Blue Star India has been in the business of cooling for many decades now. Historically they have largely been a B2B company, but recently they have also ventured into selling cooling solutions directly to retail consumers. This company has been delivering excellent return on investment over the last decade. Blue Star is the biggest player in the commercial cooling business in terms of market share, and it has a very good brand reputation for commercial cooling solutions. Blue Star is in 3 lines of businesses –
1) Electro Mechanical Projects and Packaged Air Conditioning Systems – which covers the design, manufacture, installation and maintenance of central air conditioning plants as well as contracting services in electrification, plumbing and fire fighting. This is primarily a B2B business.
2) Cooling Products – Room air conditioners for both residential and commercial applications, commercial refrigeration products and cold chain equipment. This represents the fastest growing business segment, and in the coming years might scale up to be much larger than the Electro Mechanical Projects and packaged air conditioning division, which currently earns over 60% of revenues
3) Professional Electronics and Industrial Systems – special industrial projects undertaken for steel and power plants, testing equipment from manufacturing companies, and a small medical equipment business
More details can be found in the company’s annual report.
In FY11, the company's current assets have gotten a bit out of hand, with increased inventories and receivables. Almost all of this working capital increase has been funded by new debt. While there has definitely been a case of management slipping up in letting the working capital requirements grow so much so quickly, the resultant dip in the company’s operating performance has caused the stock price to be punished quite severely. This punishment has meant that the company is quoting at a market cap of a little over Rs 2,100 cr currently (The company has averaged an EBITDA of Rs 275 cr over the last 4 years). This represents a great investing opportunity since the punishment has been far in excess of the crime.
By all accounts, the FY11 income statement and balance sheet have been the worst of the last five years. But the current market cap is definitely understating the worth of the company by a fair margin. Here is why:
1) Return on Investment: The company has consistently delivered a return on investment above 20% in each of the last 5 years – that is right, even in the just past bad year FY11. The average RoI over the last 5 years (including FY11) is a staggering 37%.
2) Cash flows: The company has been throwing off strong cash from operations, well in excess of any reinvestment needs of the business. Only FY11 was a bad year from a cash flow perspective. The Cash Conversion Cycle (receivable days + inventory days – payable days) has been negative in 4 of the last 5 years – testimony to Blue Star’s strong leverage with its customers and suppliers.
3) Debt: After using only a miniscule amount of leverage for a long time, in FY11, debt levels mushroomed to fund the increased receivables and inventories. However, even at current levels, debt is less than two times annual EBITDA and debt service (interest payments, finance charges) is less than a one-fourth of the corresponding period’s EBITDA level. The debt is easily serviced and in fact the company can comfortably take on some more debt. In such circumstances, management is, reassuringly for us, working on reducing the working capital requirements, and correspondingly retiring some of the debt
4) Growth industry: Blue Star is involved in cooling offices, industries, airports, power plants, hotels, restaurants, retail spaces (showrooms) and so on and so forth - an unending list of commercial entities. They are the largest player in this business and have the best brand in the business. In addition to HVAC (commercial cooling solutions), they are now offering complete electrical, plumbing and firefighting (MEP) services. The brand, the large installed base, scale of operations and full bouquet of MEP services are all sharks and alligators in a very formidable moat around the business that will make it very, very difficult for a competitor to complete effectively against. Blue Star has now also ventured into the consumer (B2C) cooling business and has started selling retail – you may have noticed their advertisements on television – this business has been growing at a vociferous pace and bodes well for future growth. Blue Star is in some ways a bet on and a proxy for the scaling up of Indian businesses and an increase in per capita incomes over the long term
5) Promoters: While Blue Star is an excellent company in a growth industry, it also has the benefit of having superlative management in the mix. Both the exceptional return on investment and strong operating cash flows are a by-product of management’s simple thinking and focus on getting the few important things right. This is evident in reading the company’s annual reports, which are not only very informative and educational, but also reflect the lucidity of their thought processes. This is a welcome change from most annual reports we peruse, where empty platitudes and insipid inanities adorn page after page. What is even more heartening to note is that management frankly acknowledges that they were caught sleeping at the watch in FY11, and have undertaken measures to rein in the runaway working capital. We should start seeing the positive effects of these measures over FY12 and FY13
This golden combination of great business, attractive long term prospects for the industry and a superior management at the helm is a very rare. Combine the very reasonable valuation the stock is quoting at currently, and you are looking at a singularly rare amalgamation of ingredients to create a blockbuster investment. The stock has lost almost 50% in the last few days, owing to the bad results announced over the last quarter. But if you believe that the company will revert to its historical efficiency in fund management and operations, then the earnings and RoI should see a big jump in the coming few quarters, and consequently the stock price should rise again. From the Q1FY12 (July 29, 2011) Investor Report, 'the company will be tempering revenue growth through this year as it works on reducing the capital employed in the business'. Consequently the income statement might have to get worse before it gets better. If the stock falls further in response, it will represent a bigger discount in this ongoing sale.
1) Electro Mechanical Projects and Packaged Air Conditioning Systems – which covers the design, manufacture, installation and maintenance of central air conditioning plants as well as contracting services in electrification, plumbing and fire fighting. This is primarily a B2B business.
2) Cooling Products – Room air conditioners for both residential and commercial applications, commercial refrigeration products and cold chain equipment. This represents the fastest growing business segment, and in the coming years might scale up to be much larger than the Electro Mechanical Projects and packaged air conditioning division, which currently earns over 60% of revenues
3) Professional Electronics and Industrial Systems – special industrial projects undertaken for steel and power plants, testing equipment from manufacturing companies, and a small medical equipment business
More details can be found in the company’s annual report.
In FY11, the company's current assets have gotten a bit out of hand, with increased inventories and receivables. Almost all of this working capital increase has been funded by new debt. While there has definitely been a case of management slipping up in letting the working capital requirements grow so much so quickly, the resultant dip in the company’s operating performance has caused the stock price to be punished quite severely. This punishment has meant that the company is quoting at a market cap of a little over Rs 2,100 cr currently (The company has averaged an EBITDA of Rs 275 cr over the last 4 years). This represents a great investing opportunity since the punishment has been far in excess of the crime.
By all accounts, the FY11 income statement and balance sheet have been the worst of the last five years. But the current market cap is definitely understating the worth of the company by a fair margin. Here is why:
1) Return on Investment: The company has consistently delivered a return on investment above 20% in each of the last 5 years – that is right, even in the just past bad year FY11. The average RoI over the last 5 years (including FY11) is a staggering 37%.
2) Cash flows: The company has been throwing off strong cash from operations, well in excess of any reinvestment needs of the business. Only FY11 was a bad year from a cash flow perspective. The Cash Conversion Cycle (receivable days + inventory days – payable days) has been negative in 4 of the last 5 years – testimony to Blue Star’s strong leverage with its customers and suppliers.
3) Debt: After using only a miniscule amount of leverage for a long time, in FY11, debt levels mushroomed to fund the increased receivables and inventories. However, even at current levels, debt is less than two times annual EBITDA and debt service (interest payments, finance charges) is less than a one-fourth of the corresponding period’s EBITDA level. The debt is easily serviced and in fact the company can comfortably take on some more debt. In such circumstances, management is, reassuringly for us, working on reducing the working capital requirements, and correspondingly retiring some of the debt
4) Growth industry: Blue Star is involved in cooling offices, industries, airports, power plants, hotels, restaurants, retail spaces (showrooms) and so on and so forth - an unending list of commercial entities. They are the largest player in this business and have the best brand in the business. In addition to HVAC (commercial cooling solutions), they are now offering complete electrical, plumbing and firefighting (MEP) services. The brand, the large installed base, scale of operations and full bouquet of MEP services are all sharks and alligators in a very formidable moat around the business that will make it very, very difficult for a competitor to complete effectively against. Blue Star has now also ventured into the consumer (B2C) cooling business and has started selling retail – you may have noticed their advertisements on television – this business has been growing at a vociferous pace and bodes well for future growth. Blue Star is in some ways a bet on and a proxy for the scaling up of Indian businesses and an increase in per capita incomes over the long term
5) Promoters: While Blue Star is an excellent company in a growth industry, it also has the benefit of having superlative management in the mix. Both the exceptional return on investment and strong operating cash flows are a by-product of management’s simple thinking and focus on getting the few important things right. This is evident in reading the company’s annual reports, which are not only very informative and educational, but also reflect the lucidity of their thought processes. This is a welcome change from most annual reports we peruse, where empty platitudes and insipid inanities adorn page after page. What is even more heartening to note is that management frankly acknowledges that they were caught sleeping at the watch in FY11, and have undertaken measures to rein in the runaway working capital. We should start seeing the positive effects of these measures over FY12 and FY13
This golden combination of great business, attractive long term prospects for the industry and a superior management at the helm is a very rare. Combine the very reasonable valuation the stock is quoting at currently, and you are looking at a singularly rare amalgamation of ingredients to create a blockbuster investment. The stock has lost almost 50% in the last few days, owing to the bad results announced over the last quarter. But if you believe that the company will revert to its historical efficiency in fund management and operations, then the earnings and RoI should see a big jump in the coming few quarters, and consequently the stock price should rise again. From the Q1FY12 (July 29, 2011) Investor Report, 'the company will be tempering revenue growth through this year as it works on reducing the capital employed in the business'. Consequently the income statement might have to get worse before it gets better. If the stock falls further in response, it will represent a bigger discount in this ongoing sale.
