Blue Star: Conditioned well to the market conditions?

Blue Star

What should you do when a marquee investor trims its exposure to a leading company in a sunrise sector?

Well, the tempting answer could be to follow the footsteps of the marquee investor. But doing so blindly isn’t the most intelligent way to manage your investment.

Blue Star is a case in point. And the marquee investor is HDFC Mutual Fund.

As per the disclosures made to the stock exchanges, HDFC Mutual Fund sold 19.1 lakh shares of Blue Star on March 12, 2021, from two of its schemes—HDFC Long Term Advantage and HDFC Mid-cap Opportunities. With this, the aggregate holding of the schemes of HDFC Mutual Fund in the paid up equity share capital of Blue Star reduced to 3.49% from 5.50% earlier.

The company management is participating in two virtual investor conferences scheduled to be conducted on March 23, 2021.

On this backdrop, we decided to do a quick scan of the company’s fundamentals.

Macro factors for any company (not just Blue Star) dealing in air conditioning products and services are strong. Market penetration of air conditioners in India is still 6% against the global average of 30%. With India aiming to become a manufacturing hub and committing more funds to ramping up infrastructure development and healthcare facilities, the scope for air conditioning products in the commercial/institutional space remains immensely high.

Composition of India’s air conditioning market

(Source: Company records)

Blue Star operates in three segments namely:

  1. Electro-mechanical projects and commercial air conditioning systems (contributes ~52% based on FY20 earnings)
  2. Unitary Products (contributes ~42% based on FY20 earnings)
  3. Professional electronics and industrial systems (contributes ~6% based on FY20 earnings)

In other words, electro-mechanical projects and commercial air conditioning is a B2B (Business-to-Business) segment, while the unitary products segment, which includes cooling appliances and cold storage products, is the B2C (Business-to-Consumer) component.

Professional electronics and industrial systems is a third-party distribution business. Nonetheless, the company also engages as a system integrator and value-added re-seller.

How has the quarterly performance of Blue Star been?

Quarterly results declared by the company so far in FY21 suggest that, the institutional business hasn’t gone back to the pre-COVID level yet. But, the company has been seeing a good traction in its B2C segment.

Within the institutional space, the composition of the company’s order book has been substantially different than that during the pre-pandemic times. Unlike then, the demand from the commercial offices sector and IT parks has dried up. Instead, manufacturing related segments, healthcare, commercial refrigeration, cloud kitchens and cold storages have emerged as high growth areas.

Speaking about the B2C business of the company, the demand for room air-conditioners has picked up from Q2FY21. The festive season was exceptional for the company. Work From Home (WFH) has been driving the sales of room air conditioners these days.

Report Card: Blue Star

(Source: Company records)

Despite operating in a very competitive environment, the company has been able to hike prices of its products in the range of 5%-10% across the board. Considering a massive jump in the prices of some key raw materials such as steel, copper and ABS plastic, the company hasn’t ruled out another price hike in the foreseeable future.

What does the future for Blue Star look like?

According to information available in the public domain, the company management is aiming to grow its market share in the B2C business from the present 13% to 15% by FY23. Slightly near term outlook appears bright too with the management expecting ~20% growth in the B2C segment and that in the commercial refrigeration.

Blue Star’s board-approved strategic growth plan reveals that the company endevours to:

  • Grow faster than the market in its core business
  • Improve profitability through economies of scale and backward integration
  • Expand the distribution network
  • Increase the share of e-commerce
  • Enhance the product portfolio

In Q3FY21, the government banned the import of air conditioners with refrigerants. This move is expected to affect small players importing the entire unit, and not just compressors and refrigerants. Small players collectively have a market share of about 10%. At present, the top 6-7 players collectively hold ~90% of the Indian air conditioning market.

According to the CEAMA-Frost & Sullivan report, India’s room air conditioning market is likely to grow ~2.5 times by 2025—from 6.5 million units in 2019 to 16 million units in 2025.

Blue Star has been expanding its existing capacities for the range of commercial refrigeration products using some of the most advanced manufacturing techniques, including virtual factory simulation and 3D modeling, to name a few. The company is hopeful that the new capacities will come on-stream in FY22. Blue Star optimizes its manpower through robotic interventions.

Blue Star to expand its online presence

Only about 5% of sales of unitary appliances comes from e-commerce, at present. The company intends to grow its online sales to 20% by FY24. It has been enhancing process automation and introducing more analytics-driven tools to optimise visibility.

The recent developments have been interesting

Historically, Blue Star has catered to the premium segment in the household air conditioning market.  Unfortunately, the premium market is unlikely to give Blue Star a scale that it aims to achieve to be able to expand its market share by 2% in the next two years. Recent launches by the company in the affordable split air conditioning segment indicate that it’s getting rather aggressive about the mass market now.

The sales pitch of the company to appeal to the market has been: Affordability while retaining Blue Star’s ‘Premium Build Quality. Blue Star has an extensive distribution muscle comprising 7,000 outlets at 650 locations and 200 brand exclusive stores. It plans to add 50 more exclusive stores by the end of FY22.

Valuations

On FY20 earnings, Blue Star trades at the Price-to-Earnings (P/E) multiple of ~61. The P/E ratio drops marginally to ~59 at annualized Q3FY21 earnings.

By no means is this valuation cheap. However, the valuations have been high for quite a few businesses that represent a huge untapped market. Take the example of paint companies.

Bottom line:

B2C business is growing faster than the institutional business for now; however, that remains a crowded space where the competition from domestic and international players is intense. Although the company has managed to pass on rising costs to consumers so far, will mass-market products offer it such leeway going ahead? That’s crucial to watch.

The rapidly expanding room air conditioners market is a positive, though.

Speaking about institutional business, the management guidance appears somewhat sombre. Healthcare and commercial refrigeration would be the key segments to monitor while gauging Blue Star’s performance.

Q4FY21 numbers will tell us if the company has managed to carry forward the growth momentum it witnessed in Q3 due to the festive season. Whether it can hike the prices beyond Q4FY21 and Q1FY22 would give an idea about how strong its pricing power is.

Disclaimer & Important disclosure

The blog is for information purposes only and shouldn’t be construed as part of or an extension to any stock recommendation made by Ventura Securities on any of its properties in the past or that it may make in future. Moreover, the references made herein to buying and selling decisions of marquee investor(s), are incidental to presenting the relevant information about the company discussed in the blog, and do not implicitly suggest anything.

The information presented in the blog could just be the starting point for deeper analysis that you might want to carry out on your own. You may also take professional help as you feel appropriate.

Our technical expert, Bharat K Gala, had discussed Blue Star on Ventura’s YouTube channel on February 27, 2021 as a momentum stock idea. For your convenience we have embedded the link below. If you follow his advice, you should also keep in mind crucial price levels he has highlighted in the video while taking appropriate action.

You may also like to read: Are you a long term investor? Don’t get scared by the inflation scare!

Disclaimer:

We, Ventura Securities Ltd, (SEBI Registration Number INH000001634) its Analysts & Associates with regard to blog article hereby solemnly declare & disclose that:

We do not have any financial interest of any nature in the company. We do not individually or collectively hold 1% or more of the securities of the company. We do not have any other material conflict of interest in the company. We do not act as a market maker in securities of the company. We do not have any directorships or other material relationships with the company. We do not have any personal interests in the securities of the company. We do not have any past significant relationships with the company such as Investment Banking or other advisory assignments or intermediary relationships. We are not responsible for the risk associated with the investment/disinvestment decision made on the basis of this blog article.

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