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BLUE STAR LTD
PRICE: RS.178 RECOMMENDATION: REDUCE
TARGET PRICE: RS.188 FY13E P/E: 14.2X
Numbers are sharply lower than expectations mainly due to loss in the
Central Air Conditioning projects business and MTM loss on forex exposure.
The company during the quarter may have continued with its process of
short-closing of sluggish projects and has booked losses on such projects.
Thus, as a prudent measure, the company has front-loaded most of the
foreseeable costs in the quarter. Consequently, the performance should
improve progressively in the coming quarters. However, given the cost
inflation, change in profile of order book and presence of low margin
orders, EBITDA margins may continue to remain below normal levels in
FY13 as well.
Amidst the poor set of numbers, we take note of the fact that the company
has been able to reduce its capital engagement in the projects business. The
company has also repaid part of its outstanding borrowings. This as a
positive development.
Medium-term outlook for the Central Air-conditioning business continues to
remain negative given over-supply in office space, which is translating into
sedate order intake.
In view of the near-term issues related to margin pressure and weak order
intake, we have reworked our target price which now stands at Rs 188 (Rs
227 earlier). Although, the worst in terms of earnings may be over for the
company, we maintain our Reduce rating on the stock in view of lack of
visible triggers in the near term coupled with weak business outlook.
Contracting environment remain challenging
n For the third quarter, net revenues are down 4% yoy primarily due to the lead
segment Electromechanical projects posting a decline of 15% yoy in Q3 FY12.
n The electromechanical projects 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. Since Q4 FY11, billings and cash flow were adversely impacted due to
slowdown in the completion of large projects.
n The company has been focusing on managing the capital employed in the segment
with a view to retrieve capital already employed. Basically, the company is
linking project completion to payment of overdue receivables. The downside of
this is that while there is better control on working capital, the revenue recognition
is getting sluggish. However, in our view the management's strategy is appropriate
in the current environment as the focus should be on cash management
rather than on revenue growth.
n The cooling products business comprises room airconditioners and refrigeration
products and systems. This segment grew 12% yoy in the third quarter, thus
maintaining the growth momentum of previous quarters. Robust growth in the
cooling products segment has been due to the renewed thrust on the residential
AC segment.
n The room AC industry was seeing strong growth till Feb 2011 and AC makers
had built inventory in anticipation of robust demand. However, the summer season
of 2011 has been unexpectedly weak for the AC manufacturers. Consequently,
most leading players are saddled with unsold inventory. As a matter of
fact, the industry posted a degrowth in volumes in Q3 FY12. We understand that
the slack demand scenario may continue given weather forecast of an extended
winter season spilling into March this year.
n The professional electronics business posted a growth of 16% yoy, reflecting
impact of general slowdown in demand for industrial products.
Segment revenues
(Rs mn) Q3FY12 Q3FY11 YoY (%)
Central Air Conditioning (CAC) 3677 4342 -6
Cooling products 1637 1278 15
Professional electronics 520 448 -20
Source: Company
Project cost pressures resulted in decline in EBITDA
n Sharp erosion in profitability of the CAC segment resulted in a overall loss at the
EBITDA level. Several ongoing projects (lumpsum turnkey) have been delayed
well beyond their schedule completion and the management is taking steps to
either expedite those or curtail the scope of work. Given the age of these
projects, cost variation between the estimated costs and actuals on these
projects are quite significant on account of the firm commodity price increases in
the last two years. Thus, the company had provided for these cost overruns in H1
FY12 and has continued the process in the third quarter as well. The management
foresees continued margin pressure for the coming 3-4 quarters in the
projects business.
n The main driver of cost pressure has been the prices of non-ferrous metals like
Copper and Aluminum (while commodity prices have softened recently but rupee
depreciation has offset the benefit). During FY11, the company's consumption
of non-ferrous metals increased from 4310 tons in FY10 to 8336 tons. However,
due to the sharp rise in the prices of copper and Aluminum, the cost incurred
on these commodities rose from Rs 1.0 bn to Rs 2.6 bn. Since most of the
company's projects are fixed prices, the company had to incur heavy cost overruns
on these projects.
n Projects in the Building Electricals segment, long gestation infrastructure projects
and a few projects executed for Builders and General Contractors have been
severely impacted by cost overruns.
n The cooling products segment reported sharp drop in margins on a sequential as
well as yoy basis as the industry has been reeling under cost pressures (Copper
and Aluminum) and excess inventory in the system. The recent depreciation in
Rupee has further exacerbated the cost pressures.
Segment margins
(%) Q3FY12 Q3FY11 Q2FY12
Central AC -4.1 6.7 -0.9
Cooling products 4.4 7.9 5.4
Professional electronics 22.5 26.1 29.2
Source: Company
Significant MTM loss on account of forex movement
During the quarter, the company incurred MTM loss of Rs 137 mn which was included
as part of interest expenses. The company is a net importer of commodities
like copper and Aluminum to the extent of 15% of revenues. Due to the sharp depreciation
in Rupee vs the USD, the company had to incur MTM losses on its
unhedged positions. We expect the situation to improve in Q4 FY12 as the INR has
appreciated by around 5-6% from lows.
Order booking continues to be depressed
n The Central Airconditioning projects business is a play on the domestic commercial
real estate activity in the country. IT/ITES which is one of the major drivers of
Central Airconditioning systems has not moved to capacity building as yet given
sufficient room for utilization of existing space. The retail segment has slowed
down. Moreover, the commercial real estate remains oversupplied. Given these
factors, the company expects the order intake to remain sedate for the coming
3-4 quarters.
n On a quarterly basis, estimated order intake is down 23% yoy to around Rs 5.8
bn. Sequentially, order intake is down 14% qoq. Order intake has progressively
weakened in the past two quarters, an indication of subdued project activity.
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 into 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 at Rs 21.6 bn is up 4% yoy, providing revenue visibility at 10.8
months of trailing four quarter revenues.
Capital engagement has declined - a silver lining
The capital employed in Central Airconditioning (CAC) has remained high on a yoy
basis but sequentially it has declined. 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. There has been a general slowdown
in cash collection cycle. The management is focusing on tighter control over its
working capital.
The company has taken several measures at correcting its working capital cycle
through intense follow-ups with clients, closing of jobs that have been extensively
delayed and enforcement of contractual terms.
Capital employed
(Rs mn) Q3FY12 Q3FY11 Q2FY12
Central AC 4986.8 5256.2 6377.0
Cooling products 2328.5 1112.9 2699.8
Professional electronics 677.3 637.9 754.8
Source: Company
Business Outlook
n Outlook for the company's business continues to be weak atleast until the next
12-18 months due to oversupply in the commercial real estate front.
n CAC segment margins would continue to be at current depressed levels (relative
to earlier years) in the foreseeable future, though there is expected to be improvement
on a progressive basis in FY13. Order book continues to be largely
fixed-price based hence the pressure on margins due to inflation. The Company
targets to restructure its capital employed while simultaneously focusing improving
the quality of new orders with respect to margins and payment terms.
n Margin pressure continues to be a concern in cooling products segment as well,
and the Company has initiated several actions including price increases as well
as value engineering and product cost reduction efforts that should yield results
in early FY13.
n It is noteworthy that the Company has battled through several challenging periods
in its seven-decade history and has been able to adapt well to the circumstances.
We take comfort from the fact that the underlying demand for its products
and services are driven by increasing urbanization, rising incomes and infrastructure
investment. These are long-term demand drivers. Moreoever the company
commands a market leadership position.
n The Company expects to return to the growth path in the next financial year,
and is focused on returning to profitability on a stand-alone quarterly basis from
Q1FY13.
Earnings revision driven by lower growth outlook
FY12 earnings have been revised sharply down in view of the loss posted by the
company in 3Q FY12 and MTM impact.
Earnings estimates
Earlier Revised Earlier Revised
(Rs mn) FY12 FY12 FY13 FY13
Revenue 28328 27947 31248 28003
EBITDA (%) 6.3 2.3 8.8 8.3
EPS (Rs) 9 (3) 16 12
% change -137 -24
Source: Kotak Securities - Private Client Research
Target Price Revision - Reiterate Reduce
In view of the near-term issues related to margin pressure, longer working capital,
oversupply in commercial real estate, increased cost pressures in room ACs, we
have reworked our target price which now stands at Rs 188 (Rs 227 earlier). Although,
the worst in terms of earnings may be over for the company, we maintain
our REDUCE rating on the stock in view of lack of visible triggers in the near term
coupled with weak business outlook
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
BLUE STAR LTD
PRICE: RS.178 RECOMMENDATION: REDUCE
TARGET PRICE: RS.188 FY13E P/E: 14.2X
Numbers are sharply lower than expectations mainly due to loss in the
Central Air Conditioning projects business and MTM loss on forex exposure.
The company during the quarter may have continued with its process of
short-closing of sluggish projects and has booked losses on such projects.
Thus, as a prudent measure, the company has front-loaded most of the
foreseeable costs in the quarter. Consequently, the performance should
improve progressively in the coming quarters. However, given the cost
inflation, change in profile of order book and presence of low margin
orders, EBITDA margins may continue to remain below normal levels in
FY13 as well.
Amidst the poor set of numbers, we take note of the fact that the company
has been able to reduce its capital engagement in the projects business. The
company has also repaid part of its outstanding borrowings. This as a
positive development.
Medium-term outlook for the Central Air-conditioning business continues to
remain negative given over-supply in office space, which is translating into
sedate order intake.
In view of the near-term issues related to margin pressure and weak order
intake, we have reworked our target price which now stands at Rs 188 (Rs
227 earlier). Although, the worst in terms of earnings may be over for the
company, we maintain our Reduce rating on the stock in view of lack of
visible triggers in the near term coupled with weak business outlook.
Contracting environment remain challenging
n For the third quarter, net revenues are down 4% yoy primarily due to the lead
segment Electromechanical projects posting a decline of 15% yoy in Q3 FY12.
n The electromechanical projects 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. Since Q4 FY11, billings and cash flow were adversely impacted due to
slowdown in the completion of large projects.
n The company has been focusing on managing the capital employed in the segment
with a view to retrieve capital already employed. Basically, the company is
linking project completion to payment of overdue receivables. The downside of
this is that while there is better control on working capital, the revenue recognition
is getting sluggish. However, in our view the management's strategy is appropriate
in the current environment as the focus should be on cash management
rather than on revenue growth.
n The cooling products business comprises room airconditioners and refrigeration
products and systems. This segment grew 12% yoy in the third quarter, thus
maintaining the growth momentum of previous quarters. Robust growth in the
cooling products segment has been due to the renewed thrust on the residential
AC segment.
n The room AC industry was seeing strong growth till Feb 2011 and AC makers
had built inventory in anticipation of robust demand. However, the summer season
of 2011 has been unexpectedly weak for the AC manufacturers. Consequently,
most leading players are saddled with unsold inventory. As a matter of
fact, the industry posted a degrowth in volumes in Q3 FY12. We understand that
the slack demand scenario may continue given weather forecast of an extended
winter season spilling into March this year.
n The professional electronics business posted a growth of 16% yoy, reflecting
impact of general slowdown in demand for industrial products.
Segment revenues
(Rs mn) Q3FY12 Q3FY11 YoY (%)
Central Air Conditioning (CAC) 3677 4342 -6
Cooling products 1637 1278 15
Professional electronics 520 448 -20
Source: Company
Project cost pressures resulted in decline in EBITDA
n Sharp erosion in profitability of the CAC segment resulted in a overall loss at the
EBITDA level. Several ongoing projects (lumpsum turnkey) have been delayed
well beyond their schedule completion and the management is taking steps to
either expedite those or curtail the scope of work. Given the age of these
projects, cost variation between the estimated costs and actuals on these
projects are quite significant on account of the firm commodity price increases in
the last two years. Thus, the company had provided for these cost overruns in H1
FY12 and has continued the process in the third quarter as well. The management
foresees continued margin pressure for the coming 3-4 quarters in the
projects business.
n The main driver of cost pressure has been the prices of non-ferrous metals like
Copper and Aluminum (while commodity prices have softened recently but rupee
depreciation has offset the benefit). During FY11, the company's consumption
of non-ferrous metals increased from 4310 tons in FY10 to 8336 tons. However,
due to the sharp rise in the prices of copper and Aluminum, the cost incurred
on these commodities rose from Rs 1.0 bn to Rs 2.6 bn. Since most of the
company's projects are fixed prices, the company had to incur heavy cost overruns
on these projects.
n Projects in the Building Electricals segment, long gestation infrastructure projects
and a few projects executed for Builders and General Contractors have been
severely impacted by cost overruns.
n The cooling products segment reported sharp drop in margins on a sequential as
well as yoy basis as the industry has been reeling under cost pressures (Copper
and Aluminum) and excess inventory in the system. The recent depreciation in
Rupee has further exacerbated the cost pressures.
Segment margins
(%) Q3FY12 Q3FY11 Q2FY12
Central AC -4.1 6.7 -0.9
Cooling products 4.4 7.9 5.4
Professional electronics 22.5 26.1 29.2
Source: Company
Significant MTM loss on account of forex movement
During the quarter, the company incurred MTM loss of Rs 137 mn which was included
as part of interest expenses. The company is a net importer of commodities
like copper and Aluminum to the extent of 15% of revenues. Due to the sharp depreciation
in Rupee vs the USD, the company had to incur MTM losses on its
unhedged positions. We expect the situation to improve in Q4 FY12 as the INR has
appreciated by around 5-6% from lows.
Order booking continues to be depressed
n The Central Airconditioning projects business is a play on the domestic commercial
real estate activity in the country. IT/ITES which is one of the major drivers of
Central Airconditioning systems has not moved to capacity building as yet given
sufficient room for utilization of existing space. The retail segment has slowed
down. Moreover, the commercial real estate remains oversupplied. Given these
factors, the company expects the order intake to remain sedate for the coming
3-4 quarters.
n On a quarterly basis, estimated order intake is down 23% yoy to around Rs 5.8
bn. Sequentially, order intake is down 14% qoq. Order intake has progressively
weakened in the past two quarters, an indication of subdued project activity.
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 into 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 at Rs 21.6 bn is up 4% yoy, providing revenue visibility at 10.8
months of trailing four quarter revenues.
Capital engagement has declined - a silver lining
The capital employed in Central Airconditioning (CAC) has remained high on a yoy
basis but sequentially it has declined. 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. There has been a general slowdown
in cash collection cycle. The management is focusing on tighter control over its
working capital.
The company has taken several measures at correcting its working capital cycle
through intense follow-ups with clients, closing of jobs that have been extensively
delayed and enforcement of contractual terms.
Capital employed
(Rs mn) Q3FY12 Q3FY11 Q2FY12
Central AC 4986.8 5256.2 6377.0
Cooling products 2328.5 1112.9 2699.8
Professional electronics 677.3 637.9 754.8
Source: Company
Business Outlook
n Outlook for the company's business continues to be weak atleast until the next
12-18 months due to oversupply in the commercial real estate front.
n CAC segment margins would continue to be at current depressed levels (relative
to earlier years) in the foreseeable future, though there is expected to be improvement
on a progressive basis in FY13. Order book continues to be largely
fixed-price based hence the pressure on margins due to inflation. The Company
targets to restructure its capital employed while simultaneously focusing improving
the quality of new orders with respect to margins and payment terms.
n Margin pressure continues to be a concern in cooling products segment as well,
and the Company has initiated several actions including price increases as well
as value engineering and product cost reduction efforts that should yield results
in early FY13.
n It is noteworthy that the Company has battled through several challenging periods
in its seven-decade history and has been able to adapt well to the circumstances.
We take comfort from the fact that the underlying demand for its products
and services are driven by increasing urbanization, rising incomes and infrastructure
investment. These are long-term demand drivers. Moreoever the company
commands a market leadership position.
n The Company expects to return to the growth path in the next financial year,
and is focused on returning to profitability on a stand-alone quarterly basis from
Q1FY13.
Earnings revision driven by lower growth outlook
FY12 earnings have been revised sharply down in view of the loss posted by the
company in 3Q FY12 and MTM impact.
Earnings estimates
Earlier Revised Earlier Revised
(Rs mn) FY12 FY12 FY13 FY13
Revenue 28328 27947 31248 28003
EBITDA (%) 6.3 2.3 8.8 8.3
EPS (Rs) 9 (3) 16 12
% change -137 -24
Source: Kotak Securities - Private Client Research
Target Price Revision - Reiterate Reduce
In view of the near-term issues related to margin pressure, longer working capital,
oversupply in commercial real estate, increased cost pressures in room ACs, we
have reworked our target price which now stands at Rs 188 (Rs 227 earlier). Although,
the worst in terms of earnings may be over for the company, we maintain
our REDUCE rating on the stock in view of lack of visible triggers in the near term
coupled with weak business outlook
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