Blue Star's Q3FY19 results (Neutral) - Sharp margin deterioration

Q3FY19 result highlights

• Adj. PAT at Rs62mn (-53% yoy): Revenue +18% yoy to Rs11bn led by strong growth across segments. However, margins declined 70bps yoy to 3.9%, driving flat EBITDA on yoy basis to Rs423mn. However, higher interest cost and Rs145mn loss in Oman subsidiary impacted PAT.
• EMP revenues +16% yoy growth: to Rs6.5bn led by uptick in execution.  However, margins fell 79bps yoy to 4.6% on execution of low margin orders.
• Cooling revenue strong, but margins drop: 22% yoy growth in revenues to Rs3.9bn was driven by 35% yoy in commercial refrigeration & sustained traction in water purifiers. However, RAC saw moderate 8% yoy growth, ahead of industry, enhancing its market share to 12.8% (+50bps yoy). However, margins fell 252bps yoy to 2.4% due to inability to pass on higher RM and rupee depreciation, while increased discounts & schemes increased costs to liquidate inventory.
• Professional electronics saw strong performance: Revenue +15.6% yoy to Rs520mn and margins +333bps yoy to 13.2% led by value added products.

Conf call highlights: (1) Post evaluation of Oman market, mgmt has decided to exit the JV and has provided Rs145mn with no further loss/provision expected (2) Focus of intl opns will be on distribution of central air conditioning products (3) Both Bluestar and industry have liquidated large part of inventory at end of 3Q19. (4) RAC industry to see 0-5% growth in FY19, Bluestar at ~8-9% with ~8% margins (150bps hit on water purifier segment) (5) Central AC systems is seeing strong traction with Chillers & VRF growing 15% and 25% yoy vs industry seeing 11% and 18% yoy, Bluestar is the 3^rd largest player in VRF (6) Rs550mn water purifier sales in 9M19 resulting in 2.5% mkt share (Rs900mn revenues)

Key positives: Strong revenue growth across segments

Key negatives: Sharp decline in margins, particularly in cooling

Impact on financials: FY19/20 EPS cut by 6%/3% to Rs16.7/22.8

Valuations & view

Blue Star has emerged as a leading RAC and central cooling player through a robust product portfolio (strong inverter RACs presence) and a premium brand image, which Blue Star is looking to leverage to expand market share. Moreover, execution of profitable orders has enabled a turnaround in the EMP business. These measures should drive 26% earnings CAGR over FY18-21E, in our view. A healthy balance sheet, led by FCF generation should help post strong return ratios. We believe valuations factor in all the positives at 27x FY20E earnings. Neutral.