Crompton Greaves Consumer Electricals has been doing well but there is a tightrope walk ahead

After taking Racold to the top position in the water heaters space in just three years as the company’s managing director, Mathew Job was set for the next adventure. Only this time, the stakes were higher. From managing a Rs.5-billion company, he was asked to lead the then Rs.10-billion Crompton Greaves Consumer Electricals (CGCE) along with MD Shantanu Khosla.

The two joined in 2015, when the company was in the middle of a management reboot. The consumer electrical business had been demerged and sold to Advent International and Temasek, by the Avantha Group to repay debt. It wasn’t difficult to sell. The electricals vertical, then the undisputed leader in fans and residential pumps, had been contributing one-fifth of Avantha’s revenue. And it has kept growing. While revenue went from Rs.39.2 billion in FY17 to Rs.45.11 billion in FY20, net profit went up from Rs.2.83 billion to Rs.4.94 billion (See: Steady current).

When CEO Job started his stint, his priority was clear. “Until a few years before the demerger, the consumer electrical business was underinvested in,” he says. Therefore, he focused on improving profitability and creating a cash chest, to reinvest in the business.

The first thing he tackled was the distribution network, which was not very well organised. Earlier, distributors would hold inventories based on margins, discounts and schemes offered to them. This practice was done away with and the pricing structure was streamlined. Every channel partner was now offered margins giving him competitive return on his investments. This was to shift the focus of the distributor from ‘negotiating prices on volume deals’ to making the right assortment of products available at every store. “This was a part of our Go-to-Market transformation; to make the company’s products available wherever and whenever the consumer wanted to buy them,” says Job.

Also, earlier, every distributor could service any locality and retailers could buy from any of them. Now, these overlaps have been done away with. Every distributor has an allocated area, and the company prefers distributors with larger coverage and access to more retail touch points. Besides that, to closely track demand, the company now mines consumer data collected via the distributor network.

A tighter-run distribution network and better clarity on consumer demand allow the company to do more targeted advertising, thus saving on cost. For example, in rural areas, they are using mobile van advertising, which is essentially a van carrying a catchy billboard through different localities. Or placing display boards at shops that are frequented. “Jo dikhta hai woh bikhta hai,” says Job. During the Q4FY20 earnings call, Khosla said that this close tracking of secondary sales (at distributor level) and digitising data helped “significantly” in ramping up businesses in different verticals in May.

Running a tight ship
As part of its drive to control costs, CGCE has been using a mix of manufacturing in-house and outsourcing: about 40% of the fans, 50% of lights and more than 50% of appliances are outsourced. Overall, Job notes, the ratio is 50:50. “The decision to manufacture in-house or outsource depends on the capex and RoCE that the product segment gives,” says Nilesh Bhaiya, VP-research, institutional equities, Motilal Oswal Financial Services (MOFS). It has served them well so far. “The asset-light business model gives them higher return ratios,” says Ansuman Deb, AVP, ICICI Securities. Even MOFS’ report predicts the company’s Ebitda margin will expand by 80 basis points over FY20-22 (See: Make and buy).  However, does that high margin come at the cost of product quality?

Bhaiya says quality control is less of an issue at CGCE. “The company has been a legacy brand with more than 50 years of experience in their respective top categories. They select their suppliers and manufacturing partners accordingly,” he says. According to him, they have only been outsourcing manufacturing of products in ‘newer’ verticals of appliances and lights, a strategy any company would employ. “Once it is able to gain a certain level of return and revenue, only then they shift to manufacturing in-house,” he says.

While fat is being trimmed where possible, muscle is being added to research and development. The expenditure on R&D was around Rs.181 million in FY20, compared to Rs.5 million in FY16. Over the past five years, the company has launched several innovative products across categories and price points. This includes IoT and AI enabled fans, anti-dust fans, anti-bacterial LED lights and even coolers that are 60% more efficient. The company recently came out with its super premium silent-pro fans with plastic-like bodies, for better air circulation and energy efficiency. Super premium products are priced above Rs.4,000, while premium is above Rs.2,500 and economy above Rs.1,200.

Its bet on innovation is paying off, particularly in fans, where it is a market leader. “Anti-dust fans have seen very good response. Other brands, too, have come in but still a majority of anti-dust fan sales are happening through Crompton. Obviously, since the base is smaller, there is more room to grow,” says Bhaiya. This new offering is part of the premium segment, in which the company has grown its market share to 20% from 7%, four years ago. This anti-dust segment now contributes 30% of the company’s fans revenue, a significant increase from 10%, four years ago.

Another segment that the company leads in is the residential pumps category. Earlier, they were focused on premium-priced pumps. But, over the past two years, the company has introduced a mini pump range called Mini Crest in the economy segment. They began this line in 2018, when they started losing market share to unorganised players with low-cost products. With the new line, they have regained their pole position with 28% market share.

While analysts are impressed by the way the company has managed to maintain its stronghold with newer products in existing verticals, they are concerned that the focus still remains on fans and pumps. As of FY19, fans contribute the most to the topline with 43%, followed by lighting, pumps and appliances (See: What’s fanning growth?). “They have a fabulous brand and that’s a major strength but fans and pumps are saturated now… Success of new segments like mixer-grinders and appliances will chart the future growth for Crompton,” says Deb.

Naveen Trivedi, AVP-institutional equity, HDFC Securities, too, believes CGCE needs to diversify but for a different reason. “Contribution from smaller appliances and other products need to be higher, so that they can shift their dependency from seasonal products to some extent,” says Trivedi. Seasonal products such as fans and coolers see peak sales during summer, and water heaters during winter. He adds, “Earlier, these companies were keeping SKUs that were selling faster, now they have to create futuristic products, where the consumer will aspire to buy them and relate to the brand appeal.” The company, too, is aiming to appeal to a younger, aspirational crowd, and its products such as SilentPro and remote-controlled Duratech fans are an attempt at that. All said and done, the company has to manage this transition carefully. “Otherwise, if the management tries to enter too many segments at once, even that will be viewed as a problem,” says Bhaiya.

Job believes there is a deeper, untapped opportunity in fans and pumps. “These categories (fans and pumps) are showing consistent growth. Although we are market leaders, the share is still between 27-28%... Our premium mix can grow further,” he says. The company is also eyeing markets such as MP, Chhattisgarh, Bihar and Jharkhand, where they are not the No.1 player. He has plans to expand the company’s kitchen appliances segment and launch a line in the health and wellness segment, too. “We want to have at least four major innovations every year,” he says.

Tough cookie
When the pandemic struck and the lockdown was announced, sales in the consumer electricals industry fell by 45-50%. While other companies chose to clear their inventory with deep discounting, Job and his team tried a contrarian route. “We felt dropping prices won’t create demand. This would have been counter-productive especially in regions where demand was already very low,” he says. Interestingly, their TPW (table-top, pedestal and wall) fans, saw an unexpected increase in demand from hospitals and containment centres since these fans can be easily moved about.

CGCE also managed to save around Rs.600 million-900 million, not by laying off employees but by restructuring costs. A significant step was reducing ad spends which were brought down to Rs.20 million (0.3% of sales) from Rs.450 million (3.3% of sales) last year. It is expected to increase once demand recovers. During the last earnings call, Job mentioned that their cash reserve of Rs.5.85 billion helped them support their vendor partners through this crisis, by extending credit to them.

Even though, a large part of the cost control measures such as ad spends may not be recurring, Bhaiya has a ‘buy’ rating on the stock with price target of Rs.285. CGCE trades at 27.9x FY22 earnings, while peers such as V-Guard and Havells are trading at 37.2x and 40x, respectively. Bhaiya feels CGCE is undervalued. “CGCE’s Ebitda and earnings growth have been better than peers. Free cash flow generation, net profit and capacity growth have also been better. On FY22 basis, there is 40% difference between Havells and CGCE’s valuations. This should come down to 25%,” he explains.

However, ICICI Securities’ Deb says, “Because of a large product portfolio range and being an even larger company, Havells has got higher multiples.” V-Guard, too, fares better by this measure, since their products are in underpenetrated categories compared to CGCE’s fans and pumps stronghold. V-Guard is predominantly present in southern India and is trying to replicate that model pan-India, whereas CGCE is already a national brand. Bhaiya counters, “In the past two-three years, V-Guard’s execution hasn’t been that great. They have not been able to ramp up as per expectations although management quality is very good.”

CGCE may have played all its cards but with its commitment to innovation, it has some aces up its sleeve. With consumer insights gathered from its efficient distribution network, this innovation engine should take the company much further.