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Sluggish Near Term Outlook

While Blue Star’s prospects look bright over the long-term, it will face slowdown in orders in the near term…

I hold 500 shares of Blue Star which I purchased at an average price of Rs 359. What are the prospects of my investments provided I hold them for two years? Do you recommend holding on or exiting?
- Manoj

Blue Star Limited is a leading central air conditioning and commercial refrigeration company. It has three business segments: electro-mechanical products and packaged air conditioning systems, cooling products, and professional electronics and industrial systems.
The current penetration level of air conditioners in the country is a mere 3 per cent. Penetration is expected to double over the next three to four years, which presents significant business opportunities to players.

Over the years, the company has exhibited healthy growth in its financials. The total income and profit after tax of Blue Star have grown at a five-year compounded annual growth rate (CAGR) of 19.7 per cent and 25.9 per cent respectively. Its return on capital employed (RoCE) and return on net worth (RoNW) have registered a five-year average of 57.4 per cent and 49.3 per cent respectively. But both these numbers declined drastically by around 27 percentage points and 20 percentage points in FY11 compared to FY10.

The company’s total debt grew at an abnormal rate of 534 per cent in FY11 compared to FY10. Moreover, its operating profit margin and net profit margin have both slipped by around 3 percentage points over the same period. Its management expects the pressure on margins to continue for the next four to five quarters.
Both order inflows and the pace of execution are sluggish currently. As a large portion of the company’s order book is fixed priced, inflation and high commodity prices have adversely impacted earnings from older orders.
The stock is currently trading at a price-to-earnings (P/E) ratio of 22.68, which is above its five-year median PE of 19.46. Based on a five-year earnings per share CAGR of 9.5 per cent, its price-to-earnings to growth ratio comes to a very unattractive 2.5 times. The stock has corrected around 59 per cent over the last one year but is still expensive. The slowdown in order inflows, margin pressure, and deterioration in return ratios are here to stay in the near- to medium-term.

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