Crompton Greaves - Turnaround strategy - pieces falling in place - IDFC

We recently visited Crompton Greaves's (Crompton) plants in Hungary and Spain and also interacted with the senior management. Key takeaways:

- The ongoing restructuring, involving reduction of Belgium operations and scale-up of the Hungary plant, is on track for completion by Dec-12. Lower labour cost (Hungary is 7x cheaper than Belgium) and operating leverage (100% utilization) would drive a turnaround. Crompton has qualifications with large European utilities as part of the scale-up of the Hungary plant.

- ZIV, a strategic fit: Europe's smart metering drive (237m more meters to be installed by 2020) and smart-grid investments would increase Automation revenues to EUR200m by FY15 from EUR110m. Newly acquired ZIV, expected to drive 75% of segment revenues, seems a strategic fit. However, margins are at risk due to expensing of R&D outlay as against capitalization earlier.

- The domestic business is expected to remain steady, with order inflows and a favourable competitive landscape driving stable margins in both Industrials and Power. Sourcing initiatives, improved offerings and geographical expansion (particularly in Industrials) would drive long-term growth.

- Near-term risks: Restructuring costs (liquidated damages can be triggered due to delays), which are likely to peak in 4Q13, and continued losses in Canada. Amid persistent macro concerns for ordering activity and pricing pressure, the Crompton management outlined its strategy to improve long-term profits and competitiveness with a slew of measures, including higher efficiencies, low-cost sourcing and rationalizing manufacturing footprint. A large part of the benefits is likely to accrue in 2HFY14E-FY15, implying volatility in earnings in the near term. With the stock trading at 13.2x FY13E PE and given potential volatility in earnings, we maintain our Neutral rating.