DAIKIN

AC Stocks May Feel Some Near Term Heat, But A Promising Future Awaits

Air conditioner manufacturers (ACMs) failed to beat the heat in the first half of the current fiscal year. Their muted performance was due to a milder summer (unseasonal rains in most parts of India in Q1), slow off take/subdued restocking at dealers’ end, inventory build-up, input cost pressures, discounting and no festive season boost.

The lack of operating leverage took a toll on ACMs margins. Nevertheless, in spite of the near-term roadblocks for the sector, the long-term outlook is optimistic. So, AC stocks do warrant some attention.

Subdued outlook for FY19

We expect ACMs performance in H2 FY19 to be sluggish as distributors would focus on clearing their unsold inventory of ACs instead of placing orders for new ones. Though marketing campaigns may aid festive sales, stiff competition could necessitate cuts in product prices.

A steep rise in commodity prices, the rupee’s depreciation vis-à-vis the dollar and costlier imports of some components may lead to a contraction in the margins of ACMs. Demand in winter months (November-February) tends to be lower than in other months.

A disappointing H1, coupled with the above-mentioned challenges in H2, will, in all likelihood, result in a dip in the overall numbers of ACMs for FY19 as a whole (versus FY18).

The future looks promising

India’s AC industry is undoubtedly one worth banking on, given the low penetration of air conditioners in the country. Improved electrification coverage, availability of financing schemes, higher disposable incomes, shorter replacement cycles and tropical climatic conditions suggest that revenue generation prospects will remain steady for ACMs, going forward.

It is likely that the GST rate on ACs, which is currently 28 percent, may get reduced to 18 percent. This would result in a drop in selling prices and provide an additional fillip to ACMs.

What do we like about Amber Enterprises?

Revenue drivers

Amber supplies ACs and parts thereof to 8 of the top 10 AC brands in India, and enjoys client stickiness too. The number of AC units manufactured is estimated to increase from 1.9 million in FY18 to over 2.5 million by FY20-end.

AC models based on the internet-of-things platform, which yield better realizations than regular ones, are being developed. Customs duty hikes announced by the government on some crucial AC components should help the company bag incremental orders, as import substitution initiatives by AC brands gain momentum.

Margin drivers

Amber derives close to 75 percent of its annual revenue from original design manufacturing processes. Utilization rates at its manufacturing facilities are slated to increase from 50 percent in FY18 to around 70 percent over the next 2 fiscal years. Debt repayments from IPO proceeds will de-leverage its balance sheet. To facilitate backward integration, manufacturing of new specialized components will gain scale.

Valuation

The stock, after witnessing a sharp post-listing rally in January 2018, has corrected significantly. This makes it a good buy for those who missed the IPO bus, considering that the price is close to the upper end of its IPO price band (Rs 859).

Are Blue Star and Voltas worth looking at?

Revenue drivers

A widespread distribution network across India and a strong brand appeal should help both companies gain market share. Periodic introduction of room AC variants with differentiated features, healthy traction in commercial air cooling and a growing order book in the HVAC (heating, ventilation and air conditioning) space are among the other key positives.

Margin drivers

Both companies are working towards increasing the contribution of high-margin split inverter ACs from the current mark of 30-35 percent. Domestic procurement of raw materials for indoor ACs will be prioritized to trim exposure to imports.

Valuation

Stock prices of Blue Star and Voltas have been range-bound for the past month and trade at fairly reasonable valuations as well. In both cases, re-rating would depend on the fortunes of the relatively capital-intensive electro-mechanical projects segment’s performance, comprising 45-50 percent of revenue.

Though both companies are good investment picks for the long haul, at this point, we prefer Blue Star over Voltas. This is because the latter’s ‘Voltas Beko’ range of washing machines, refrigerators and other kitchen appliances will be entirely imported for at least a year, and would also entail high spends on dealer margins and marketing.

Why do we like an expensive stock such as Johnson Controls Hitachi?

Revenue drivers

The demand for chillers, which are mainly used in HVAC systems (at commercial, institutional and industrial properties), has been on an uptrend. The company plans to undertake room AC product launches to refresh its portfolio. Regional expansion will primarily pertain to markets in tier-2/tier-3 cities and the southern region.

Margin drivers

The company’s product mix is changing in favour of premium inverter ACs. Utilization rates at the manufacturing units (in connection with to indoor, ductable, chillers and variable refrigerant flow products) are anticipated to go up on the back of a demand uptick (relating to packaged AC systems).

Valuation

Technological expertise (by virtue of global parentage) and robust fundamentals should help the company sustain its high valuations. In light of the sharp correction in the stock’s price over the past year, it shouldn’t be overlooked.― Moneycontrol

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