Krishna Karwa Moneycontrol Research
Highlights:
- We prefer Amber Enterprises and Johnson Controls Hitachi - Weak numbers likely to be reported by AC companies in Q3 - Long-term industry prospects seem good
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India’s air conditioning (AC) industry has been going through a rough patch in FY19 so far. This is primarily on account of a mild summer spanning the Q1, that ideally should be the strongest quarter in a fiscal.
Notwithstanding the roadblocks, the long-term prospects of the industry are promising. Prevalence of warm and tropical climatic conditions for the most part of the year pan-India necessitate the purchase of cooling devices such as ACs. Growing electrification base and availability of financing options have also aided demand growth.
Amber Enterprises and Johnson Controls Hitachi are our preferred picks.
What lies in store in Q3?
Muted demand scenario to prevail
The third quarter tends to be a seasonally weak period for AC companies due to the onset of winters. But the weakness is magnified this time around as retail sales in the festive season have not been up to the mark.
Inventory overhang in trade channels to persist
H1FY19 was a disappointing phase for the industry because of subdued offtake by retail buyers. Consequently, wholesalers and distributors chose not to place new orders for ACs since clearing unsold stocks was the priority.
The inventory liquidation process is far from complete (at the intermediaries’ end) because of a weak Q3. As a result, for AC manufacturers, the possibility of any noticeable uptick in revenues is bleak.
Commodity prices to offer no respite
In September 2018, the government hiked import duties on some critical components used in manufacturing ACs. This, coupled with rising raw material costs and the rupee depreciation versus the US dollar, will likely cause gross margins of AC companies to contract. Considering how competitive the AC market in India is, it is not easy to pass on such cost hikes to the consumers.
However, metal prices in the global markets have been softening a bit lately and could possibly moderate over a period of time. This may reduce the downward pressure on earnings in the coming quarters.
High base effect of last year
Energy efficiency norms are revised every two years and become applicable from the first day of a calendar year. By virtue of these regulations, classification of star ratings of ACs undergo a change. Thus, AC companies clear stocks (by offering high discounts on models that will be subject to a downgrade in ratings) prior to implementation of the new norms.
In the October-December 2017 period or Q3FY18, AC sales were on an uptrend ahead of the new energy efficiency norms scheduled to come into play from January 1, 2018. In Q3FY19, there was no such trigger that would facilitate pre-buying. Hence, from a year-on-year perspective, there will be some de-growth in the top-line numbers.
Which stocks are worth picking?
On the back of the above-mentioned challenges, lack of volume growth will take a toll on the operational and bottom-line performance of all AC companies in Q3. However, we believe the roadblocks are discounted in the prices of al stocks. Given how sharply they have corrected, a significant de-rating post-results appears unlikely unless there is a major negative surprise or market volatility is at its peak.
We see good room for a re-rating in case of Amber Enterprises and Johnson Controls Hitachi.
Amber derives nearly 75 percent of its revenue from high-margin original design manufacturing and is scaling up utilisation levels at its factories. It manufactures room ACs for eight of the top 10 AC brands in India and is integrating processes backwards (through inorganic acquisitions over the years). The stock is reasonably valued versus its peers too.
Hitachi is largely banking on growing demand for chillers (used in heating, ventilation and air conditioning systems) to make its presence felt in the institutional space. On the retail front, it plans to refresh its product portfolio periodically, undertake regional expansion and lay impetus towards inverter ACs. Moreover, the company’s financials remain robust. Investors may consider taking advantage of the steep drop in the share’s price during the course of the past 12 months.
For Blue Star and Voltas, improved Q3 performance in the electro-mechanical segment (including mechanical, electrical, plumbing and centralised air conditioning projects) should offset the weakness in unitary cooling products (includes ACs, commercial refrigeration, air coolers and water coolers). Going forward, gradual recovery of AC sales and government projects-led order book growth will be the key factors to watch out for.
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