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UBS Investment Research
Blue Star
L evered to Indian infra
Event: Management concall; FY12 to be a challenging year
Management concall indicated a challenging FY12 due to weaker macro
environment, margin pressure due to delays and cost increase and low new orders.
Stellar cooling products revenue growth in Q1FY12 (29.5% YoY) is positive.
Medium term EBIT margins likely at 6-8%. Standalone order book is Rs20.99bn
(1.1x electro-mechanical segment revenues).
Impact: Significant downgrade in estimates and price target
We lower our estimates by 36.1%/28.4% for FY12/13E on lower margins (higher
costs, execution delay) and higher working capital. We also lower our price target
to Rs300/share. However, we like Blue Star’s presence in infra focussed markets
and leverage to the long term sustainable opportunity in consumer durables (ACs).
Action: Retain Buy- low valuations, infra opportunity and high returns
We retain our Buy rating on Blue Star, given better risk reward at P/E of
12.3xFY13E (near trough), c60% under-performance to Sensex YTD, presence in
infra focussed Indian market, retail AC opportunity and high return profile. We
assume peaking of rates and capex/investment to improve with a lag. We are
positive over the long term, albeit with medium term uncertainties (difficult to
estimate the trough of negative news flow). PT implied FY13 PE is 16x.
Valuation: Buy with a lower price target of Rs300
We derive our price target from a DCF-based methodology and explicitly forecast
long-term valuation drivers using UBS’s VCAM tool (assume a 12.7% WACC).
Retain Buy on low valuations, underperformance and
leverage to long term India infra opportunity
Blue Star stock price has hugely underperformed Sensex YTD by c60%, due to
higher-than-expected deterioration in macro such as rate hikes, slowdown of
capex/investment cycle, worsening of the global environment, operating loss in
segment 1 in Q1FY12, weak margin guidance and lower retail AC industry sales
due to pleasant weather. When we initiated coverage in April 2011, we had
expected the non-project business (retail AC and professional electronics) to at
least perform well and macro to improve in next one to two quarters, both of
which have not happened.
Post the stock price correction; risk reward of buying Blue Star is better over the
long term, given that the stock trading at -1 standard deviation to historical mean
both P/E (12.3xFY13E) and EV/EBITDA (7.6xFY13E). We maintain our Buy
rating despite the fact that FY12 is expected to be a challenging year. In our
view, it would be difficult to estimate the end of negative newsflow and trough
for the stock. The significant assumptions we make here are that we are near
the peak of the rate cycle, capex/investment will improve with a lag in India,
and UBS does not expect a recession globally. Our analysis of historical
operational performance of Blue Star indicates a part co-relation between order
book/accretion versus real investment growth in the economy and a stronger corelation
between billing or order execution and real investment growth in the
economy which should materially increase as spending sentiment improves,
indicating an immediate financial impact.
Key takeaways from the conference call with the Blue
Star management
Order book has been reasonably sluggish for both commercial (except
hotels/offices) and infrastructure sectors on account of 1) weaker
macro/spending environment and delays in new project awards; 2) Blue Star
management is highly cautious and selective in taking new projects which
has tighter terms and better visibility on execution. Standalone order book
was cRs20.99bn, out of which cRs18bn is electro-mechanical projects (75-
80% commercial comprising of offices, retail, hospitals and hotels and
remaining 20-25% is infra). Out of this Rs18bn EMP projects, 70-75% is
HVAC projects, 10-15% electrical and rest is plumbing projects. Subsidiary
order book of Blue Star Electro-mechanical Limited (plumbing) is cRs2.5bn.
Blue Star is focussing on projects from more established corporate customers.
Execution cycle of total order book is 18-24 months (~1.1x our FY12
electro-mechanical project revenues estimate).
Margin pressure; FY12 outlook for Segment 1 (Electromechanical
Projects and Packaged ACs) is bleak: Most contracts were fixed price
contracts in MEP wherein the quantity is variable but not the unit. Most
orders being executed today were taken through FY08-10 (wherein booking
business was a priority) which have faced execution delays and raw material
(copper, steel) and finished goods prices (only c30% is internally
manufactured) have escalated. This has largely resulted in margin pressure,
as witnessed in Q1FY12 and which may likely continue for next 0.5-1.0
years, as these orders get executed. They cannot do any provisioning in
advance, and can only book costs in line with revenues. In line with this,
FY12 looks is expected by the management to be a challenging year with
weak segment 1 outlook. Medium term margins are likely to be 6-8% and
long term management is targeting it to recover to 11%.
No large project risk is comforting: Blue Star carries an order book of 500-
600 projects at any time, suggesting that there no major large projects which
run the risk of largely impacting financials in a year.
New projects are being taken after due consideration: Blue Star is quite
cautious while taking new projects and have a stricter criteria now taking
into account the clients’ ability to execute project on time, financial ability,
nature of raw materials involved and ability to book prices, payment cycle
and impact on cash flows.
No plans to look at the international markets, as Blue Star indicated that
there are already numerous players in other markets and environment is
highly competitive. Further, they can leverage their significant experience
and relationships in India to grow in the business.
Stellar performance of cooling products in Q1FY12, ahead of industry:
Blue Star’s Segment 2 (Cooling Products) revenues grew by 29.5% YoY to
Rs3.28bn, despite a higher base which is encouraging despite the industry
de-growth by 10-15% over the same period. This is on account of company’s
expansion in the residential segment for room ACs, Tier4/5 cities, expanding
distributor reach and favourable performance of refrigeration and cold chain
products. Out of total yearly revenues in this segment, c50% is room ACs
(~200-250k units, out of which 200-250k units are to commercial offices),
c25% is refrigeration products, 16% cold chain products and rest 9% is
service contract revenues (annual maintenance contracts). Blue Star sells its
products largely through its exclusive sales network, multi-brand vendors
and organised retailers to a smaller extent. Over the next 2-3 years, it hopes
to expand its 850-900 dealer network by 400-500.
High inventory in the room ACs industry: Management did highlight the
high inventory in the industry, given the lack-lustre Q1/Q2FY12 and
manufacturers are waiting for the festival season in October to potentially
expand sales. In last few quarters, manufacturers have taken price hikes to
pass on high raw material prices. However, going forward this ability could
be curtailed by the weaker consumer spending environment. This coupled
with potentially high competition during festival season and discounts could
put some pressure on margins.
Segment 3 (Professional Electronics) trends should continue: Products
sold here are medical, destructive and non-destructive testing, heavy duty
pumps, etc. This segment has been cyclical historically; however
management indicated that this is more due to the presence of projects and
not due to demand. This is expected to continue to be a high margin business
(20-25%).
Significant downgrade in estimates/price target
We are downgrading our estimates for Blue Star sharply by 36.1% and 28.4%
for FY12E and FY13E, respectively driven by a sharp cut in EBITDA margins
as the company expects costs to escalate (fixed price contracts) on delayed
execution. Blue Star reported a loss in Q1FY12 at operating level only in
Segment 1 (projects business). Medium term EBIT margins are likely to be 6-
8% and long term management is targeting it to recover to 11%. We incorporate
this into our estimates. We also are assuming higher working capital, debt and
interest expenses. Net debt to equity is c0.5x in FY12, and we forecast it to be
net cash by FY13E. 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 infrastructurefocused
market – India. Lower estimates and higher WACC assumption of
12.9% (12.2% earlier) and lower long term margin assumptions has resulted in a
downgrade of our price target from Rs430 to Rs300, which implies a PE of 16x
FY13E.
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
Key risks are macro slowdown and sharp deterioration in EMP capex,
investment cycle in India; margin pressure; escalating commodity prices and
high working capital.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
UBS Investment Research
Blue Star
L evered to Indian infra
Event: Management concall; FY12 to be a challenging year
Management concall indicated a challenging FY12 due to weaker macro
environment, margin pressure due to delays and cost increase and low new orders.
Stellar cooling products revenue growth in Q1FY12 (29.5% YoY) is positive.
Medium term EBIT margins likely at 6-8%. Standalone order book is Rs20.99bn
(1.1x electro-mechanical segment revenues).
Impact: Significant downgrade in estimates and price target
We lower our estimates by 36.1%/28.4% for FY12/13E on lower margins (higher
costs, execution delay) and higher working capital. We also lower our price target
to Rs300/share. However, we like Blue Star’s presence in infra focussed markets
and leverage to the long term sustainable opportunity in consumer durables (ACs).
Action: Retain Buy- low valuations, infra opportunity and high returns
We retain our Buy rating on Blue Star, given better risk reward at P/E of
12.3xFY13E (near trough), c60% under-performance to Sensex YTD, presence in
infra focussed Indian market, retail AC opportunity and high return profile. We
assume peaking of rates and capex/investment to improve with a lag. We are
positive over the long term, albeit with medium term uncertainties (difficult to
estimate the trough of negative news flow). PT implied FY13 PE is 16x.
Valuation: Buy with a lower price target of Rs300
We derive our price target from a DCF-based methodology and explicitly forecast
long-term valuation drivers using UBS’s VCAM tool (assume a 12.7% WACC).
Retain Buy on low valuations, underperformance and
leverage to long term India infra opportunity
Blue Star stock price has hugely underperformed Sensex YTD by c60%, due to
higher-than-expected deterioration in macro such as rate hikes, slowdown of
capex/investment cycle, worsening of the global environment, operating loss in
segment 1 in Q1FY12, weak margin guidance and lower retail AC industry sales
due to pleasant weather. When we initiated coverage in April 2011, we had
expected the non-project business (retail AC and professional electronics) to at
least perform well and macro to improve in next one to two quarters, both of
which have not happened.
Post the stock price correction; risk reward of buying Blue Star is better over the
long term, given that the stock trading at -1 standard deviation to historical mean
both P/E (12.3xFY13E) and EV/EBITDA (7.6xFY13E). We maintain our Buy
rating despite the fact that FY12 is expected to be a challenging year. In our
view, it would be difficult to estimate the end of negative newsflow and trough
for the stock. The significant assumptions we make here are that we are near
the peak of the rate cycle, capex/investment will improve with a lag in India,
and UBS does not expect a recession globally. Our analysis of historical
operational performance of Blue Star indicates a part co-relation between order
book/accretion versus real investment growth in the economy and a stronger corelation
between billing or order execution and real investment growth in the
economy which should materially increase as spending sentiment improves,
indicating an immediate financial impact.
Key takeaways from the conference call with the Blue
Star management
Order book has been reasonably sluggish for both commercial (except
hotels/offices) and infrastructure sectors on account of 1) weaker
macro/spending environment and delays in new project awards; 2) Blue Star
management is highly cautious and selective in taking new projects which
has tighter terms and better visibility on execution. Standalone order book
was cRs20.99bn, out of which cRs18bn is electro-mechanical projects (75-
80% commercial comprising of offices, retail, hospitals and hotels and
remaining 20-25% is infra). Out of this Rs18bn EMP projects, 70-75% is
HVAC projects, 10-15% electrical and rest is plumbing projects. Subsidiary
order book of Blue Star Electro-mechanical Limited (plumbing) is cRs2.5bn.
Blue Star is focussing on projects from more established corporate customers.
Execution cycle of total order book is 18-24 months (~1.1x our FY12
electro-mechanical project revenues estimate).
Margin pressure; FY12 outlook for Segment 1 (Electromechanical
Projects and Packaged ACs) is bleak: Most contracts were fixed price
contracts in MEP wherein the quantity is variable but not the unit. Most
orders being executed today were taken through FY08-10 (wherein booking
business was a priority) which have faced execution delays and raw material
(copper, steel) and finished goods prices (only c30% is internally
manufactured) have escalated. This has largely resulted in margin pressure,
as witnessed in Q1FY12 and which may likely continue for next 0.5-1.0
years, as these orders get executed. They cannot do any provisioning in
advance, and can only book costs in line with revenues. In line with this,
FY12 looks is expected by the management to be a challenging year with
weak segment 1 outlook. Medium term margins are likely to be 6-8% and
long term management is targeting it to recover to 11%.
No large project risk is comforting: Blue Star carries an order book of 500-
600 projects at any time, suggesting that there no major large projects which
run the risk of largely impacting financials in a year.
New projects are being taken after due consideration: Blue Star is quite
cautious while taking new projects and have a stricter criteria now taking
into account the clients’ ability to execute project on time, financial ability,
nature of raw materials involved and ability to book prices, payment cycle
and impact on cash flows.
No plans to look at the international markets, as Blue Star indicated that
there are already numerous players in other markets and environment is
highly competitive. Further, they can leverage their significant experience
and relationships in India to grow in the business.
Stellar performance of cooling products in Q1FY12, ahead of industry:
Blue Star’s Segment 2 (Cooling Products) revenues grew by 29.5% YoY to
Rs3.28bn, despite a higher base which is encouraging despite the industry
de-growth by 10-15% over the same period. This is on account of company’s
expansion in the residential segment for room ACs, Tier4/5 cities, expanding
distributor reach and favourable performance of refrigeration and cold chain
products. Out of total yearly revenues in this segment, c50% is room ACs
(~200-250k units, out of which 200-250k units are to commercial offices),
c25% is refrigeration products, 16% cold chain products and rest 9% is
service contract revenues (annual maintenance contracts). Blue Star sells its
products largely through its exclusive sales network, multi-brand vendors
and organised retailers to a smaller extent. Over the next 2-3 years, it hopes
to expand its 850-900 dealer network by 400-500.
High inventory in the room ACs industry: Management did highlight the
high inventory in the industry, given the lack-lustre Q1/Q2FY12 and
manufacturers are waiting for the festival season in October to potentially
expand sales. In last few quarters, manufacturers have taken price hikes to
pass on high raw material prices. However, going forward this ability could
be curtailed by the weaker consumer spending environment. This coupled
with potentially high competition during festival season and discounts could
put some pressure on margins.
Segment 3 (Professional Electronics) trends should continue: Products
sold here are medical, destructive and non-destructive testing, heavy duty
pumps, etc. This segment has been cyclical historically; however
management indicated that this is more due to the presence of projects and
not due to demand. This is expected to continue to be a high margin business
(20-25%).
Significant downgrade in estimates/price target
We are downgrading our estimates for Blue Star sharply by 36.1% and 28.4%
for FY12E and FY13E, respectively driven by a sharp cut in EBITDA margins
as the company expects costs to escalate (fixed price contracts) on delayed
execution. Blue Star reported a loss in Q1FY12 at operating level only in
Segment 1 (projects business). Medium term EBIT margins are likely to be 6-
8% and long term management is targeting it to recover to 11%. We incorporate
this into our estimates. We also are assuming higher working capital, debt and
interest expenses. Net debt to equity is c0.5x in FY12, and we forecast it to be
net cash by FY13E. 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 infrastructurefocused
market – India. Lower estimates and higher WACC assumption of
12.9% (12.2% earlier) and lower long term margin assumptions has resulted in a
downgrade of our price target from Rs430 to Rs300, which implies a PE of 16x
FY13E.
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
Key risks are macro slowdown and sharp deterioration in EMP capex,
investment cycle in India; margin pressure; escalating commodity prices and
high working capital.
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