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Healthy margins, growth recovery to fuel earnings

Blue Star has reported strong 260bps YoY improvement in EBIDTA margin and room AC segment witnessed strong growth of 32% YoY vs industry growth of 25% YoY. The company increased its market share marginally to 13% in room AC and is optimistic on growth prospects of the same. Increase in commodity prices may impact the overall margins and decision on pricing will be taken in March 2021. Taking cognisance of the muted performance of the project division, we cut earnings by 12.3% and 20.8% for FY21E and FY22E, respectively. Given the impact of commodity prices, delay in recovery of project division and overall rich valuation, we maintain REDUCE with a revised target price of Rs658 (previously: Rs674).

* Strong growth in room AC and market share improvement: Room AC segment has witnessed strong growth of 25% YoY in Q3 and Blue Star grew 32% YoY, increasing the market share by 100 bps YoY to 13%. The management is confident regarding the recovery in demand and will be taking a call on pricing by March 2021, once commodity prices stabilise and summer demand clarity emerge.

* Working capital eases improving overall cashflow: Overall capital employed reduced 8.1% YoY led by 18% reduction in projects and 11.3% reduction in UCP. This has led to a reduction in debt and improvement in cashflow.

* 'Atmanirbhar Bharat' push will be an overhang for medium- to long-term margins: The recent policy actions by the government towards self-reliance can lead to an increase in cost structure for room AC industry. Management believes 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 room AC industry. Blue Star is planning to participate in the PLI scheme as it already has plans for capacity augmentation in Sri-city.

* Project execution to remain slow and margins muted: The management will be prioritising execution for projects where its chances of collections are higher based on customer’s credit-risk assessment. The overall order intake for the quarter declined 15.6% YoY to Rs6.4bn. Current overall orderbook stands at Rs31.6bn (1.2x TTM project sales) vs Rs28bn in Q3FY20. The EMP segment orderbook grew 13.4% YoY to Rs22bn.

* Maintain REDUCE on rich valuation and margin risk: Delay in scale-up of water purifier division is adversely affecting the overall margins and RoCE. The company is also unable to expand its footprint overseas as earlier targeted. Project division is facing both growth and margin challenges in near term and commodity price increase may impact UCP margins. We believe current valuation of 37.4x FY22E earnings is rich; hence, we maintain our REDUCE rating with a revised target price of Rs658 (30x Sep’22E earnings) from Rs674 earlier.

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