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Event update: Capital Goods - RAC custom duty hike to have limited impact

Event

In the Union budget, custom duty has been hiked on import of Outdoor Units (ODU) and Indoor units (IDU) of split room air conditioners (RAC) from 10% to 20%.

Details

• Earlier in September 2018, custom duty was hiked from 10% to 20% on imports of complete units (composite IDU and ODU). The impact of this hike was not much as most of the RAC players did not have significant imports of composite or complete units.
• Most players, typically import IDUs, while ODUs are largely sourced from indigenous sources, either via in-house manufacturing or local outsourcing.
• With the increase in custom duty on IDUs, we expect an increase in cost of ~Rs500/unit for players importing IDUs (typical cost of IDU at Rs5000/unit). This would require a ~1% hike in RAC prices by players to pass on the impact of higher costs.
• Considering the onset of lean season, the players are likely to absorb the hike. However, given lower volumes and likely inventory as also mix of sourcing of IDUs (part indigenous sourcing), the hike would have limited impact on profitability over the near term.

Valuations & view

• As per our earlier channel checks (), players are shifting towards higher localisation to restrict the impact of rupee depreciation, custom duty hikes as also to have flexibility in manufacturing to be able to respond effectively to market dynamics. Accordingly, as companies improve their share of indigenous sourcing of IDUs via in house manufacturing or domestic outsourcing, the impact of these custom duty hikes is likely to ebb over the medium term.
• We believe the key beneficiary of localisation would be Amber Enterprises, one of the few EMS companies manufacturing complete range of IDUs. As seen in FY19, Amber has seen sharp growth in IDU volumes driving ahead of industry volume growth in FY19. We believe the trend is likely to continue over the next few years. 
• As per our interaction with various players, the maximum impact would be seen by Indian players which have higher level of IDU imports such as Voltas, Bluestar, Havells, Godrej, etc. However, considering the limited cost increase as also mix of sourcing would not have a material impact on costs and thereby on margins.

·      Overall, we remain positive on the RAC industry considering the structural drivers in place for sustained growth such as low penetration, improved power availability, improving affordability as also availability of energy-efficient products.