Management Speak: Blue Star (Neutral) - Laying the foundation for strong growth

Key takeaways of our meeting with the Blue Star management:

Strategy for 25% PAT CAGR over next 5 years: Blue Star outlined its long-term business strategy to surpass market growth and gain market share across segments. The company expects to support growth through differentiated and innovative products and services. In a bid to achieve profitable growth, Blue Star intends to enhance backward integration, value add manufacturing process to de-risk against imports and also improve quality and productivity. Growth will also be driven by adjacencies in segments such as Air coolers & purifiers, kitchen refrigeration, etc. Accordingly, the company is targeting 20% revenue, 25% PAT CAGR and 30% RoCE over the next 5 years.

Focus on market share gains in North India for RAC: Blue Star aims to increase its RAC market share from 12% currently to 15% over the next 5 years by 1) focusing on the North market, in which Blue Star has 5-7% share; this market comprises 36% of India’s RAC market; 2) strategically expanding distribution network from 4,500 to 6,000 touch points, particularly in North, where its reach is barely 25% of the market leader’s reach, 3) continued premiumization and enhanced customer service. The company expects the weak season to drive muted 3% industry volume growth in FY19 (8% yoy decline in 1HFY19). Currently, the Industry has inventory of 0.6m (typically at 0.3m).

MEP projects & products – gaining market share: Blue Star’s projects business has a healthy order backlog; the company is focused on retaining its market leadership in buildings MEP, consolidating and increasing market share in infrastructure projects as also focusing on higher margin opportunities in factory & industrial projects. Blue Star expects to sustain growth in the central cooling space and focus on enhancing market share from 16% & 14% in VRF & Chillers, respectively, to 20%. The company’s plan is to enlarge market share by improving product mix, expand reach, and investing in technology and R&D. Although current orders are funded, management remains cautious, as it sees challenges in booking new orders on deepening liquidity crunch.

Valuation and view

Blue Star has emerged as a leading RAC and central cooling player through a robust product portfolio (strong presence in inverter RACs) and a premium brand image, which the company 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 25% earnings CAGR over FY18-20E, in our view. A healthy balance sheet, led by FCF generation and strong dividend payouts should help post strong return ratios. We believe valuations factor in all the positives at 27x FY20E earnings. Neutral.