Blue Star Ltd: Stock Analysis for Long Term Investment
Blue Star Limited (BLUESTARCO) is India’s largest central air conditioning company with an annual turnover of Rs 2574 crores, a network of 29 offices, 5 modern manufacturing facilities, 700 dealers and around 2600 employees. Blue Star primarily focuses on the corporate and commercial markets. These include institutional, industrial and government organizations as well as commercial establishments such as showrooms, restaurants, banks, hospitals, theatres, shopping malls and boutiques. It also has leadership in the field of commercial refrigeration equipment ranging from water coolers to cold storages.
I like that fact that the company is generating approximately Rs 1 Crore of revenue per employee, has low debt, brand value, and leading position in its industry. Blue Star passed my stock screen, and hence it warranted an analysis to understand if meets my objectives.
Trend Analysis
The whole reason for any business to exist is to generate sales revenue and make more profits. At a minimum, the parameters listed below should have continuously increasing trends. All the data below is based on last 8 years i.e. from 2000 to 2008.
- Revenue: Increasing trend since 2000 with average growth of 21% (SDev. 13%). Good observation.
- Earnings per share: Increasing trend with average growth of 31% (SDev. 51%). High variability and has possibility of negative growth. Neutral observation.
- Net cash flow from operations: Continuously increasing trend. In general, the net cash flow is less than reported net profit. This is not good operational scenario. The company has sundry debtors of approximately Rs650 cr. This is almost 25% of its revenue. This seems to repeat every year. Not a good observation.
- Profit/Loss from operations: Consistently increasing trends in profits from its operations since 2000. Very good observation.
- Reported net profit: Overall an increasing trend since 2000. Very good observation.
- Gross margins: Current GM of 9.0% is higher than historical average of 7.2% (stdev. 1.1%). Stable and hence very good observation.
- Operating margins: Current OM of 10% is higher than historical average of 7.0% (stdev. 1.8%). Stable and hence very good observation.
Blue Star Ltd. - Trend Analysis
Quality of Dividends
In this part of my analysis, I am trying to understand dividend growth rate, consistency, and ability of the corporation to demonstrate sustainability. In is also an indirect way to gauging management’s policy vis-à-vis sharing of profits with common shareholders.
- Dividend per share: Chart 3 shows that anemic dividend payments since 2003. Neutral observation.
- Payout factor: This has been range bound from 35% to 53%. This is higher than my comfort limit of 50%. It leaves less room for dividend growth and makes it highly dependent on the increase profitability. Contrarily, it could be considered good because management shares more profit with the shareholders. Neutral observation.
- Dividend growth rate: The dividends have not grown at sustained year-on-year basis. i.e. there has been a high level of variability. Overall, on the basis of last nine years, the dividends have grown at an average of 26% (std dev. 42%) which is less than overall EPS growth rate of 31% (std. dev 45%). Not a good observation.
- Ratio of cash from operations to reported net profit: This ratio is less tore than 1.0. Not a good observation.
- Ratio of profits from operations to reported net profit: This ratio is more than one. Good observation.
- Ratio of Cash from operations to total debt: This ratio was consistently less than one. However, it seems have lowered its debt in 2008 and 2009 time period. Good observation.
Dividend Cash Flow vs. Risk Free Savings Cash Flow
Why should I take risk if I can get a same or more cash flow by putting my capital into any risk free savings, fixed deposits, or any such risk free accounts? Therefore, I try to understand how dividends will affect my cash flow in 10 years of time period. The baseline assumptions are (1) the stock’s dividend yield is 2.0% at current price of Rs. 354; and (2) savings interest rate is 7%.
- Best case scenario: considering average dividend growth rate of 26% for last nine years, the dividend cash flow will be 1.23 times the cash flow from savings interest at the end of 10 years.
- Worst case scenario: considering low end of the expected dividend growth of 10%, the dividend cash follow will be only 0.36 times the cash flow from savings interest at the end of 10 years.
- In order to have equal cash flow (i.e. dividends = savings interest) in 10 years time period, the current yield should be 5.6% with average dividend growth of at least 10.0%. At this yield the buy price is Rs 126.
Projected Beta-based Expected Return
I measured Beta for this stock’s risk (or price movement) relative to the S&P CNX NIFTY (or index movement). Here, I am trying to understand how a stock price behaves relative to the market and how to factor in the capital appreciation into my expected returns.
- The stocks three year Beta value is 0.54. This means this stock is relatively less volatile w.r.t. S&P CNX NIFTY index.
- The expected return is 11.6% relative to market index.
- Now factoring in 11.6% of expected return into the worst case dividend growth of 10% and current yield of 2.0%, the total cash flow is 2.8 times the savings interest rate.
Fair Value Calculation
The next step is to estimate the fair value so that we can understand return characteristics for this investment.
- NPV price based on 15 year DCF: Rs 257.8
- Average high yield price calculated based on past 9 years: Rs 174.6
- Pricing relative to 9 year average PE ratio: Rs 381.4
- Pricing based on PE ratio of 12: Rs 189.3
- Graham number: Rs 120.4
The range of fair value is calculated as Rs 175 to Rs 225.
Qualitative Analysis
- Blue star has a good brand image, leading market share in Indian central air conditioning industry.
- Blue star is well positioned to take part in infrastructure growth and office building construction I expect the company to grow along with the growth in Indian economy.
- The company is dividend friendly (relative to other companies in this industry). However, in absolute terms, I do not consider it as dividend friendly.
- It has been able to manage its debt level. However, I would have concern about its cash flow. Sundry debtors are at 25% which to me is very high.
- Although Blue Star is higher margin relative to its peers, it is still in single digits.
Summary…
I would expect Blue Star to provide a very slow and anemic growth over a long time period. I do not consider it as good dividend paying company. The only rationale for investing in Blue Star could be to hedge in this domain (i.e. infrastructure and/or air conditioning). It is current pricing is at 58% premium to what I would be willing to buy it.
I do not consider Voltas, its competitor, to be an option because of miniscule dividends, high debt relative to cash flow, extremely high sundry debtors, and very low margins.
I will not be initiating a new position in Blue Star. However, I believe who have bought Blue Star stock at lower pricing, should continue to hold. It will provide low volatility to your overall portfolio and slow growth for next 5 to 10 years time scale.
Disclosures: No positions in Blue Star.
Disclaimer: This analysis is in the context of my long term buy and hold investment philosophy. It is in line with my investment objectives and my personal risk profile. Please do your own research for your own objective before making an investment decisions for Blue Star Ltd.
500067, beta for blue star, blue star, blue star dividend history, BLUESTARCO, dividends
Hello Sir,
I spent some time going through P/BV as one of the parameters in valuing companies.now i came across a presentation about it by some prof in US.He gives various ways of finding the ratio ,and mainly draws the dependence of ratio on ROE and beta.
In it he concludes that undervalued companies could potentially be those which have high ROE but low P/BV .Similarly,companies with low ROE and high p/bv are overvalued. What do you think about this approach in finding undervalued companies.Is it logical to find value in this way.(of course with other parameters)
He also used some Regression Analysis and gave a approx formula for Reliance, as
-1.68+24.04(ROE).
If we take ROE as 16% comes to 2.16.(Currently Reliance has p/bv of 3.2)
Hello Saif,
This could be used as a screen to shortlist a set of companies. This may bring out the quantitative aspect only. Plus, also look for why the P/BV is small. There could be come underlying reason. i.e. you still have to understand qualitative aspect.
In addition, ROE can be artificially jacked up by taking on debt and/or share buyback.
Keep you with your curiosity.
Best Wishes,