Back On Home Grid

At a time when plans were afoot to set up a National Power Grid, Crompton Greaves was looking to spread its wings overseas. A Rs.2,000-crore enterprise at that time, the Gautam Thapar-led company manufactured transformers upto 400kV. In 2005, it acquired Belgium-based Pauwels Group for €32.1 million, thereby getting access to technology upto 525kV, placing itself among the top 10 transformer companies.

Europe around this time was looking to improve cross-border inter-connectivity, increase competition, bring down costs and increase the share of renewables, so that’s where Crompton focused. It bought Hungary-based Ganz in 2006 for €35 million. The deal gave it access to EHV transformers technology of upto 1200kV, for 12 MW motors and GIS substations. 

With investors cheering its acquisitions, Crompton’s stock rose nearly 5x between 2005-06. Spurred, it began entering new businesses such as EPC power systems, automation and maintenance services. The plan was to become a fully integrated global power systems player, with capability to provide solutions in all power transmission segments. Between 2007-2008, the company acquired Microsol (Ireland, USA and UK; sub-station automation), Sonomatra (France; on-site maintenance/repair of power transformers and on-load tap changers, oil analysis, oil treatment and retrofilling) and MSE Power Systems (US; EPC player in high-voltage electric power systems). 

Not satiated, the company resumed its buying spree after a year’s hiatus. Between 2010-2012, the company acquired PTS (UK; consulting, technical and engineering support), Emotron (Sweden; drives), QEI (USA; automation for electric utilities and electrified transit) and ZIV (Spain, Germany, USA, UK and France; smart-grid and grid automation). Considering its expanding footprint, Crompton set up a holding company – CG International BV (CGIBV) – in Netherlands for its international operations. CGIBV’s net profit grew 32% CAGR over a 5 year-period (FY06-11). Towards end-FY11, the parent’s stock price reached an all-time high of Rs.342, 14x more than what it was trading in CY05. 

Shrinking pie
Crompton’s star performer, however, faltered in FY12. It started incurring losses and draining the parent’s cash. Increasing competition from Korean and Chinese players started eating into its domestic and global margins. Rising raw material prices only added to the woes. CGIBV’s operating margin fell from 10.6% in FY11 to 1.4% in FY12. On a standalone business, the company’s operating margin dropped from 16.4% in FY11 to 11.6% in FY12. 

Meanwhile, Crompton’s overseas T&D power business – CG Power Systems – was facing a headwind as well. Several customers in North America and Europe were not taking delivery of their transformer or sub-stations due to economic uncertainties and their own cash problems. This not only extended the working capital cycle, but also led to a pile up at its factory. Further, certain orders needed to be re-worked, which blocked production lines, adding to costs. In FY12, CGIBV’s operating EBITDA was down 84% to Rs.68 crore. By the end of FY12, the stock had corrected 60% from its all-time high.

The slump continued in FY13 and re-work costs at the end of 4QFY13 stood at Rs.55 crore. A little before, in 3QFY13, the management initiated restructuring of its overseas business to address operational issues. Once it realised that the Tapioszele plant in Hungary was more cost-efficient that its Mechelen plant in Belgium (the minimum wage in Belgium is the second highest in the world after Luxembourg), Crompton laid off 200 employees at the latter. It had to pay Rs.121 crore as one-time cost for this besides incurring Rs.108 crore as incidental costs to transfer transformers from Belgium to Hungary.

While the move helped and CGIBV’s losses contracted to Rs.2 crore in FY14 (the stock also gained 15% during the year), internal and external pressure continued. Intense competition kept a lid on pricing while customers continued to defer taking physical delivery. Besides, there was added stress on working capital as customers wanted at least one of their units to be short-circuit tested. The test meant sending transformers to external laboratories, bringing them back, re-assembling them and then shipping them. Meanwhile, re-work issues continued overseas.

The operational difficulties continued in FY15 too. Its losses had widened to Rs.38 crore overseas as its plants in Hungary, Belgium and Canada continued to incur losses. The European excursion was not working. On a consolidated basis, Crompton’s return on equity had declined from a high of 39% in FY06 to 5.5% in FY15. 

With no signs of improvement, the company’s recent announcement that it would be selling its loss-making T&D business to private equity investor First Reserve for €115 million (Rs.850 crore) has provided some respite. Crompton’s consolidated debt at the end of Q3FY16 was Rs.900 crore. Of this, €84 million or Rs.620 crore is on the books of the international assets that are being sold. However, the debt will not be taken over by First Reserve. The way this deal has been structured, Crompton will get €85 million (Rs.627 crore) on the closure of the deal and balance €30 million (Rs.223 crore) over an 18-month period. The management has indicated that it will settle the Rs.500-crore long-term debt with the money, and take a call on working capital debt later. 

While the sale essentially means that Crompton would lose out on €525 million of revenue, it shouldn’t pinch shareholders much as the company would end up avoiding Rs.93 crore of EBITDA loss & depreciation of Rs.112 crore respectively. “A total of Rs.277 crore will be saved by doing this deal. Additionally, the capital that we will get will help reduce debt,” Madhav Acharya, CFO at Crompton Greaves, said during a recent analyst call. 

“There is no issue with the strategy. They were making losses in European and North American geographies and exiting these businesses is the right way forward for the company,” says Misal Singh, director, institutional equities, Religare Capital Markets. By using this money to de-leverage its books, analysts believe Crompton can finally turn around operations. Analysts at Edelweiss estimate the return on adjusted equity to go up to 7.6% in FY17 and 14.8% in FY18. “It will help them to a great extent to deleverage their books and focus on growth possibilities here,” adds Tarang Bhanushali, assistant vice-president, research, IIFL. 

Post the sale, Crompton will be left with the India T&D business, ZIV’s automation business and Emotron’s drives business. The management though has already said it intends to sell the automation business by FY17, but retain the Emotron business as it will help its Indian drives arm augment its technology.

Upgrade needed
Technology is the only catch that Crompton faces post the sale. “During the last cycle, Ganz and Pauwels’ portfolio helped Crompton get a lot of 765kV orders, but 765kV is getting commoditised and becoming a low-margin business,” says Amit Mahawar, vice president, institutional equities research, Edelweiss.

Analysts believe that Crompton would need to upgrade its technical capabilities and offer higher-end products if it wants to improve its domestic margin. In FY15, CG Power India’s EBITDA margin stood at 9.7%. As an analyst puts it, “Without higher technology, the power business is almost akin to a commodity business, where you need high volumes to survive.” 

Even though Crompton is a dominant player in traditional power-transformation products such as distribution and power transformers, it lacks technologies for high-end and high-margin grid products (GIS-400kV-765kV, static var compensators, Statcoms, wide area management system, and fixed-series compensators). Many of these products are used to improve grid stability, given the growing share of renewable energy power projects in India coupled with bunched up additions of conventional power capacity.

However, if Crompton can get its product portfolio right, the power business can be a strong growth driver. Analysts believe the company should tie-up with technologically advanced Korean or Japanese manufacturers. As Crompton has a strong presence in India, it is pre-qualified to bid for Power Grid tenders. A tie-up can thus help Japanese and Korean players, who are yet to foray into India, proving to be mutually beneficial.  

“In India, we are seeing a lot of demand for new technology like HVDC (high-voltage direct current), UHV (1200kV), high-end GIS, etc. Only a select few companies have the capability to deliver this technology, so Crompton Greaves will have to tie-up with Japanese or Korean OEMs who have this technology as the big players ABB, Siemens and Alstom are unlikely to enter into a technology-sharing tie-up. You need to be in niche technologies for higher margins,” adds Mahawar. 

Meanwhile, its industrial business (motors and drives) is likely to be a steady performer. “They have a dominant position in low-tension motors. The industrial business is a double-digit margin business and will grow as capex goes up in the next two to three years. This segment should grow anywhere between 15-20%,” says Mahawar. The business reported a 5.4% growth in EBITDA to Rs.180 crore in FY15 and return on capital employed increased by 220 basis points to 15.7%. 

Crompton’s stock is currently trading at 13x FY18 estimated earnings. The domestic power business is expected to report a topline growth of 5% and profit growth of 26% over FY16-FY18, while the industrial business is likely to report a topline growth of 10% and profit growth of 19% over the same period. With most of the debt getting off-loaded post the deal and considering the government’s thrust on power capex, Crompton’s clean books may help it command a higher valuation once potential write-offs (Rs.1,400 crore of loans and advances given to subsidiaries) are dealt with.