Blue Star

Blue Star has strengthened its position in the domestic central air-conditioning (CAC) market and is poised to tap opportunities in the cold storage segment. Steady growth, expanding profit margins and healthy cash position are factors that lend visibility to the earnings growth of the company. Investors can consider exposure in the stock with a two-three year perspective. At the current market price, the stock trades at 19 times its expected earnings for FY 2009.

Both Blue Star and Voltas have undergone significant re-rating in their PE multiples in the past year. Investors may, therefore, have to temper expectations as returns may not be of the same order as the past one year. Buy in lots to gain advantage from any volatility linked to broad markets.
CAC to drive growth

Blue Star’s central air-conditioning segment continues to be the key growth driver, with contribution of over 70 per cent to FY 2007 sales. Among the major user industries, IT and IT-enabled services and retail segments have accounted for the bulk of the revenues. Blue Star’s strength in the CAC segment arises from its well-rounded capabilities in mechanical, electrical and installation services and after-sales service.

In a move to further equip itself in the Mechanical, Electrical and Plumbing (MEP) area, Blue Star recently acquired Naseer Electricals, an electrical contracting firm. This move is likely to improve the company’s ability to win orders in the infrastructure and commercial segments that require supplementary engineering capabilities. Its success in bagging orders from Delhi Metro Rail Corporation and Nuclear Power Corporation indicate that it has already made progress in tapping infrastructure players.

Blue Star has also quickly made a mark in its telecom segment where it provides air-conditioning for cell sites. With a 185-per cent growth in FY 2007 segment revenue, Blue Star has a market share of 50 per cent in this business. With every cell site requiring air-conditioning, customers such as Bharti Airtel among its clients, and the significant expansion likely in tower infrastructure, we expect Blue Star to enjoy strong growth in this segment.

Blue Star is the preferred supplier for companies such as Infosys and Wipro and enjoys strong order flows from retail and real-estate players such as Pantaloon Retail, DLF and PVR. We expect the present activity in real-estate and expanding demand for space by IT/ITES to convert into order flow for Blue Star, given its entrenched status with corporates. In the super-market refrigeration segment, the company may benefit from its tie-up for equipment with Italy-based ISA on the back of an increase in super/hyper market formats in India.
Robust volumes from split air-conditioners

Blue Star’s room air-conditioner sales have also been clocking strong volumes. While competition in this segment is intense, the company has higher revenue contribution from commercial users, thus reducing competition to some extent. This strategy provides twin benefits of superior profit margins and repeat orders from corporate clients.

Within the home segment, Blue Star has capitalised from the increasing market preference for split air-conditioners compared to window ACs. In 2007, the company’s split AC volumes grew by over 75 per cent as against industry average growth of 47 per cent.

Higher volumes, combined with lower costs arising from its plant in Himachal Pradesh (which enjoys tax exemption for five years), has resulted in increased profitability for this segment. Split AC sales could continue to drive growth in the cooling products business.

For the quarter ended December 2007, Blue Star’s operating profit margins jumped over 4 percentage points to 10.8 per cent, while net profit margin also rose over 3 percentage points.

A better product mix, higher volumes and gains on imported raw material due to a depreciating dollar led to improved margins.

While price re-negotiations by suppliers due to a weakening dollar could mute some gains in future, volume growth and the company’s plan to maximise production at its Himachal Pradesh plant could help profits grow at a healthy pace.