of 50% and a very dominant flashlight player with 76% share in the market. Eveready has been a serious participant in EESL. In FY17, it managed to service EESL orders worth Rs465mn compared to Rs777mn of Crompton. Lighting foray: Eveready entered in the lighting products market with CFLs in 2007 and then GLS lamps in The company had big plans in this segment. There was widespread acknowledgement about the risks posed by LED in the lighting business. However, the company rightly knew that there would be a time gap before LED could provide meaningful competition to CFL. In need of scale and expansion, the company added more electrical lighting products in The strategy has remained to be present in all lighting products, evolving in line with innovations. The lower margin CFL bulbs now form a small percentage of the category. LED bulbs and LED based Luminaires with higher margins now constitute more than 70% of the category turnover. In order to make a meaningful range offering to the market, more products are being added to the portfolio. These include professional luminaires like streetlights, floodlights, downlights, spotlights and panels apart from the existing portfolio of LED bulbs, luminaires and electrical appliances. Growth drivers remain twofold for Eveready: The company has a focus on LED business, trying to increase the brand offering in this segment by developing an extensive line of home, professional, and infrastructural lighting solutions for homes, offices, industries, showrooms and road lighting. The company is also proactively bidding in the UJALA scheme. The company executed government orders worth Rs465mn in FY17. It wants to aggressively pursue government business. Apart from LED, the company wants to consolidate its distribution network and grow the consumer appliances business. While the flashlight and battery business remains the core business offering. Eveready has 12.5mn pieces flashlight making capacity and 2.3mn battery making capacity. The company also has significant rural marketing activity in more than 50 rural mela s to promote and directly expose Eveready product range to the end consumers. Other initiatives included publicising through wall paintings across villages and regular Haat and Chaupal activities. This is another company which has benefitted from a distribution network and a recallable brand among consumers. 61

62 Crompton Greaves Consumer Electricals, October 16, 2017 Chart 28: Business verticals of Eveready and distribution network 50%+ Market share in the Indian dry cell battery segment 18 Sales office branches across India 75%+ Market share in the Indian organised flashlights market 4,000+ Distributor network 3.2mn+ Outlets store Everyday s products 42+ Distribution network 1mn+ Outlets are serviced by our network 1,000+ Van servicing retailers Chart 29: Revenue split of Eveready Small home appliances, 3 Packet tea, 5 Lighting and electricals, 21 Flashlights, 14 Batteries, 57 The consumer appliance division of the company is currently into 21 product offerings under an asset light model wherein the vertical operates through outsourced products from China and India (domestic vendors) in a 40:60 ratio. Source: Company data Consumer appliances are a growth area for Eveready: The company currently is into 21 product offerings under an asset light model wherein the vertical operates through outsourced products from China and India (domestic vendors) in a 40:60 ratio. Eveready appliances are available in general trade, modern trade as well as e-commerce platforms across India. Eveready is present in almost all large format stores (LFR) like hyper city, D-Mart, Spencer, among others along with Cash & Carry operators (Metro Cash & Carry and Walmart). The company provides two year warranty on these products. Distribution strength reinvigorated with higher lighting revenue. The company employs dedicated teams for trade, modern retail and institutional sales, so that they can increase the sales volume in a focused manner. Eveready focused on concentrating more on institutional sales and electronic OEMs to increase volumes. It also pursued replenishment demand in hotels, offices, hospitals and restaurants. 62

63 Crompton Greaves Consumer Electricals, October 16, 2017 Eveready has improved its performance significantly from the lows of FY12. To give a perspective as amply illustrated by the charts below, the EBITDA margins have improved from ~4% in FY12 to ~10% in FY17. Looking at change agents, one could find the entire proposition of the company to add LED and consumer appliances as key landmark positive events for the company. Electrical products (lights + LED+ appliances) revenue share increased from 8% in FY10 to 24% in FY17. Here is a classic example of a company with core product offerings being unique (battery and flashlights), benefitting from the entire LED wave. The distribution network was a big strength of the company which enabled it to monetise the LED opportunity. Asset light model of operation further provided an easy growth opportunity. Asset turnover increased from 1.1 in FY10 to 2.7 in FY17. EBITDA/EBIT margins have improved from 4%/2.5% in FY12 to ~10% in FY17. Adjusted RoE/RoCEs increased from 8%/11% in FY13 to 33%/25% in FY17. Table 10: Financial highlights of Eveready FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 Comments Asset Turnover Increased with asset light LED/appliances business Payable Days Decreased Inventory Days Unchanged Receivable Days RoE 21.9 (2.4) Asset turnover driven increase in returns RoCE Asset turnover driven increase in returns Net Debt 3,144 3,146 3,648 2,716 2,239 2,212 1,932 2,104 Electrical product (%) New business- LED and appliances EBITDA Margins (%) EBIT Margins (%) PAT Margins (%) (1.0) Source: Company data, I-Sec research 63

64 Crompton Greaves Consumer Electricals, October 16, 2017 Pumps: High growth potential Chart 30: Pumps revenue and revenue growth Chart 31: Pumps revenue share of Crompton (%) 12,000 10,000 8,000 6,000 4,000 2,000 - FY10 FY11 Pump revenue (Rs mn) Pump revenue growth (%, RHS) FY12 FY13 FY14 FY15 FY16 FY17 FY18E FY19E FY20E 45% 40% 35% 30% 25% 20% 15% 10% 5% 0% -5% -10% 30% 25% 20% 15% 10% 5% 0% FY09 FY10 Pumps revenue share (%) FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18E FY19E FY20E Source: Company data Crompton has consistently outgrown the overall pump market Crompton is a leader in the domestic residential pump category in India and has managed to increase its revenue from Rs2.6bn in FY08 to ~Rs7bn in FY17. Like in the fan segment, Crompton has managed to outperform the industry in this segment. Chart 32: Crompton has outperformed the overall pump market growth in India Growth in Pump market (%) (5) (10) (15) Source: Company data Crompton growth (%) Industry growth(%) FY10 FY11 FY12 FY13 FY14 FY15 Crompton engaged in active marketing in the pump segment which highlights the prominent features of the product offering as shown below. Residential print ad campaign: It mentions that the pump can be used to pull water up to 55meteres high, self-priming capacity of 8 meters, 180V to 240V range of operations and throughput capability of 4300lts/hour. The pumps range from 0.25HP to 2HP. 64

65 Crompton Greaves Consumer Electricals, October 16, 2017 Chart 33: Residential pump ad Chart 34: Agricultural Pumps ad Source: Company data 65