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Reduce Blue Star Ltd For Target Rs.764

Uncertain outlook and margin stress

Blue Star has reported strong 68% YoY growth in revenues driven by robust demand in North markets for room ACs and healthy project execution. Room AC segment witnessed impressive growth of 58% YoY vs industry growth of 55% YoY, implying a marginal increase in market share to 13%. Despite 5-8% price hikes, margins were low due to high marketing and normalisation of operating expenses.

E-commerce channel sales were strong given the pandemic situation. Factoring-in the lower margins of Q1FY22, we cut earnings by 11.6% and 6.9% for FY22E and FY23E respectively. Given the cost pressures leading to margin stress and overall rich valuations, we maintain REDUCE with a revised target price of Rs765 (previously: Rs658).

* Strong growth in room AC segment and market share improvement: Room AC industry witnessed robust 55% YoY growth in Q1FY22 and Blue Star grew 58% YoY, with current market share of 13%. Company took 5-8% price hikes during Jan’21 and again 3-4% in Apr’21, the impact of which is likely to be reflected with a lag. The uncertainty of any likely change in emission norms in Jan’22 deadline will be a key determinant of overall growth in H2FY22.

* Margin stress continues to limit earnings growth: Despite the strong revenue growth, margins were under stress due to higher marketing expenses, commodity prices and normalisation of other expenses, and brand-related spending.

* Atmanirbhar Bharat push will be an overhang for medium to long term margins: Recent policy actions by the government towards self-reliance can lead to an increase in cost structure for the room AC industry. Management believes the shift will be gradual and will provide a level playing field for all. This will be a key development to watch out for given the high dependence on Chinese imports by the room AC industry.

* Exploring opportunities to participate in PLI scheme: Though the current PLI scheme is not for finished products, the company is exploring opportunities in some components. This is currently in the evaluation phase.

* Maintain REDUCE on rich valuations, and margin risk: Delay in scale-up of the water purifier division and normalisation of other expenses is adversely affecting overall margins and RoCE. Uncertainty on energy norm changes and cost pressures are likely to further impact margins. We believe the current valuation at 34.5x FY23E earnings is rich, hence we maintain REDUCE rating with a revised target price of Rs764 (30.7x FY23E earnings) vs Rs813 earlier.

Outlook and valuation

The stock is currently trading at 46x FY22E EPS of Rs18.5 and 34.5x FY23E EPS of Rs25. Increase in freight costs, commodity prices, pricing pressures and higher spend towards branding and marketing are likely to keep overall margins under stress. Given the delay in scale-up of water purifier business, execution and margin challenges in projects and commodity pressures in UCP, we maintain REDUCE on the stock with a revised target price of Rs765 (earlier: Rs658).

We value the stock at a target P/E multiple of 29.4x FY23E earnings. Our target multiple of 30.7x FY’23E earnings is based on a weighted EBIT contribution average of 40x for UCP segment, 20x for EMP segment, and 20x for professional electronics and industrial equipment segment (table-1). Focus towards technology, in-house manufacturing and introduction of new products will be long-term growth drivers for Blue Star.

Company is exploring any lucrative opportunities under the recently announced PLI scheme for components of air conditioners. Any announcement under the same will have a positive impact. Implementation of the change in energy efficiency table due in Jan’22 will also result in pre-buying during Q3FY22.

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