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UBS Investment Research
Blue Star
Proxy to Indian infra; initiate with Buy
Beneficiary of high MEP spend in India; 42% FY06-10E EPS CAGR
Blue Star is a mechanical, electrical and plumbing (MEP) contractor, which also
manufactures air conditioners (AC) and commercial refrigeration systems. We
believe it is a structural growth story and a beneficiary of growing infrastructure
spending in India. While H1 FY12 performance could be muted due to lower
billing, a pick up in domestic activity could lead to a share price re-rating. We
estimate its non-MEP markets—commercial refrigeration/AC—will grow 25-30%
YoY over the next few years and we expect contributions to rise.
Integrated offerings, experience, broader market focus, de-risk business
We believe earnings will be supported by its integrated project execution ability in
MEP, significant experience, a presence in the high-growth AC and commercial
refrigeration segments, a broader market focus and its de-risking by focusing on
the industrial and infrastructure sectors. Slower execution should reduce
receivables, while project selection could improve its balance sheet.
FY11-13E EPS CAGR of 21%; high-return business
We estimate an EPS CAGR of 21% in FY11-13 and 44% ROIC in FY12. Positives
include its asset-light business model, low leverage and Rs21bn order book for
electro-mechanical projects, which provides visibility for about one year. A good
economic environment could lead to an upside surprise on its outlook.
Valuation: initiate coverage with Buy rating and Rs430.00 price target
We believe the share price is attractive, after the correction since September 2010.
We would likely view any near-term weakness on the stock (due to muted results),
as an attractive buying opportunity. Our price target implies 16.5x FY13E PE. We
derive our price target from a DCF-based methodology and explicitly forecast
long-term valuation drivers using UBS’s VCAM tool (12.2% WACC).
Investment Thesis
We initiate coverage of Blue Star with a Buy rating and a price target of
Rs430.00, 18.5% above the current share price. While its share price has
corrected 37-45% from a 52-week high of Rs524.00 at end-September 2010, we
view current levels as attractive. We would likely view any near-term weakness
from its potentially muted results for the next one to two quarters as an attractive
buying opportunity. We see Blue Star as a long-term structural story and a
beneficiary of Indian infrastructure spending (we estimate US$500bn in
spending in India overall, of which MEP is a segment). A pick up in domestic
capex could lead to a significant re-rating given Blue Star’s high growth
potential, better returns than most its peers, stronger balance sheet and good
growth of its non-MEP businesses (we estimate the AC and commercial
refrigeration markets will have a 25-30% YoY growth rate over the next few
years; and these segments will contribute to around 45% of EBIT). Our
estimates are slightly more conservative than consensus, but we are likely to
revisit our assumptions with a better economic environment. While
electromechanical projects (MEP projects) are ‘Segment 1’, the AC and
commercial refrigeration business falls under ‘Cooling Products’ or ‘Segment
2’. It also markets and maintains hi-tech professional electronic and industrial
products (professional electronics or ‘Segment 3’).
We believe key catalysts for the share price will be a broad recovery in domestic
capex spending given significant infrastructure outlay, better project execution
and billing, continued strong performance in ‘Segment 2’, high returns and the
easing of working capital. Although performance could be muted in the near to
medium term, we focus more on the company’s long-term catalysts. Its
integrated project execution ability in MEP, five decades of experience and
broader market focus should support earnings, in our view. In FY11-13, we
estimate an EPS CAGR of 20.9% and 40-50% ROIC (assuming some easing).
Positives include its asset-light model, low leverage and Rs2.1bn order book in
electro-mechanical projects (‘Segment 1’), which provides visibility for about
one year. A good economic environment could lead to a surprise on its outlook.
Blue Star is trading at FY12/FY13E PE of 17.5x/13.9x, a slight discount to the
peer capital goods median. It is also trading near its historical median range.
Key catalysts
Although its share price performance could be muted in the near to medium term
as the company is slowing its billing slightly to lower its receivables (we estimate
EBIT for MEP or ‘Segment 1’ at 52-55% through FY11-13), we think the longterm
structural story is attractive given Blue Star’s presence in India, which has a
strong focus on infrastructure. The company has had strong growth (EPS CAGR
in FY06-10 was 42%) in a good environment. Furthermore, we think its cooling
products and professional electronics segments should continue to grow well (we
estimate 45-48% contribution to EBIT in FY11-13). Hence, we focus more on its
long-term catalysts and would likely view any near- to medium-term
weaknesses/corrections in its share price as an attractive buying opportunity. Blue
Star continues to have low leverage, high return on capital employed (ROCE) and
about one year of visibility on its order book.
Improvement in India project execution and awards. Barring one to two
quarters of muted order flow/execution, we expect a significant pick up in
new orders given the high spending allocation for infrastructure in India. We
believe a pick up in infrastructure spending is the biggest catalyst and could
lead to a re-rating.
Continued strong performance of cooling products segment. Comprising
ACs and commercial refrigeration products, we think this market and
segment is on a fast growth trajectory of 25-30% YoY growth for the next
few years. A growing middle class population, rising consumption and
aspirations, rapid urbanisation and agriculture growth should continue to
support the segment. Any progress and implementation of the budget
proposals on cold chains should further strengthen market opportunities.
Diversification of end-markets. Blue Star’s focus on the infrastructure and
industrial segments could facilitate order book growth at a time when
commercial activity is expected to remain subdued over the near to medium
term.
High returns due to asset-light model and working capital management.
Blue Star’s business model has historically generated high returns.
Management attributes this to a fixed asset-light model, judicious project
selection, execution, and working capital management. Although we assume
returns will ease, they are still higher than those of other companies in the
sector. We believe this will continue to boost investor sentiment and interest.
Risks
We believe the key risks are as follows.
An extended delay in project execution and a significant economic
slowdown in India. Blue Star’s EMP segment contributes significant revenue
and earnings, and has an order book of Rs21bn, ensuring about one year of
revenue visibility. Management highlighted it is slowing order execution and
focusing on lowering receivables. Hence, a longer-than-expected delay in
execution (beyond one to two quarters), a delay in the awarding of new projects
and a weak economic environment would adversely impact our growth estimates
for FY12-13.
Volatile commodity prices could impact margins. Most of Blue Star’s
contracts are fixed priced contracts, with its major raw materials being steel and
copper. The company tries to take into account rising prices and as it uses endproducts
(where there is a lag), the impact of volatile commodity prices is
slightly lower. Many recent government contracts take into account price
escalation.
Higher-than-expected working capital, unattractive payment terms in new
projects. These could hamper returns and stretch the company’s balance sheet.
Stronger competition and limited product differentiation. Many MNCs
are planning a foray into India’s MEP segment. While Blue Star’s brand and
experience should help it get new orders, most products in the AC segment
have become Energy Star rated, which limits product differentiation.
We derive our price target from a DCF-based methodology and explicitly forecast
long-term valuation drivers using UBS’s VCAM tool. We believe DCF captures
Blue Star’s long-term growth potential in infrastructure-focused markets such as
India, where sales of similar companies have typically grown substantially in a
good economic environment. We assume a WACC of 12.2%, higher than those
for capital goods and construction companies under our coverage. Given MEP is
an asset-light business, we forecast high ROCE over our forecast horizon.
However, we assume an easing from its high levels in FY10.
Peer and historical valuation
Blue Star is trading at FY12/FY13E PE of 17.5x/13.9x, a slight discount to the
peer capital goods median. It is also trading near its historical median range. On
metrics such as EV/EBITDA and P/BV, it is either trading in line or at a slight
premium. Blue Star recorded the highest EPS CAGR of 42% in our capital
goods coverage universe in FY06-10. Given our cautious stance, we forecast
21% EPS CAGR in FY11-13, in line with the peer median. There is potential
upside risk to our estimates over the long term, as the company has historically
posted robust growth in a favourable economic environment.
UBS versus consensus
We are broadly in line with consensus earnings for FY11. However, we are around
12% below consensus on FY12 earnings. This is because we assume there will be
slow execution of orders in H1 FY12, with an improvement only in the second half
of the year. While consensus estimates are higher, they could be lowered after a
quarter of muted results. We also assume higher working capital than previous
levels. For FY13 earnings, we are marginally below consensus. While we think its
near-term outlook is muted, we remain positive on the company and the industry in
the long term.
Blue Star
Blue Star is a turnkey electromechanical or MEP (mechanical, electrical,
plumbing, fire fighting) contractor catering to commercial real estate, IT parks,
industries and infra sectors such as airports, ports, power plants and
manufacturing establishments. It also caters to requirements of commercial
refrigeration equipment ranging from water coolers to cold storages. Blue Star
has three business segments: electro-mechanical products and packaged air
conditioning systems, cooling products, and professional electronics and
industrial systems.
Statement of Risk
We believe the key risks for Blue Star are delays in project execution, a
significant economic slowdown and volatility in commodity prices.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
UBS Investment Research
Blue Star
Proxy to Indian infra; initiate with Buy
Beneficiary of high MEP spend in India; 42% FY06-10E EPS CAGR
Blue Star is a mechanical, electrical and plumbing (MEP) contractor, which also
manufactures air conditioners (AC) and commercial refrigeration systems. We
believe it is a structural growth story and a beneficiary of growing infrastructure
spending in India. While H1 FY12 performance could be muted due to lower
billing, a pick up in domestic activity could lead to a share price re-rating. We
estimate its non-MEP markets—commercial refrigeration/AC—will grow 25-30%
YoY over the next few years and we expect contributions to rise.
Integrated offerings, experience, broader market focus, de-risk business
We believe earnings will be supported by its integrated project execution ability in
MEP, significant experience, a presence in the high-growth AC and commercial
refrigeration segments, a broader market focus and its de-risking by focusing on
the industrial and infrastructure sectors. Slower execution should reduce
receivables, while project selection could improve its balance sheet.
FY11-13E EPS CAGR of 21%; high-return business
We estimate an EPS CAGR of 21% in FY11-13 and 44% ROIC in FY12. Positives
include its asset-light business model, low leverage and Rs21bn order book for
electro-mechanical projects, which provides visibility for about one year. A good
economic environment could lead to an upside surprise on its outlook.
Valuation: initiate coverage with Buy rating and Rs430.00 price target
We believe the share price is attractive, after the correction since September 2010.
We would likely view any near-term weakness on the stock (due to muted results),
as an attractive buying opportunity. Our price target implies 16.5x FY13E PE. We
derive our price target from a DCF-based methodology and explicitly forecast
long-term valuation drivers using UBS’s VCAM tool (12.2% WACC).
Investment Thesis
We initiate coverage of Blue Star with a Buy rating and a price target of
Rs430.00, 18.5% above the current share price. While its share price has
corrected 37-45% from a 52-week high of Rs524.00 at end-September 2010, we
view current levels as attractive. We would likely view any near-term weakness
from its potentially muted results for the next one to two quarters as an attractive
buying opportunity. We see Blue Star as a long-term structural story and a
beneficiary of Indian infrastructure spending (we estimate US$500bn in
spending in India overall, of which MEP is a segment). A pick up in domestic
capex could lead to a significant re-rating given Blue Star’s high growth
potential, better returns than most its peers, stronger balance sheet and good
growth of its non-MEP businesses (we estimate the AC and commercial
refrigeration markets will have a 25-30% YoY growth rate over the next few
years; and these segments will contribute to around 45% of EBIT). Our
estimates are slightly more conservative than consensus, but we are likely to
revisit our assumptions with a better economic environment. While
electromechanical projects (MEP projects) are ‘Segment 1’, the AC and
commercial refrigeration business falls under ‘Cooling Products’ or ‘Segment
2’. It also markets and maintains hi-tech professional electronic and industrial
products (professional electronics or ‘Segment 3’).
We believe key catalysts for the share price will be a broad recovery in domestic
capex spending given significant infrastructure outlay, better project execution
and billing, continued strong performance in ‘Segment 2’, high returns and the
easing of working capital. Although performance could be muted in the near to
medium term, we focus more on the company’s long-term catalysts. Its
integrated project execution ability in MEP, five decades of experience and
broader market focus should support earnings, in our view. In FY11-13, we
estimate an EPS CAGR of 20.9% and 40-50% ROIC (assuming some easing).
Positives include its asset-light model, low leverage and Rs2.1bn order book in
electro-mechanical projects (‘Segment 1’), which provides visibility for about
one year. A good economic environment could lead to a surprise on its outlook.
Blue Star is trading at FY12/FY13E PE of 17.5x/13.9x, a slight discount to the
peer capital goods median. It is also trading near its historical median range.
Key catalysts
Although its share price performance could be muted in the near to medium term
as the company is slowing its billing slightly to lower its receivables (we estimate
EBIT for MEP or ‘Segment 1’ at 52-55% through FY11-13), we think the longterm
structural story is attractive given Blue Star’s presence in India, which has a
strong focus on infrastructure. The company has had strong growth (EPS CAGR
in FY06-10 was 42%) in a good environment. Furthermore, we think its cooling
products and professional electronics segments should continue to grow well (we
estimate 45-48% contribution to EBIT in FY11-13). Hence, we focus more on its
long-term catalysts and would likely view any near- to medium-term
weaknesses/corrections in its share price as an attractive buying opportunity. Blue
Star continues to have low leverage, high return on capital employed (ROCE) and
about one year of visibility on its order book.
Improvement in India project execution and awards. Barring one to two
quarters of muted order flow/execution, we expect a significant pick up in
new orders given the high spending allocation for infrastructure in India. We
believe a pick up in infrastructure spending is the biggest catalyst and could
lead to a re-rating.
Continued strong performance of cooling products segment. Comprising
ACs and commercial refrigeration products, we think this market and
segment is on a fast growth trajectory of 25-30% YoY growth for the next
few years. A growing middle class population, rising consumption and
aspirations, rapid urbanisation and agriculture growth should continue to
support the segment. Any progress and implementation of the budget
proposals on cold chains should further strengthen market opportunities.
Diversification of end-markets. Blue Star’s focus on the infrastructure and
industrial segments could facilitate order book growth at a time when
commercial activity is expected to remain subdued over the near to medium
term.
High returns due to asset-light model and working capital management.
Blue Star’s business model has historically generated high returns.
Management attributes this to a fixed asset-light model, judicious project
selection, execution, and working capital management. Although we assume
returns will ease, they are still higher than those of other companies in the
sector. We believe this will continue to boost investor sentiment and interest.
Risks
We believe the key risks are as follows.
An extended delay in project execution and a significant economic
slowdown in India. Blue Star’s EMP segment contributes significant revenue
and earnings, and has an order book of Rs21bn, ensuring about one year of
revenue visibility. Management highlighted it is slowing order execution and
focusing on lowering receivables. Hence, a longer-than-expected delay in
execution (beyond one to two quarters), a delay in the awarding of new projects
and a weak economic environment would adversely impact our growth estimates
for FY12-13.
Volatile commodity prices could impact margins. Most of Blue Star’s
contracts are fixed priced contracts, with its major raw materials being steel and
copper. The company tries to take into account rising prices and as it uses endproducts
(where there is a lag), the impact of volatile commodity prices is
slightly lower. Many recent government contracts take into account price
escalation.
Higher-than-expected working capital, unattractive payment terms in new
projects. These could hamper returns and stretch the company’s balance sheet.
Stronger competition and limited product differentiation. Many MNCs
are planning a foray into India’s MEP segment. While Blue Star’s brand and
experience should help it get new orders, most products in the AC segment
have become Energy Star rated, which limits product differentiation.
We derive our price target from a DCF-based methodology and explicitly forecast
long-term valuation drivers using UBS’s VCAM tool. We believe DCF captures
Blue Star’s long-term growth potential in infrastructure-focused markets such as
India, where sales of similar companies have typically grown substantially in a
good economic environment. We assume a WACC of 12.2%, higher than those
for capital goods and construction companies under our coverage. Given MEP is
an asset-light business, we forecast high ROCE over our forecast horizon.
However, we assume an easing from its high levels in FY10.
Peer and historical valuation
Blue Star is trading at FY12/FY13E PE of 17.5x/13.9x, a slight discount to the
peer capital goods median. It is also trading near its historical median range. On
metrics such as EV/EBITDA and P/BV, it is either trading in line or at a slight
premium. Blue Star recorded the highest EPS CAGR of 42% in our capital
goods coverage universe in FY06-10. Given our cautious stance, we forecast
21% EPS CAGR in FY11-13, in line with the peer median. There is potential
upside risk to our estimates over the long term, as the company has historically
posted robust growth in a favourable economic environment.
UBS versus consensus
We are broadly in line with consensus earnings for FY11. However, we are around
12% below consensus on FY12 earnings. This is because we assume there will be
slow execution of orders in H1 FY12, with an improvement only in the second half
of the year. While consensus estimates are higher, they could be lowered after a
quarter of muted results. We also assume higher working capital than previous
levels. For FY13 earnings, we are marginally below consensus. While we think its
near-term outlook is muted, we remain positive on the company and the industry in
the long term.
Blue Star
Blue Star is a turnkey electromechanical or MEP (mechanical, electrical,
plumbing, fire fighting) contractor catering to commercial real estate, IT parks,
industries and infra sectors such as airports, ports, power plants and
manufacturing establishments. It also caters to requirements of commercial
refrigeration equipment ranging from water coolers to cold storages. Blue Star
has three business segments: electro-mechanical products and packaged air
conditioning systems, cooling products, and professional electronics and
industrial systems.
Statement of Risk
We believe the key risks for Blue Star are delays in project execution, a
significant economic slowdown and volatility in commodity prices.
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