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BLUE STAR LTD
RECOMMENDATION: ACCUMULATE
TARGET PRICE: RS.448
FY12E P/E: 17X
q Numbers are lower than expectations as sedate revenue booking in Central
Airconditioning segment fails to offset the fixed costs resulting in
margin compression.
q Order intake remains anaemic, a reflection of continuing subdued activity
in commercial real estate.
q The company is consolidating its product offering in the domestic market
by acquiring businesses that bring in complementary competencies. It
has recently finalized acquisition of DS Gupta constructions which will
enable it to bundle fire-fighting and plumbing solutions with the
company's central AC systems. A good strategic move, we opine. While
the company is making the right moves, growth in the near-term remains
challenging.
q The disappointing 3Q numbers has resulted in a downward revision in
earnings. We expect stock to remain weak in near-term. Maintain Accumulate
with a revised target price of Rs 448 (Rs 500 earlier).
After a decent H1, revenue growth loses momentum in 3Q which
is a disappointment and indicative of the continued weakness in
commercial real estate activity
n For the third quarter, net sales were flat on a yoy basis but down on a qoq basis.
Segment-wise, the Central Airconditioning (CAC) segment registered a degrowth
of 6% yoy, which was quite contrary to expectations since this segment had
grown at a healthy pace in the H1 FY11. This line of business comprises the
central airconditioning, packaged airconditioning and electrical contracting business,
collectively called Electro Mechanical Projects and Packaged
Airconditioning Systems
n This segment is project based and continuing slackness in commercial real estate
development is reflecting in moderation in execution momentum. In view of the
existing oversupply, user segments like Offices and IT developers have either deferred
or slowed down their plans to increase capacity.
n As the traditional lines of user segments like IT and Retail have slowed down,
Blue Star has enhanced its exposure to infrastructure (Electrical), healthcare, hospitality
and education segments. The Company is receiving orders from power
project companies such as Siemens and ABB for their airconditioning requirements.
n The cooling products business comprises room airconditioners and refrigeration
products and systems. This segment grew 34% yoy in the third quarter, thus
maintaining the growth momentum of previous quarters.
n The cooling products segment also includes the cold chain equipment, which has
vast growth potential considering the sheer magnitude of agri-produce that is
wasted due to lack of proper storage facilities. Blue Star is working with various
industry bodies to improve the viability of cold chain. It is expected that to handle
15% of fruits and vegetables in a time span of 3-4 years, an investment of Rs
150 bn would be required.
n The professional electronics business posted a growth of 28% yoy. This is a product
cum project business catering to the requirement of the industrial sector.
Over the years, the Company has changed its business model from merely being
a distributor of leading global manufacturers to that of a system integrator and
value added reseller, thereby moving up the value chain. The Company executes
several turnkey engineered projects in the areas of non-destructive material testing
and compressed air systems.
Project mix changes and subdued revenue booking eat into margins
n EBITDA margins declined 240 bps to 6.7% from 9.1% in Q3 FY10. While material
costs have been kept under check, there has been sharp increase in purchase
of traded items. Thus, we believe, the margin compression is mainly due
to change in nature of project mix. Lower revenue booking could not offset the
rise in employee and other expenditure.
n During the quarter, prices of Steel, Aluminum, Copper traded firm resulting in
material cost pressures. This may be the prime reason for loss of margins in the
cooling products division (which is material cost intensive).
n The company is working on extracting cost savings in its equipment manufacturing
business which should start yielding results from Q4 FY11.
n On the Electromechanical projects business, the management has been indicating
that margin shrinkage is due to lower margin projects won during poor
market conditions. However, with the improvement in market conditions, the
management has taken a decision that it will focus on projects that have profitability
above a threshold limit.
No sign of meaningful rebound in order booking
n The Central Airconditioning projects business is a play on the domestic commercial
real estate activity in the country. Order booking in FY09-10 was affected by
the slowdown in construction, retail and infotech segments. As a result, growth
in order booking declined to 10.6% and 4.9% in FY09 and FY10 respectively
from 41% in FY08.
n On a quarterly basis, estimated order intake is sedate at 3% yoy to Rs 6.1 bn.
Sequentially, order intake is down indicating that commercial real estate activity
continues to remain weak.
n We believe the company may also be cautious on taking fresh orders due to
poor pricing scenario and longer cash conversion cycle.
n The profile of order backlog has changed with more number of infrastructure
orders in the mix. The company has amalgamated Nasser Electricals with itself
and has started taking electrical projects as well. Thus from a largely Central
Airconditioning projects company, Blue Star is evolving into infrastructure projects
company capable of doing electrical, plumbing as well as fire fighting systems
jobs. This has had negative implications on margins as well as execution cycle.
n Order backlog is up 10% yoy but flat on a sequential basis. Revenue visibility at
8.9 months of trailing four quarter revenues has huge scope for improvement
considering that the execution cycle of orders is 12-14 months.
Capital engagement in CAC has remained high:
The capital employed in Central Airconditioning (CAC) has remained high on a yoy
basis. The company has been grappling with rising payment cycle in the projects
business as given the overcapacity in office space, developers are going slow on
project execution.
Blue Star's strategy is to expand its services portfolio to tap a
higher share of revenue from the same client
Over the years, Blue Star has continued to focus on the commercial AC business and
added new competencies including Electrical, Plumbing and Fire Fighting to tap a
higher share of the customer's wallet. Taking cue from the way the MEP business
has evolved in India, Blue Star foresees that in years to come, the customer would
be looking at a single vendor to provide entire services also covering maintenance of
buildings systems (including systems like security, elevator etc) , in addition to traditional
MEP.
Earnings Outlook
At the end of H1 FY11, the company had indicated that it expects to grow by 20%
plus in terms of revenues in FY11. However, in view of the subdued 3Q, we have
revised our revenue growth for current fiscal. The order intake has also been weak
suggesting than revenue booking may continue to remain subdued in the near-term.
On the EBITDA front, the management has been indicating that margins at the
EBITDA level is close to bottoming out. However, taking cognizance of the 3Q numbers
(and also the firm material price trend), we have adjusted our margin expectations
downwards for Q4 and FY12.
Stock Outlook and Valuation: Stock likely to remain weak.
n The stock has been a market performer over the past quarter. Going ahead,
given the rather disappointing set of numbers delivered by the company, the
stock may remain weak and trend lower. While the business outlook for the
company is expected to improve following the strong hiring outlook provided by
the IT and the infrastructure sector, we expect order intake in the near-term may
continue to remain subdued as there is excess capacity which needs to get utilized.
n In view of the earnings revision, we have reduced our one-year forward DCF
based target price to Rs 448 (Rs 500 earlier)
n The stock is currently trading at 22.3x and 17.0x FY11 and FY12 earnings respectively.
n Given the subdued outlook for the stock, we maintain ACCUMULATE with a reduced
target price of Rs 448.
India Equity Research Reports, IPO and Stock News Visit http://indiaer.blogspot.com/ for complete details �� ��\
BLUE STAR LTD
RECOMMENDATION: ACCUMULATE
TARGET PRICE: RS.448
FY12E P/E: 17X
q Numbers are lower than expectations as sedate revenue booking in Central
Airconditioning segment fails to offset the fixed costs resulting in
margin compression.
q Order intake remains anaemic, a reflection of continuing subdued activity
in commercial real estate.
q The company is consolidating its product offering in the domestic market
by acquiring businesses that bring in complementary competencies. It
has recently finalized acquisition of DS Gupta constructions which will
enable it to bundle fire-fighting and plumbing solutions with the
company's central AC systems. A good strategic move, we opine. While
the company is making the right moves, growth in the near-term remains
challenging.
q The disappointing 3Q numbers has resulted in a downward revision in
earnings. We expect stock to remain weak in near-term. Maintain Accumulate
with a revised target price of Rs 448 (Rs 500 earlier).
After a decent H1, revenue growth loses momentum in 3Q which
is a disappointment and indicative of the continued weakness in
commercial real estate activity
n For the third quarter, net sales were flat on a yoy basis but down on a qoq basis.
Segment-wise, the Central Airconditioning (CAC) segment registered a degrowth
of 6% yoy, which was quite contrary to expectations since this segment had
grown at a healthy pace in the H1 FY11. This line of business comprises the
central airconditioning, packaged airconditioning and electrical contracting business,
collectively called Electro Mechanical Projects and Packaged
Airconditioning Systems
n This segment is project based and continuing slackness in commercial real estate
development is reflecting in moderation in execution momentum. In view of the
existing oversupply, user segments like Offices and IT developers have either deferred
or slowed down their plans to increase capacity.
n As the traditional lines of user segments like IT and Retail have slowed down,
Blue Star has enhanced its exposure to infrastructure (Electrical), healthcare, hospitality
and education segments. The Company is receiving orders from power
project companies such as Siemens and ABB for their airconditioning requirements.
n The cooling products business comprises room airconditioners and refrigeration
products and systems. This segment grew 34% yoy in the third quarter, thus
maintaining the growth momentum of previous quarters.
n The cooling products segment also includes the cold chain equipment, which has
vast growth potential considering the sheer magnitude of agri-produce that is
wasted due to lack of proper storage facilities. Blue Star is working with various
industry bodies to improve the viability of cold chain. It is expected that to handle
15% of fruits and vegetables in a time span of 3-4 years, an investment of Rs
150 bn would be required.
n The professional electronics business posted a growth of 28% yoy. This is a product
cum project business catering to the requirement of the industrial sector.
Over the years, the Company has changed its business model from merely being
a distributor of leading global manufacturers to that of a system integrator and
value added reseller, thereby moving up the value chain. The Company executes
several turnkey engineered projects in the areas of non-destructive material testing
and compressed air systems.
Project mix changes and subdued revenue booking eat into margins
n EBITDA margins declined 240 bps to 6.7% from 9.1% in Q3 FY10. While material
costs have been kept under check, there has been sharp increase in purchase
of traded items. Thus, we believe, the margin compression is mainly due
to change in nature of project mix. Lower revenue booking could not offset the
rise in employee and other expenditure.
n During the quarter, prices of Steel, Aluminum, Copper traded firm resulting in
material cost pressures. This may be the prime reason for loss of margins in the
cooling products division (which is material cost intensive).
n The company is working on extracting cost savings in its equipment manufacturing
business which should start yielding results from Q4 FY11.
n On the Electromechanical projects business, the management has been indicating
that margin shrinkage is due to lower margin projects won during poor
market conditions. However, with the improvement in market conditions, the
management has taken a decision that it will focus on projects that have profitability
above a threshold limit.
No sign of meaningful rebound in order booking
n The Central Airconditioning projects business is a play on the domestic commercial
real estate activity in the country. Order booking in FY09-10 was affected by
the slowdown in construction, retail and infotech segments. As a result, growth
in order booking declined to 10.6% and 4.9% in FY09 and FY10 respectively
from 41% in FY08.
n On a quarterly basis, estimated order intake is sedate at 3% yoy to Rs 6.1 bn.
Sequentially, order intake is down indicating that commercial real estate activity
continues to remain weak.
n We believe the company may also be cautious on taking fresh orders due to
poor pricing scenario and longer cash conversion cycle.
n The profile of order backlog has changed with more number of infrastructure
orders in the mix. The company has amalgamated Nasser Electricals with itself
and has started taking electrical projects as well. Thus from a largely Central
Airconditioning projects company, Blue Star is evolving into infrastructure projects
company capable of doing electrical, plumbing as well as fire fighting systems
jobs. This has had negative implications on margins as well as execution cycle.
n Order backlog is up 10% yoy but flat on a sequential basis. Revenue visibility at
8.9 months of trailing four quarter revenues has huge scope for improvement
considering that the execution cycle of orders is 12-14 months.
Capital engagement in CAC has remained high:
The capital employed in Central Airconditioning (CAC) has remained high on a yoy
basis. The company has been grappling with rising payment cycle in the projects
business as given the overcapacity in office space, developers are going slow on
project execution.
Blue Star's strategy is to expand its services portfolio to tap a
higher share of revenue from the same client
Over the years, Blue Star has continued to focus on the commercial AC business and
added new competencies including Electrical, Plumbing and Fire Fighting to tap a
higher share of the customer's wallet. Taking cue from the way the MEP business
has evolved in India, Blue Star foresees that in years to come, the customer would
be looking at a single vendor to provide entire services also covering maintenance of
buildings systems (including systems like security, elevator etc) , in addition to traditional
MEP.
Earnings Outlook
At the end of H1 FY11, the company had indicated that it expects to grow by 20%
plus in terms of revenues in FY11. However, in view of the subdued 3Q, we have
revised our revenue growth for current fiscal. The order intake has also been weak
suggesting than revenue booking may continue to remain subdued in the near-term.
On the EBITDA front, the management has been indicating that margins at the
EBITDA level is close to bottoming out. However, taking cognizance of the 3Q numbers
(and also the firm material price trend), we have adjusted our margin expectations
downwards for Q4 and FY12.
Stock Outlook and Valuation: Stock likely to remain weak.
n The stock has been a market performer over the past quarter. Going ahead,
given the rather disappointing set of numbers delivered by the company, the
stock may remain weak and trend lower. While the business outlook for the
company is expected to improve following the strong hiring outlook provided by
the IT and the infrastructure sector, we expect order intake in the near-term may
continue to remain subdued as there is excess capacity which needs to get utilized.
n In view of the earnings revision, we have reduced our one-year forward DCF
based target price to Rs 448 (Rs 500 earlier)
n The stock is currently trading at 22.3x and 17.0x FY11 and FY12 earnings respectively.
n Given the subdued outlook for the stock, we maintain ACCUMULATE with a reduced
target price of Rs 448.
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