Blue Star Ltd Q1 FY2023 Concall Summary

Key Takeaways

• Demand surge, margins still healing: Revenue jumped across all segments as the first normal summer in three years drove a demand surge, but EBITDA margin at 6.3% remains well below management's own "reasonable" target, with commodity cost relief not expected until September.
• The pull-forward question: Demand started slowing from May onwards, with June lower than May, as pre-buying ahead of expected price increases and an early peak in March-April pulled demand forward, raising questions about H2 momentum.
• Unitary products margin path is structural, not cyclical: Management sees room AC EBIT topping out at 12%, not the 14-15% some hoped for, with PLI benefits likely to be competed away into lower prices rather than retained as margin.
• EMP order book is the quiet strength: A Rs 390 cr Bangalore Metro win and a healthy pipeline across factories, data centers and infrastructure give visibility, with management confident in sustaining ~6% segment margins alongside healthy cash flow.
• What to watch next quarter: Whether the September commodity tailwind actually materializes and flows through to margins, the pace of festival-season demand, and any sign that the May-June demand deceleration was a blip rather than a trend.

Demand: Surge, Then a Softening

• The Q1 surge was real and broad: After two consecutive summers disrupted by the pandemic, Q1FY23 saw business and economic activities return to complete normalcy. The company outperformed in every business segment compared to Q1 of the last three years, with unitary products revenue growing 163% and commercial air conditioning growing 57%.
• But demand started softening from May: May was lower than April, and June lower than May. Management attributed this to two forces: peak demand shifting to March-April as consumers now buy when temperatures shoot up rather than waiting, and pre-buying by dealers and customers who anticipated price increases and purchased ahead of the usual season.
• Consumer sentiment took a hit late in the quarter: Interest rate hikes around May-June increased the cost of consumer finance schemes, and petrol price increases further dented customer sentiment, adding headwinds to the already softening demand trajectory.
• Supply chain planning cushioned the comparison: Blue Star planned for January-June as a block and secured its supply chain in advance. Compared to January-June 2019, the last real summer, the period grew approximately 30% for the industry, and Blue Star outperformed that.

Thiagarajan: "In the event of a slowdown, it takes time to impact the air conditioning refrigeration industry and similarly when there is revival also it takes time to impact."

Margin Recovery: A Story of Patience

• Q1 margin improvement was real but incomplete: EBITDA margin improved to 6.3% from 4.0% a year ago, driven by revenue growth, price increases taken in the first week of April, and continued cost focus. But management was explicit that this is not nearly enough.
• Commodity headwinds will persist through Q2: Raw materials for Q2 were already in the pipeline at higher costs. Just as margin impact was delayed when commodity prices first rose due to lower-cost inventory, the reverse will also take time. Positive margin impact from softening commodity prices is expected only from September onwards.
• The H2 margin bridge, if commodities cooperate: Management indicated that if commodity softening continues, H2 EBIT margin could improve by approximately 200 bps, with the peak quarter reaching around 10% and the full year around 9%.
• Three structural margin levers are in play: Product redesign to address the belly of the market through an affordable premium range, a total cost management program, and operating leverage from increased scale. An additional tailwind: industry advertising spend as a percentage of revenue is structurally declining, benefiting all players.
• Sri City plant adds a logistics edge: The new plant, expected to commission by October-November 2022, will receive raw material via Krishnapatnam and Ennore ports and enable overnight finished goods movement to southern states, providing a sustainable logistics cost advantage.

Thiagarajan: "While we are happy that to an extent we are able to improve the margins, we still have a long way to go in order to get back to the reasonable margin levels."

Unitary Products: The Margin Ceiling Debate

• Room AC delivered 163% revenue growth: Strong demand and a new range of affordable mass-premium products that were very well received drove performance. The company grew in line with the market and gained share across product categories.
• Management drew a line on margin ambition: Asked whether the room AC business could become a 14-15% operating margin business, management was unequivocal: a 12% EBIT is feasible, but 14-15% is not. The 8-10% operating margin range is viewed as sustainable even with competition.
• PLI benefits will grow the market, not margins: Management expects PLI money to eventually get diluted in prices, expanding the market and providing operating leverage, but not flowing directly to the bottom line. The developing component ecosystem will benefit the industry broadly.
• E-commerce is a marketplace, not a moat: Management does not view e-commerce as a competitive advantage or differentiator; it is a channel that drives price competition. Blue Star will not compromise long-term brand personality or product standards for market share, even if that means share loss.
• BEE rating change was navigated without a price hike: Future-ready models were launched ahead of the July 1 energy label change, with five-star rated ACs remaining five-star even after the change. Management stated there was no reason to increase prices due to the rating change alone, though new five-star models conforming to new standards would be costlier depending on the brand.

Thiagarajan: "To the question as to whether this business can become a 14% or 15% operating margin, we do not think so. A 12% EBIT business could be feasible for the room AC business."

EMP & Commercial Air Conditioning: The Order Book Anchor

• Segment I revenue grew 57% with margin improvement: The onset of the construction and capex cycle drove order inflows from commercial buildings, factories, data centers and infrastructure. Segment result margin improved to 5.7% from 4.0%.
• Bangalore Metro win headlines the order book: A couple of major orders worth Rs 390 cr from Bangalore Metro Rail Corporation were received during the quarter, alongside orders from Reliance Industries (Jamnagar), L&T for the Railway Freight Corridor, and Laxmi Diamond.
• Management is disciplined on EMP margin ambition: The segment can consistently deliver around 6% margins with healthy cash flow and balance sheet management prioritized over market share. A move to 7% is possible but management refused to commit, citing what the industry has been through.
• Professional electronics added breadth: Major orders were bagged from HDFC Bank, Reliance Jio, Axis Bank, Grasim Industries and IDBI Bank, with management describing prospects as positive given the wide portfolio of contemporary products and solutions.

Thiagarajan: "There a possibility this margin will move to 7%, but we are not willing to commit it at this point of time because of what the industry and we had gone through."

Commercial Refrigeration & International: Building the Next Leg

• Commercial refrigeration grew but below the 15%+ CAGR expectation: Q1 growth was approximately 10-11%, held back because ice cream manufacturers placed deep freezers in Q4 ahead of summer, and wedding and festival buying happens well ahead of the season.
• Deep freezer indigenization is now live: The factory for 300L and sub-300L deep freezers was commissioned in April after trial production in February-March, with depreciation impact beginning from April. A new range of visi coolers with wide capacity was also launched, and exports of deep freezers to the Middle East commenced.
• Water coolers faced a structural headwind: Storage water cooler growth was lower than the typical 7-8% because offices, factories and public places continue to discourage shared water cooler use. Manufacturing was shifted from Himachal Pradesh to the Wada plant, causing a one-time revenue shortfall of Rs 10-15 crores.
• International business grew 38% on GCC strength: Economic activity in the GCC region remained good against the backdrop of higher oil prices, and newly entered markets of Nigeria, Bangladesh and Nepal responded well to new product launches.

Balance Sheet & Capital Allocation

• Net cash position flipped positive: The company ended the quarter with a net cash balance of Rs 81.03 cr versus net borrowing of Rs 68.47 cr a year ago, driven by higher cash from operations and continued focus on working capital management.
• NCDs partially redeemed: Rs 175 cr of NCDs were redeemed in June 2022 out of the Rs 350 cr raised in June 2020, with management committing to stay focused on healthy cash flows and mitigating the impact of cost escalations.
• Capacity expansion is fully funded and underway: The Sri City plant is expected to commission by October-November 2022, and the Himachal Pradesh plant expansion is also in progress to meet demand.

Guidance & Commitments

Key Metrics