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Crisis in peak season poses risk to AC offtake

The initial few days of the summer season were strong (Mar’21), with higher secondary sales reported in Air Conditioners (ACs). However, the recent announcement of state-wide lockdowns has dented consumer sentiment in a key season for ACs. In this report, we delve into the key risks and outlook.

* COVID-led disruption comes at the wrong time for AC industry:

AC is a highly seasonal product, with ~70% of calendar year primary sales in this category reported over January–June. In fact, the three-month period from March to May accounts for 50% of CY sales. Any disruption during this period results in a disproportionate impact on industry sales. Moreover, since ACs require installations, implying house visits by technicians, the consumer may be hesitant to purchase ACs in the current situation – although, we understand that companies did manage this technicality last time around.

* April sales adversely impacted, similar to FY20– a Déjà vu moment:

The onset of the summer season was strong, leading to channel filling in Mar’21. This was also partly due to expected price hikes in Apr’21 on account of inflationary pressure in commodity costs. However, the second COVID wave ultimately led to the announcement of lockdowns across various key consumption states in Apr’21. This has been a dampener for secondary sales across key geographies in the country, with South faring marginally better than other regions—this appears to be almost a replay of last season.

* Current situation could lead to washout in key summer season:

Feedback from the channel was that the loss of 8–15 days does not pose a high risk for summer products (fans, air coolers, and ACs) – as sales could be recouped in May’21 based on the ongoing strong summer demand. However, the advent of the second COVID wave in India has led to states such as Maharashtra and Uttar Pradesh extending restrictions, with other states following suit (such as Delhi, Jharkhand, and Haryana). Also, as per channel feedback, the impact of the second COVID wave could potentially lead to demand postponement by the end consumer, thus further posing a risk to AC sales in the key season. Notably, ACs was a trailing product category last year. Pent-up demand played out within months for non-seasonal/non-discretionary products, while pent-up demand was expected to play out in ACs this season.

* Commodity inflation and rising competitive intensity pose risk to margins:

The uptrend in commodity prices has continued, with various commodities such as copper/aluminum/steel seeing a 16%/7%/10% QoQ rise (up 61%/30%/45% YoY) in 4QFY21. While price hikes are relatively easier in Consumer Electricals, taking hikes in Consumer Durables is challenging. Also, based on channel feedback, Samsung has turned aggressive in the AC market and gained market share from fringe players. This poses a risk to the Top 5 players – as Samsung has an established distribution network in the Durables segment. Also, almost all of the AC companies refrained from taking price hikes in Apr’21 due to state-wide lockdowns and higher competitive pressure.

* Valuation and view:

We cut our FY22/FY23E EPS for Voltas by 8%/3%, lowering our target multiple to 50x from 55x earlier, to arrive at TP of INR1,060 (prior: INR1,170). We maintain our Neutral rating on Voltas. We assign a Sell rating to Blue Star as the stock trades more expensive than Voltas, adjusted for the Projects business. Also, BLSTR remains a single-product company, while VOLT is expanding into the wider White Goods space in Refrigerators and Washing Machines.

The restructuring of VOLT’s Projects business may be the precursor to a demerger and could help sustain higher multiples. On a relative basis, VOLT scores over BLSTR as an investment thesis. We prefer Consumer electricals over consumer durables, with Orient Electric (OEL) and Crompton Greaves Consumer Electricals (CROMPTON) as our top picks.

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