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Down with a Chill

Blue Star, India’s largest air-conditioning company, has a lot of cleaning up to do. Should you clean out its stock?

Much through the last bull run, Blue Star was on a roll. Revenue growth in the three years preceding March 2006 had compounded annually at 27 per cent. Profits were up 16 per cent. The company did even better the following year, clocking in a run-rate of 36 per cent while PAT galloped 46 per cent. Blue Star became the blue-eyed boy of the stock market. In only two years (between early 2006 to late 2007), the stock turned a five-bagger – zooming from Rs 100 levels to over Rs 500. But, Blue Star was paying a hard price for this growth.

Why does Blue Star feature here? In its bid to chase topline growth, Blue Star started going after low margin projects – electrical jobs with contractors and builders. To fulfil those contracts, the company needed more finance. Debt as a result rocketed up. Total outstandings now stand at more than 10 times the 2005 levels. The killer punch came in later when the recession caused Blue Star’s low margin contracts to falter – some got shelved, others saw payments delayed. Where does it go from here? Around 50 per cent of the order book now operates at less than 3 per cent ebitda margins. Cost overruns amounting to Rs 70 crores (9MFY12) have been booked and could extend by Rs 30 crores in the March quarter. Delayed payments have made bad debts a possibility. The company has initiated cost cutting and corrective measures now. Debt is targeted to be reduced from Rs 460 crores (9MFY12) to Rs 280 crores by end FY13.

What should you do? The road to recovery may be long and difficult, especially if the weak operating environment continues. Blue Star has a lot of cleaning up to do to make it a star performer again. Sell.