Blue Star Ltd Q2 FY2023 Concall Summary

Key Takeaways

• Broad-based demand, margin tightrope: All segments grew, with room ACs up 17% despite a seasonally weak quarter, but operating margin was marginally lower as higher input costs and operating expenses bit.
• Commodity tailwind delayed by rupee and old inventory: Softening commodity prices did not flow through to margins because raw material was bought at old prices; the rupee's depreciation is now offsetting those savings, making the margin outlook a "tightrope walk."
• Supply chain still stretched, inventory elevated: The company is holding 75 days of inventory versus the usual 45 days to mitigate continuing disruptions, and management is "not yet sure when things will normalize."
• B2B order book is the quiet strength: A record integrated data center order, a first railway electrification win, and buoyant tender inflows in infrastructure and factories underpin the optimistic H2 outlook.
• What to watch next quarter: Whether the January price increase review and the start of commercial production at the Sri City plant can shift the margin trajectory, and if the supply chain stabilizes post-Chinese New Year as vendors indicate.

Demand Environment

• Room ACs held momentum: 17% growth in a seasonally low quarter, driven by product repositioning in the Hindi-speaking belt with Virat Kohli as brand ambassador and an expanding distribution footprint that is only halfway built.
• Commercial refrigeration snapped back: Growth was partly a base effect from a COVID-hit Q2FY22, but demand from food retail, processed food, and pharma is now structurally robust; management expects a ~20% CAGR in this business alone. [8-9]
• Electromechanical projects stayed selective: The company is picking segments with good cash flows (data centers, factories) rather than chasing market share, while infra investments in water, metro railways, and power distribution pick up.
• Retail capex returned: Investments in shop-showroom-boutique air conditioning restarted after many years, with Diwali-linked opening and renovation of restaurant and retail outlets accelerating.
• International business grew across the board: Strong demand for commercial air conditioning and refrigeration products, with notable orders from fast food chains including Americana, Dominos, and Tim Hortons.
• The Malaysia JV remained a soft spot: Operations continued to be impacted by a slowdown in construction and order finalizations.

Thiagarajan: "We have no insight further than what is available in the public domain on whether there will be a slowdown, how much it will impact in India."

Margins: The Tightrope Walk

• Commodity-currency cross-currents: Softening commodity prices have not yet helped margins because raw material was procured at older, higher prices; any benefit that does arrive in H2 is being offset by rupee depreciation against the dollar.
• Price increases did the heavy lifting: Five rounds of price increases (April 2021 through April 2022) prevented a margin drop of more than 10%; without them, the damage would have been far worse.
• Advertising spend stayed lean: Reduced advertising expenses versus pre-COVID levels also helped contain the margin decline.
• Project business operating leverage is a FY24 story: Margin improvement from operating leverage in the electromechanical projects business is not expected in FY23; it could materialize in FY24.
• Unitary cooling margin target held: Management maintained its expectation of 8% to 8.5% margin for the unitary cooling segment in FY23.
• The January review is the next catalyst: The next round of price revisions will be reviewed in January, after factoring in the rejigged product portfolio and the changing supply chain mix as new capacities commence commercial production.

Thiagarajan: "Therefore, on the margin front, it is going to be a tightrope walk, but we have mitigation measures for Q3 and Q4."

Supply Chain & Capacity

• Inventory buffer stayed high: The company continues to procure in advance, holding around 75 days of inventory instead of the normal 45 days, covering both metallurgical raw materials and components.
• Capital employed rose: The increase was driven by higher inventory holding to mitigate supply chain disruptions and by capital investments for manufacturing capacity expansion projects.
• Sri City plant nears launch: Trial production has started and commercial production is expected by January 2023; the plant should provide a competitive advantage over the Himachal facility.
• China stabilization is a known unknown: Vendors indicate some stability from January onwards, post-Chinese New Year, but management is explicit that it is "not yet sure when things will normalize."
• Supply chain mix set to shift: By the beginning of Q4, the supply chain mix is expected to change as new capacities, both Blue Star's and competitors', commence commercial production.

Thiagarajan: "We are not yet sure when things will normalize as far as the supply chain disruptions are concerned."

Competitive Landscape & Market Position

• Room AC competitive intensity set to rise: All players are expanding capacity, and the PLI scheme's design (incremental sales over FY21 required to avail benefits) means everyone will have to sell more, intensifying competition.
• Market share is uneven: All-India market share is 13.25%, but it is not uniform; the company is strong in some parts and weak in the Hindi-speaking north, which is the focus of the current repositioning.
• VRF: a clear number 2: Strength comes from R&D and manufacturing investments, and the company intends to keep growing from that position.
• Distribution is not measured by outlet count: Management does not review the number of distribution outlets, arguing that share is not uniform across stores and that outlet-count metrics "don't deliver real results."
• Market share goal set: The target is 15% by FY25, with some improvement possible in FY23.

Thiagarajan: "In room air conditioners, many people are expanding the capacity and in order to avail PLI, all players will have to sell more, because in PLI x-axis is the investment and the y-axis is the incremental sales over FY21. Therefore, there will be higher competitive intensity."

Order Book & Project Wins

• Record data center order: The largest ever integrated data center project order in the Electro-Mechanical Projects business was received during the quarter.
• First railway electrification order booked: A new adjacency for the projects business.
• Commercial air conditioning wins: Major orders from West Bengal Medical Services Corporation Ltd., Nouveau Diamonds (Surat), and L&T for the Hockey Stadium in Rourkela.
• Professional electronics orders: Bagged from Arcelor Mittal Nippon Steel India Ltd., Jindal Saw Limited, HDFC Bank Limited, Tata Steel Limited, and ICICI Bank Limited.
• Order book is broad-based: Sub-sectors (factories, data centres, infra projects, buildings) are broadly equal in the carry-forward order book, and Q3 order finalization continues to be good.
• Inflow outlook remains buoyant: Infrastructure investments and the capacity expansion cycle in manufacturing are expected to keep order inflows strong throughout the year.

Guidance & Commitments

Key Metrics