Blue star india is primarily in the commercial air conditioning and refrigeration business. The three main business segments are

1.Central air conditioning: This is the main business for blue star. It accounts for 70 %+ of the company’s revenue, has been growing at 25 % and has a pre-tax ROCE of almost 60 %. Blue star is fairly dominant in this sector and has a good market share of almost 30%. This sector is dependent on industrial demand, IT/ITES sector and retail. Lately the industrial sector, IT/ITES and retail sector have been boyant due to which Blue star has a good backlog of orders.

2.Cooling products: This comprises of Window, split A/c and other retail products such as water coolers, cold storage etc. This is a fairly competitive segment with strong brands such as carrier aircon and other vendors. This segment had a good volume growth and revenue growth of 30%. However as this segment is competitive, the pre-tax ROCE is at a respectable 15%.

3.Professional electronics and industrial equipment: This segment had a good growth last year on a small base of 60 Crs. The segment is small accounting for less than 10% of the total revenue. The pre-tax ROCE is high at almost 70%+.

Key competitive strengths
Blue star has key advantages via a strong brand in its key segments. It has a good reputation in terms of project execution and after sales service for the institutional segment. There is certain amount of lockin once a customer (especially if it is an institutional one) has selected and installed a blue star system. Subsequent orders would likely be for the same vendor. Due to high market share, blue star has certain demand and production economies of scale, which allows it to be a low cost provider. The central air conditioning segment is project driven, where project skills, experience and scale matters as the margins are fairly low (pre-tax margins were < 10 %) and hence a company has to be efficient to be a profitable business.

Problems areas
The company has performed well on most parameters such as revenue growth, NPM, ROE etc. However for the last 1-2 years, the free cash flow of the company has been dropping. The current year’s FCF was around 40 % of the operating profits. The main culprits have been account recievables and inventory. The recievables ratio has dropped from 6 to 4.9 and the inventory ratio has dropped from 9 to 7.9. The drops are not alarming and are still good in an absolute sense. However they need to be watched closely to see if the growth is not coming a high price (write-offs of bad debts and inventory later)

Assuming (a big assumption though), the company can manage its Working capital, the Net profit can be taken as Free cash flow. The last year EPS (post split) was 5.8. The current year EPS should come be conservatively at 7. Using a DCF (with various assumptions) I would value the company roughly at 140-160 Rs/ Share. My personal opinion is that the stock is fairly priced.

Disclosure : I have owned the stock for the past few years.

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