Soaring summer temperatures have brought cheer to air conditioner (AC) manufacturers. Based on dealer feedback, analysts are pegging AC sales growth at 20-25% year-on-year in April and May.
This is welcome news for investors in these firms, especially as it comes after a slightly extended winter, which had dampened March quarter sales. To add to this, the overall slowdown in consumption had increased dealer inventory across consumer durable segments. The sudden spurt in demand in April, therefore, led to clearance of inventory channels.
Of course, investors should be cautious in extrapolating these growth numbers. The onset of the southwest monsoon in mid-June may cool demand for the last two weeks of the June quarter.
Besides, the moot question for an investor is whether the strong sales growth for AC makers will translate into margin expansion. After all, stiff competition among a host of established companies has fragmented the market. Incumbents are luring customers with various offers, which implies higher marketing and advertising costs that could impact margins.
Meanwhile, note that the room AC market had stagnated with sales at 4.7 million units in FY19 (see chart). Further, a change in regulatory energy rating norms for ACs has led to cost increases, which along with a jump in commodity prices, has weighed on profit margins. For instance, Voltas Ltd’s Ebitda (earnings before interest, tax, depreciation and amortization) margin dropped from 11.4% in the June 2018 quarter to 7% in the March 2019 quarter. Likewise, Blue Star Ltd’s margin fell from 9.1% to 6.2% in the same period.
A report by Jefferies India Pvt. Ltd points out that after the introduction of the new energy rated products in calendar year 2018, AC prices have moved higher by more than 10% for a similar rating AC.
With the summer season being a sequentially better quarter, analysts expect margins to improve by 100-150 basis points in the June quarter vis-à-vis March. Coming after three quarters of downtrend, this should cheer investors. But margins are still expected to be lower than the year-ago period.
Shares of listed companies Voltas and Blue Star have risen 20% and 40%, respectively, from their mid-February lows. The shift to mass-market, quality air conditioning by consumers places Voltas (with a 24% market share) on a strong wicket.
At the current market price, these stocks trade at a trailing price-to-earnings multiple of 50-60 times. Given these valuations, it looks like stocks of AC manufacturers need to cool off a bit.