Blue Star Reaction Done; Upgrade to BUY: Emkay

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Blue Star

Reaction Done; Upgrade to BUY

BUY

CMP: Rs 340                                       Target Price: Rs 455

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n     Blue Star reports weakest performance of last 16 quarters  - net profits decline 33% yoy to Rs224 mn  – led by low revenue growth of 4% yoy to Rs6.1 bn

n     Gross margins improve 60 bps yoy – pointing at negative impact of operating leverage on Ebidta margins, resulting in 210 bps decline in Ebidta margins

n     Revise earning estimates by -9% - Revised earnings of Rs20.2/Share and Rs26.0/Share for FY11E and FY12E respectively

n     Post 20% price correction in past week, stock trades at 13X FY12E. Upgrade from ‘Accumulate’ to Buy’ with revised target price Rs455/Share

Net profit decline 33% yoy to Rs224 mn – Weakest performance of last 16

quarters

Blue Star (BLSR) reported its weakest performance of last 16 quarters in Q3FY11 -

reported 33% yoy decline in net profits to Rs224 mn. This was attributed to (1) Low

revenue growth at 4% yoy to Rs6.1 bn – led by 5% yoy decline in EMP&PAC segment

(2) 210 bps yoy drop in EBIDTA margins, influenced by operating leverage (3) jump in

interest costs (up 249% yoy to Rs79 mn).

EMP& PAC segment performance was impacted by slowdown in execution on projects

in Infrastructure sector & commercial sector, delayed recovery in IT sector and lower

billing by BLSR in few projects (in view of pending dues). However, Cooling Products

and PEIS registered strong growth at +35% yoy and +29% yoy respectively.

…But gross margins improve 60 bps yoy – pointing at negative impact of

operating leverage on Ebidta margins

Q3FY11 performance remains below expectation, but certainly not impacted by the

input costs. Gross margins at company level, remain intact at 24% - improve 60 bps on

yoy basis from 23.7% to 24.3%. Further, the sequential increase in fixed costs

(employee and others) was nominal at 5.3% à hence, impact on EBIDTA margins

(down 210 bps yoy) were led by muted revenue growth and corresponding impact of

operating leverage.

Order accretion at Rs6.8 bn, Order book at Rs20.1 bn

Order accretion stood at Rs6.8 bn (up 7% yoy) – below estimates. Major orders bagged

include (1) Power sector – Indu Projects (500MW), Reliance Infrastructure (2x300MW)

(2) Integrated MEP – Godrej group, Chandigarh, (3) HVAC orders - Infosys, DLF, HCL,

Volkswagen, Hindalco. Consequently order book increased to Rs20.1 bn (up 5% qoq

and 11% yoy). Considering, inflows YTD, the implied run-rate for Q4FY11 is Rs9.9 bn à

which management believes is achievable

BLSR changes strategy – to increase focus on residential market

W.e.f Jan’11, BLSR would increase focus on the residential room air-conditioners (RAC)

market (so far focused largely on commercial RAC market). The idea is to participate in

30% CAGR residential RAC market and improve the growth trajectory of Cooling Products

division. Towards this end, BLSR has launched a new range of spilt air-conditioners, which

will be distributed through reputed retail chain in select cities alongside current dealer

network. BLSR expects share of residential RAC to increase from about 25% to 50% of

total RAC revenues (under Cooling Products).

Earning revision of -9% - unnerved by high asking rate in Q4FY11E

With lower-then expected performance for YTD 2011 and Q3FY11 specifically, we have

revised our assumptions on bookings in EMP & PAC segment and company-level Ebidta

margins. Consequently, we have revised earning estimates for FY11E and FY12E by -9%

to Rs20.2/Share and Rs26.0/Share respectively.

Post earnings revision, FY11E earnings estimates factor implied earnings for Q4FY11E at

Rs9.3/Share (up 7% yoy and 46% of FY11E earnings). This is higher-end of consensus

estimates. Considering stable gross margins in YTD 2011, we remain relatively confident on

BLSTR meeting our FY11E estimates (though being higher then consensus).

Upgrade to BUY with revised price target of Rs455

We continue to maintain a positive bias on Blue Star. Post the recent price correction (stock

has corrected +21% in the past week and 39% since Sep’10 peak), the stock is attractively

valued at 16.9X FY11E and 13.1X FY12E earnings. We upgrade rating from ‘Accumulate’

to ‘BUY’ with revised target price of Rs455 per share (@ 17.5X FY12E earnings).