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Blue Star: Competition keeps profitability on edge - Outside View by Luke Verghese

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Blue Star: Competition keeps profitability on edge
Oct 11, 2013

A fine branded company of long standing which is steering in very deep waters in a very competitive market

Trying to make a go of it

Blue Star Ltd at 65 years of age as a corporate entity is almost as old as Independent India is, and is still making a go of it. But we are also informed that the year 2012-13 is also the 70th anniversary of the founding of Blue Star.

Starting out as a reconditioner of air conditioners and refrigerators, the company has come quite some way since. Today the company boasts three business divisions-namely Electro mechanical projects and packaged air-conditioning systems, cooling products, and professional electronics and industrial systems. The first named covers the design, manufacturing, installation, commissioning and maintenance of central air-conditioning plants, and allied services. The cooling products division deals with room air-conditioners for home, commercial and cold chain equipment units. The last named deals with the exclusive distributorship for many internationally renowned manufacturers of professional electronic equipment and services. It also undertakes specialised industrial projects - whatever that means. The company makes do with seven plant locations -two in Maharashtra, two in Himachal Pradesh, two in Gujarat, and one in Dadra & Nagar Haveli. It is among the four listed companies that feature in Capital Market magazine under the heading Air-Conditioners-the others being Fedders Lloyd, Hitachi Home and Lloyd Electric. Voltas is featured under the heading 'Diversified'.

The company makes do with a piddling paid up capital of Rs 180 m and 40.07% of the paid up capital is held by the promoter directors and relatives. Of this promoter holding, the personal holding of the chairman, Mr Ashok M Advani alone amounts to 12.1%, while Sunil M Advani the vice chairman controls another 6.4%. Another interesting point to note is that a substantial 9.04% of the capital is in the form of foreign holdings. If this foreign holding is also in a sense a part of the promoter holding, then the total promoter stake in the permanent capital work out to 49.11%. This low level of permanent capital, given the size of its operations, could well be one of the main factors for its poor showing in generating margins. For the matter of record the company had a 'net' book enterprise value of Rs 21 bn at year end.

How it earns its bread

The company generated gross revenues from operations of Rs 27.9 bn and separately other income of Rs 363 m. But the pre-tax profit after provision of interest of Rs 499 m and depreciation of Rs 329 m amounted to only Rs 526 m against a pre-tax loss of Rs 884 m previously. If one were to reduce the element of 'other income' of Rs 363 m from this pre-tax profit, the company would have been scraping the very bottom of the barrel in the latest year too. In the preceding year the other income toted up to Rs 238 m.

The up-lift to the bottom-line appears to have been engineered by controlling the input cost of materials-well almost. The other two revenue expenditure items -employee costs and other expenses -were kept under a tight leash. The main body of the revenues accrue from several streams. It sells finished goods, traded goods, sale of services (annual maintenance contract), revenues from construction, and, other operating revenues. The sale of manufactured finished goods at Rs 11.7 bn gross of excise is the biggest contributor to revenues, followed by revenue from construction at Rs 8 bn. Traded goods chip in at third place with Rs 5.3 bn. The traded goods sold include all items sold under the category of manufactured finished goods and also includes electronic and other appliances.

There was actually a tricky turn of events on the material cost front. As I had stated earlier the company sells both manufactured goods and traded goods. The company made far less money during the year selling traded goods than it made in the preceding year. On a rough working the company would have made a gross margin of Rs 589 m in the 2012-13 as compared to a gross margin of Rs 1.20 bn previously. (It may be noted that the traded sales for the year amounted to Rs 5.28 bn against Rs 4.89 bn previously). But at the same time the company managed a turnaround by recording a pre-tax profit of Rs 526 m against a pre-tax loss of Rs 884 m previously or a gross turnaround of Rs 1.4 bn. This was made possible by a rationalisation of material inputs costs. The input cost of materials fell to 82.6% of net revenues from operations compared to 86.7% previously. How the company achieved this remarkable transformation in a year when the gross margin on traded sales fell so sharply is not known.

Operating in a competitive environment

It would also appear from the stranglehold of the 'cost of materials' consumed that the company operates under very tight margins thanks to a possible competitive environment. There is another twist here to the expenditure pattern. The company consumed a sizeable amount of forex to the tune of Rs 6.6 bn against much lower forex earnings of Rs 1.6 bn during the year. The corresponding figures for the preceding period are Rs 5.4 bn and Rs 1.5 bn respectively. The forex consumption however does not pertain only to raw material and component imports. The value of such imports amounted to Rs 4.3 bn. The balance imports of Rs 2.28 bn pertain to spares and traded goods in the main. One does not know whether the 'excessive' dependence on imports had any play in the company being unable to generate the requisite margins during the year. To be fair to Blue Star it does not appear to have had any inter-se dealings with group companies on this score. The only inter-se dealing of any import was the purchase of software services worth Rs 107 m from a joint venture called Blue Star Infotech Ltd.

As a matter of fact the cash flow statement reflects the very opposite of the profit and loss statement and this is true about very annual report that I have surveyed. In 2011-12 the year in which the company rummaged up a pre-tax loss the company generated positive cash of Rs 2.6 bn from operations. In the very next year when the company managed to feature a pre-tax profit the net cash flow from operations fell to Rs 400 m. In the latter year the increase in trade receivables and inventories, and the concurrent decrease in current liabilities created the hiatus. Fortunately, given the business that it is in, the company does not have to splurge that much on fixed assets. The total spending on gross block during the year amounted to a relatively small Rs 262 m against a much larger outlay of Rs 530 m previously. The gross block of Rs 4.1 bn generated finished goods gross sales of Rs 11.7 bn. Not included in the sales figure is revenues from construction of Rs 8 bn.

How the company managed to reduce finance costs in a year when the borrowings totalled the same as in the preceding year and on much larger business operations at that is not quite coming out. The borrowings at year end amounted to Rs 3.72 bn. The finance charges on the borrowings however fell to Rs 219 m from Rs 273 m previously. (Separately it has provided for forex differentials of Rs 224 m against Rs 367 m previously). But the company is making a bid to reign in working capital costs. The trade payables at year end are more than the trade receivables. The trade receivables come in two parts. The trade receivables of Rs 6.5 bn that form a part of current assets, and trade receivables of Rs 806 m under noncurrent assets. The current liabilities are larger than the current assets implying a net working capital deficit.

The siblings are a drain

There is another well founded reason why the company is borrowing so much to run its business. It has a wholly owned sibling called Blue Star Electro Mechanical Ltd. The parent has an investment of Rs 1.17 bn in the share capital of the sibling. The parent also advances large sums to the sibling during the year and then withdraws the funds at year end to show a clean slate. During 2011-12 the parent advanced Rs 1.21 bn and during 2012-13 the parent advanced Rs 1.19 bn. It is not known what interest if any the parent is charging on such advances but the other income schedule lists 'interest from others' of Rs 21.4 m. The sibling pays no dividend at the end of the day but that should not come as any surprise. For the matter of record this worthy on revenues of Rs 977 m made a pre-tax loss of Rs 149 m. It made a slightly larger loss in the preceding year on lower revenues. What exactly this company does to earn its sustenance is not very clear. It has also given a corporate guarantee of Rs 587 m on behalf of another affiliate Blue Star Qatar WLL.

Separately, the company has also advanced modest sums to group entities under both short term and long term loans and has also provided for some of these advances. Blue Star makes do with three JVs including the entity mentioned in the earlier paragraph. Two of the three JVs are foreign based. From the brief financials which Blue Star has made available all the three companies appear to be just about 'managing'. Significantly, the results have not stated the pre-tax profit if any of each of the three ventures. The revenue statements of the siblings and joint ventures that get to be published by India Inc are about as opaque as it can get.

From the broad looks of it, this is not a company that should feature in the portfolio of a potential investor.

Disclosure: I do not hold any shares in this company, either directly, or under any non discretionary portfolio management scheme

This column Cool Hand Luke is written by . Luke has been a business journalist, financial analyst and knowledge management head with a professional experience of more than 20 years. An avid watcher of the stock market, he has written extensively on stock market trends. His articles have featured in Business Standard, Financial Express and Fortune India amongst others. He has also been the Deputy Editor, Fortune India and the Financial Editor of The Business and Political Observer.


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