Motilal Oswal, in its recently released report, Room Air Conditioners, projects the focus to shift to inverter AC, with its volume share going up from 10 percent in FY16 to 30 percent in FY18 and to 50 percent in FY20.
Over the past few years, demand has been continually shifting toward energy-efficient ACs (5-star/inverter), which contribute ~30–35 percent of overall industry volumes.
Expect industry volume CAGR of 15 percent over FY2017–2020. Indian room air conditioner (AC) volumes are estimated to grow from 4.7 million units in FY17 to 7.2 million in FY20, implying a 15 percent CAGR. After being strong in FY17, AC sales are expected to maintain momentum in FY18, despite demonetization-driven weakness. Volumes are forecasted to increase ~20 percent in FY17 and ~15 percent in FY18. This growth is expected to be driven by rising penetration of ACs (4–5 percent currently versus 30 percent global average), higher disposable income, growing urbanization and the year-round AC usage trend. AC, could be one of the largest discretionary items in India over next few years.
Higher commodity prices may impact margins – price hikes needed. Star ratings, which are normally revised every two years, have not been changed since January 2014. Therefore, manufacturers have not resorted to any price hikes. None of the manufacturers has increased prices of late to stay competitive; however, cost pressures stemming from a sharp rise in raw material prices would force companies to hike prices going forward, likely post GST roll out in July, 2017.
Competition remains intense; brand, distribution, service center network, and dealer margins as key differentiators. Brand, distribution channel (>50–55 percent of AC sales now in Tier-II to Tier-IV cities), service center network, and dealer support/margins are the key success factors in the AC industry. Competition has increased with players eyeing a larger market share.
Valuation and risks. Increasing risks can be seen from industry convergence to inverters, inventory destocking prior to GST implementation in July 2017, and new ratings for ACs in January 2018. The run up in stock prices over the past two months factor in the positives of a hot summer while ignoring the aforementioned risks to growth and margins.
In the US, AC penetration started to pick up from 1950s – it then jumped to 15 percent in 1960 and to 50 percent by 1975. In contrast, penetration in China grew from 8 percent in 1995 to 70 percent in 2004, implying that penetration rates are increasing much faster versus earlier years. India’s PPP per capital GDP at USD 6000 is similar to that of the US in 1960s. According to the Indian Weather Data Handbook, 2014, the weather profile of 54 major cities shows that 65 percent of the total numbers of hours in a year have a temperature above 24°C. This, supported by rising income levels, has been the key driver of increasing demand for ACs. AC could be one of the largest discretionary budget items in India over next few years.
CY17 Outlook – IMD Expects Above-Normal Summer Season
According to the Indian Meteorological Department (IMD), CY16 recorded significantly above-normal temperature during summers (mean of +1.4°C above normal temp). This led to strong AC sales in the year. For CY17, it expects mean temperature to be above normal (>1°C higher) in the North, Northwest, and the plains. Also, most of the south, central, and west India regions are expected to have 0.5–1°C above-normal temperature. Notably, above-normal heat waves (+5 percent degree over max temp) are likely to be witnessed in the North, North-West, East, Madhya Pradesh, and Andhra Pradesh. Overall, summer in CY17 is likely to witness above-normal temperature, but should be less severe than last year, as per the IMD forecast.
For FY18, industry growth is forecast to decelerate to 15 percent. As the BEE’s star ratings remain unchanged, no price hikes are expected on this account. On the other hand, with a sharp rise in commodity prices, the cost of ACs is likely to increase during the year, subject to INR movement (nearly 50–60 percent of the parts of a split AC are imported, and manufacturers usually offset the impact of currency depreciation by passing on price hikes to end consumers).
CY17 off to a good start; March end witnessed a spike in volumes. The summer season typically starts from March in the South and from April in the North – AC demand picks up during these months. The entire country witnessed a relatively warm February, but the temperature was higher in West India, with cities like Mumbai seeing a 15–20 percent jump in AC sales. However, the first three weeks of March were a dampener for AC sales, with hail/snow storms leading to a dip in temperatures across North, West, and East India. However, a spike in temperatures in the last week of March has led to a strong revival in volumes. March 2016 had witnessed record temperatures, driving a spike in demand for AC sales and subsequent inventory stock-out for dealers in April 2016.
Although industry players have majorly relied on the summer months (50–60 percent of total sales), sustained high temperatures following the monsoon (October–December) in recent years have created a new window for AC sales. As a result, AC demand is for almost 7–8 months in a year, compared to 4–5 months previously.
The 3-star-rated ACs account for 60 percent of overall AC sales in India. According to BEE, all ACs that operate on invertor technology will have to be compulsorily rated from 2018 (with the same set of fixed-speed norms). Thus, the rating for fixed and variable compressors will be merged. Accordingly, a 4- or 5-star-rated AC will be considered as inverter AC, while the rating of the current 5-star product will be changed to 3-star. Also, the fixed-speed AC market would transition to inverter technology over the next few years. Given their expected price fall, energy-efficient inverter ACs may eat into the market share of the 5-star fixed-speed ACs. Consequently, inverter ACs should command a market share of 30–35 percent by FY18 and 50 percent by 2020.
By region, North India continues to remain the largest market (38–40 percent of total sales), followed by South India (30 percent). A key trait of the North Indian market is the preference for window ACs. Split ACs are largely in demand elsewhere in the country. However, since the northern region is the largest market, companies have continued manufacturing window ACs to cater to this demand.
Samsung and LG exited the window AC market in 2012 as the share of split ACs increased and the price gap between split and window ACs reduced considerably. However, LG has now re-introduced select window AC models. In the northern market, demand for window ACs continues to remain high. Also, the window AC market size has been relatively stable, with many buyers shifting from air coolers to ACs for the first time (especially in Tier-II and Tier-III cities). Distribution reach is the key differentiator in the Indian AC market. This has become all the more important since ~50–55 percent of overall industry volumes are outside metros/ Tier-I cities.
Branding and ad spends: Brand name and trust are the other key differentiators in the AC industry. Companies generally spend 1–7 percent of their sales on advertising. Typically, with the onset of the summer season, AC manufacturers step up their advertising spends to capture customer mindshare.
R&D spending. Most AC manufacturers in India follow the outsource-and-assembly model with low spending on R&D. Compressors are mostly sourced from China/Thailand and condensers from local vendors, with the complete AC being assembled at the AC manufacturer’s factory. R&D spends are in the range of 0.2–2 percent of sales. Daikin has been among the front runners in terms of R&D spending and has built its first R&D facility at an investment of Rs.0.6 billion in Rajasthan.
Typically, February and March of each year see the launch of new models by AC manufacturers to cater to summer season demand. This year too has been no different. Some of the key features highlighted this year by AC manufacturers are:
- Wi-Fi-enabled ACs which allow users to control the machine using a smartphone. Additionally, smartphones can be used to monitor power usage and consumption.
- Increased focus on power saving and thus higher range/models of inverter ACs, with each brand trying to highlight the energy-saving potential.
- Air purifiers as a result of increasing concerns about polluted air within cities.
- R410A refrigerant gas being used in ACs as an alternative to the ozone-damaging R22 gas. The R22 gas has to be phased out by 2030, but the industry intends to completely switch to R410 by FY20 itself. Most inverter models across companies are using R410 refrigerant gas.
- Dehumidifiers for controlling humidity, especially during monsoon, so as to offer better comfort.
Room AC Industry Shifts to Inverters
The room AC industry is shifting toward energy-efficient models (i.e., 5-star/inverter ACs) over the past few years, as customers are increasingly becoming aware of lifetime costs of ACs vis-à-vis upfront costs. To promote energy efficiency, the BEE initiated star labeling in 2007 for fixed-speed ACs, where the compressor cuts off or cuts in when the desired temperature has been achieved or the room temperature increases. This program was conducted in 2006, involving key stakeholders such as consumer organizations and manufacturers of ACs/components. January 2007 became a voluntary year for AC star ratings. It was made mandatory from January 2010 for 1-star to 5-star ACs. The ratings were upgraded in January 2012 and January 2014. Also, the first energy-efficiency ratio (EER) came into force in 2015.
Inverter ACs are to be voluntarily labeled from January 2016. These ACs are considered to be more efficient than fixed-speed ACs. Apart from power savings, the key unique sales proposition of an inverter AC is that the set temperature is precise, delivering comfort. As inverter ACs have variable compressors, they have different standards compared to fixed-speed compressor ACs. According to the BEE, all ACs that operate on invertor technology will have to be compulsorily rated from 2018. Thus, the ratings for fixed and variable compressors will be merged. Accordingly, a 4- or 5-star-rated AC will be considered as inverter AC, while the rating of the current 5-star product will be changed to 3-star. The split AC market is expected to transition to inverter technology over next few years, with inverter ACs projected to account for 30 percent of the market by FY18 and 50 percent by 2020.
Since June 2015, the BEE has introduced the Indian Seasonal Energy Efficiency Ratio (ISEER) for inverter ACs. ISEER is defined as the ratio of total amount of heat that an AC can remove to total energy consumed to remove this heat. The minimum ISEER is 4.5 for a 5-star-rated inverter AC and 3.5 for a 3-star-rated inverter AC (equivalent to a 5-star fixed-speed AC). Currently, inverter ACs account for 12–15 percent of the overall market, while 5-star-rated ACs account for 22 percent. However, 3-star rated ACs are the largest contributors to the market.
As per Indian Weather Data Handbook, 2014, the weather profile of 54 major cities shows that 65 percent of the total numbers of hours in a year have a temperature above 24°C. Air conditioners in India have hitherto been tested under the IS 1391 code at standard operating conditions (outside temperature of 35°C). Star rating is given to manufacturers based on the test results. Ratings based on the ISEER have been introduced on a voluntary basis for variable-speed (inverter) ACs since June 2015. However, ratings of variable-speed and fixed-speed ACs are proposed to be merged from January 2018.
High Competitive Intensity
AC prices retained at 2016 level. With no change in the BEE star ratings in CY17, most manufacturers have maintained last year’s prices for ACs. However, with a sharp rise in commodity costs, there may be a need to increase prices or else margins would come under pressure. With aggressive pricing being offered, players are unable to raise prices of their fixed-speed ACs, as this would reduce the price gap with inverter ACs.
Sale promotions via exchange offers, discounts, and free installations to continue. To promote sales during the upcoming summer season, brands are offering exchange schemes, free installation, and discounts. Typical discounts being offered are in the range of 10–15 percent of MRP. For premium brands, the discounts are in the range of 8–12 percent, while in case of other brands, the discounts are in the 12–15 percent range. Companies are also offering comprehensive 5-year warranty on ACs. In case of inverter ACs, companies are offering 10-year warranty on the compressor and 5-year warranty on the condenser.