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BLUE STAR LTD
RECOMMENDATION: ACCUMULATE
TARGET PRICE: RS.365
FY12E P/E: 15.9X
In the Annual Report, the management has indicated that they were
aggressive in booking new business in the deteriorating environment and in
the process diluted their focus on cash flow and working capital, which has
resulted in higher borrowings.
Share of income from spares and services has declined in overall revenue,
which could be one of the reasons impacting profitability.
The annual report outlines slowdown in economic growth in FY12 and cites
challenges on cost and cash flow front.
The stock is trading at 15.9x FY12 earnings. In view of the near-term
challenges on business growth and cash flow front, we maintain cautious
view on the stock and maintain Accumulate with a revised price target of Rs
365 (Rs 372 earlier).
The main takeaways from our review of the Annual Report are
as under :
Electromechanical Projects business
n The Electromechanical projects 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. In Q4 FY11, billings
and cash flow were adversely impacted due to slowdown in the completion of
large projects.
n The estimated market size of the airconditioning industry was around Rs 130 bn
in FY11. Of this, market for central airconditioning including packaged/ducted
systems and VRF systems was about Rs 61 bn while that of room ACs was
around Rs 70 bn.
n Accordingly, the company's market share in central airconditioning segment
works out to around 27% (possibly the highest in the industry). However, in the
room ACs the company lags behind Voltas, LG and Samsung (mainly due to its
focus on institutional customers).
n During the year, the growth in the central airconditioning segment was driven by
healthcare, education and hospitality segment even as the commercial real estate
market slowed down further. IT/ITES segment may take a while to get into
an expansion mode.
n During the year, the company launched the VRF airconditioning systems with inverter
technology. This technology is suitable for multizone cooling through intelligent
controls resulting in cost savings. Blue Star now offers both the scroll compressor
as well as inverter technology for VRF applications.
n Among the major orders won during the year were Central airconditioning for
Terminal 2 of CSI Airport, Mumbai (Rs 1.2 bn). The company won several orders
in the healthcare and power sectors.
n To strengthen its offerings in plumbing and fire-fighting business, the company
acquired DS Constructions at a cost of Rs 1.0 bn. This subsidiary is now housed
under Blue Star Electro-mechanical Ltd.
Cooling Products business
n In the cooling products segment, the company has traditionally focussed on the
institutional segment but in FY11 the company made a thrust into the residential
segment with a wide range of stylish room airconditioners in 2,3 and 5 star ratings.
n The professional electronics business posted a growth of 14% yoy. This is a product
cum project business catering to the requirement of the industrial sector.
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.
Lower commission income and cost pressures resulted in decline in
EBITDA
n EBITDA margins declined 150 bps to 8.6% in FY11 from 10.9% in FY10 mainly
due to change in product mix (higher share of project revenues) and cost pressures.
n During the year, the share of income from spares and income from services also
declined in within the revenue mix, which may have further pressured the profitability.
Income from commission also declined from Rs 265 mn in FY10 to Rs 250
mn in FY11.
No sign of meaningful rebound in order booking
n Order backlog at Rs 19.7 bn is up 16% yoy, providing revenue visibility at 8.1
months of trailing four quarter revenues. After a slight pick up in August-September,
order finalizations have been delayed. Infrastructure projects are moving
slower than anticipated, the telecom industry has not returned to capital spending
and the IT sector is yet to commence building of development centres. As a
result, the order booking has been weak for the year.
Capital engagement has increased
n 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. There has been a general slowdown in cash collection
cycle. The management is focusing on tighter control over its working capital.
n In the Annual Report, the management has indicated that they were aggressive
in booking new business in the deteriorating environment and in the process diluted
their focus on cash flow and working capital, which has resulted in higher
borrowings.
Borrowings increased due to higher capital employed and acquisition
of DS Constructions
n Net working capital in terms of days of sales has increased to 79 days vs 41 days
in FY10 and 25 days in FY09. This is resulting in higher borrowed funds to finance
the working capital. There has significant increase in "other current assets",
which mainly reflects unbilled revenue for which revenue booking is pend-
ing but costs are incurred.
n During the year, the company also bought acquired DS Constructions for Rs 980
mn. These factors have resulted in the borrowings increasing to Rs 4.2 bn vs Rs
659 mn in FY10.
Capex
n The company incurred capex of Rs 280 mn in FY11 including mainly new manufacturing
unit at Himachal Pradesh
Business Outlook
n The annual report reflects that general economic outlook for the Indian economy
for FY12 and expects slower growth of GDP that in FY11. Rising interest rates
and slowdown in cash flow may impact business growth.
n The company has chalked out a 3-year strategic plan that addresses a number of
corporate priorities. The major focus areas include a) strengthening of R&D and
building product development capabilities b) upgrading technical and managerial
skills c) modernizing the project planning and execution process d) consolidating
and integrating the newly acquired businesses f) increasing market presence in
smaller towns.
Valuation: Stock likely to remain weak
n The stock is trading at 15.8x FY12 earnings. In view of the near-term challenges
on business growth and cash flow front, we maintain cautious view on the stock
and maintain Accumulate. In our DCF model, we have factored in higher working
capital, which has resulted in minor revision in price target to Rs 365 (Rs 372
earlier).
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