HITCHING YOUR WAGON to an untested star may not be quite the safest way to grow, but for Vir Advani, 37, executive director and president, electro-mechanical projects business, Blue Star, it’s a better option than having “blood on our balance sheet”. Till 2008, Blue Star was the largest supplier of air conditioners to commercial complexes across the country. Despite the gloom, the senior management realised that the construction of apartments was still rising and the future could lie beyond the company’s core strength. Blue Star began building an integrated mechanical, electrical, and plumbing (MEP) business from late 2007. “An air-conditioning contractor is insignificant, but an MEP contractor is significant because the construction doesn’t progress unless he does,” says Advani.
The central air-conditioning sector, estimated to be worth Rs 6,900 crore, has its fair share of unorganised players, who largely focus on projects of Rs 10 crore or less. The larger projects, which account for some 60% of the market, are mainly shared by four players—Voltas, Blue Star, Sterling & Wilson, and ETA. Foreign players had entered this space but the construction industry requires local knowledge and ability to keep local teams together. This is why global players such as Carrier and ABB chose to cut their losses within a few years of starting out.
Among its peers, Blue Star is well placed to get a larger piece of the MEP pie, with ETA its only big competitor. Voltas, which has a presence in the MEP space, gets a larger chunk of revenue from its overseas operations, while Sterling & Wilson (owned by the Shapoorji Pallonji group) is still seen as a Mumbai- and Delhi-centric player. Advani seems unflustered by competition, saying they “may have high technology, but they are trying to catch up in terms of reach and a services network”.
Despite flip-flops, the gamble on MEP seems to have paid off: Today, Blue Star is the largest MEP player, with 30% market share. Things could be better though, claims Advani. “MEP revenues are a third of what they would be if the construction sector were more mature,” he says, adding that he is hopeful of exponential growth in FY16. So far, Blue Star has worked with marquee names such as Oberoi Realty, Godrej Properties, JW Marriott, Radisson, Novotel, Apollo Hospitals, and Fortis Healthcare, apart from infrastructure projects, including major airports and Metro rail projects.
Despite the perceived slowdown, Mumbai alone has at least five ultra-large projects, including Lodha’s World Towers, being touted as the tallest residential building in the world. All these will have central airconditioning. “The next construction boom will be dramatically different for Blue Star. The value of work will be substantially higher, and MEP will help cater to a larger pie,” says Advani, who sees the buildings projects business growing 10 times to $3 billion (Rs 18,300 crore) by 2020.
For builders, it will mean dealing with one good brand instead of a ragtag bunch of vendors. With the construction sector now seeing merit in adopting international practices and quality standards, MEP’s the way to go. Building projects in the West employ six to eight contractors; in India they require about 65. “Timelines are under control when only one vendor is accountable; so integrated contracts earn an additional premium of 5% to 7%,” says Tikam Jain, president for procurement at Mumbai-based Lodha Developers.
Blue Star’s end-to-end solutions offering has seen it retain its No. 1 position in central airconditioning despite competition from American, European, and Japanese players and their latest technologies. Blue Star ensures its customer experience begins from the dealers (with whom the company has maintained a close relationship) and continues to a strong after-sales services network. “We don’t deliver just a box, but solutions,” says Advani. The company is ramping up its tech capabilities as well: It has invested Rs 75 crore on internal R&D in the last three years.
Advani isn’t blind to the fact that a slowdown could hit the MEP business hard. That’s why Blue Star is looking at diversification within the industry, by looking at industrial MEP (building factories), where margins are substantially higher than in residential projects. It is also looking at overseas projects—exporting MEP—especially in West Asia.
WHEN ADVANI RETURNED to India in 2003 from the U.S., where he had studied and worked for a few years, he came to a company that was growing comfortably. Blue Star, founded by his grandfather Mohan Advani, was the country’s biggest supplier of central airconditioning. In the five years after Advani’s return, Blue Star’s market capitalisation nearly doubled to Rs 4,810 crore in 2008. But in the two years after that, market cap fell to Rs 1,500 crore (in 2011), making Blue Star a potential acquisition target. (The Advani family owns 21.76% of the 40% promoter holdings.) Barring engineering giant Larsen & Toubro, automobile maker Tata Motors, and a few others, most Indian technology and manufacturing businesses have lost out to Korean and Japanese companies.
That’s when the MEP foray was considered. To help kick-start this business, Blue Star acquired Naseer Electricals, a Bangalore-based electricals contracting firm, in 2008 for Rs 42 crore; this got it 117 electrical services employees and an order book of nearly Rs 100 crore. In FY10, the projects business posted a profit of Rs 181 crore. The company made another acquisition in July 2010, when it bought Mumbai-based D.S. Gupta Construction, a plumbing and firefighting firm for Rs 80 crore.
Though these acquisitions helped Blue Star win projects, the company posted a consolidated loss of Rs 104 crore in FY11 because of a loss of Rs 98 crore in its project business. Advani admits that the integration of the acquired businesses as well as project costing and execution took a toll on the company. Observers says Blue Star’s due diligence before its acquisitions was questionable. Small construction contractors’ businesses aren’t transparent—they are often known to be run partially on cash, says a Mumbai-based air-conditioning contractor. “The cash is used to buy raw material at a bargain and push up profitability in their books,” he adds.
Advani doesn’t blame the acquisitions alone (though he acknowledges that these were “mistakes”). “It was unfortunate that the [MEP] strategy was rolled out at a time when commercial real estate went into the doldrums,” he says. Around the same time (2010-11), the investing community, which had so far backed Blue Star, began turning cautious. In April 2011, for instance, UBS Investment Research came out with a “buy” report on Blue Star, with a target price of Rs 440 over one year (at the time of the report, Blue Star traded at Rs 370 levels). By October that year, however, UBS cut the target price to Rs 300. Then, Kotak Securities, which had a recommendation similar to UBS’s—a target of Rs 448—revised it to Rs 227 by November 2011.
IN THE LAST TWO and a half years, Advani says there have been signs of improvement in the running of projects. Older orders were bleeding the company, and the projects business started breaking even after Blue Star became selective in accepting new orders, he says. All orders bagged after mid-2011 have stringent controls in place: If dues are not settled, additional material is not delivered and work is stopped. In the past, Blue Star would deliver 90% of the material—and would then have to wait for payment. “Now, we also renegotiate rates when timelines are breached due to no fault of ours,” says Advani.
Advani also “closely monitors” projects to see if they come up with “cash in hand and repeat business”. Of the total order book of Rs 1,737 crore at the end of December 2013, orders worth Rs 275 crore had low or no margins. Blue Star turned profitable again in 2012-13, but the projects business still does not reflect that. Advani believes this will continue for another four quarters—that is, until the old orders taper off. He hopes to start 2014-15 with a clean slate.
Despite his optimism, Advani declines to reveal sales targets. “It’s an exciting opportunity, but it requires a measured and sensible approach. We need a capital turnover ratio (it compares revenue with capital—a higher number indicates that capital has been utilised better to generate revenue) of six; if this doesn’t happen, the business isn’t running well.” He admits “it’s about four now” but could be between eight and 10 in a couple of years.
Advani claims that many of Blue Star’s larger projects are now running at zero to positive cash flow owing to tight management and favourable payment terms, which include defining the financial implications for delays caused by client, as well as seeking revolving letters of credit (LCs) from first-time customers. “A Rs 3 crore LC in a Rs 10 crore project will not be very costly but provide us a safety net.”
“If the business is run right it can be operated at zero to positive cash flow. Then, at any given time you should have your customer’s money,” says Advani. “It is the operating efficiency which determines whether customers have Blue Star’s money or Blue Star has theirs. So commercial management of the project business is as important as technical.”
MEANWHILE, THE COMPANY isn’t putting all its eggs in the MEP basket. It’s relying on its core competence—air conditioners—to help it grow faster, “but not at the cost of profitability”, says B. Thiagarajan, Blue Star’s executive director and president of the air-conditioning and refrigeration products business.
“China’s market size is above 50 million units of room air conditioners, India’s is just 3.5 million though airconditioning is needed more here due to weather conditions,” he says. With just 3% of the country’s residential segment opting for airconditioning, Thiagarajan believes there’s a huge potential to be tapped. However, Paras Sirohia, chairman and managing director of Seagull Cooling, a Mumbai-based distributor of air conditioners and vice president of industry body All India Air Conditioning and Refrigeration Association, points out that “rate-cutters are the market leaders in this segment”. It, therefore, remains to be seen how Blue Star can succeed in this segment if it doesn’t offer competitive rates. So far, it has remained one of the few profitable players in the industry because of its focus on the high-margin non-retail market.
In the commercial segment, including hotels, hospitals, malls, and offices, only a third of what’s needed has been set up, he says. Organised retail will further drive demand, Advani says. Already, consumption of ready-to-eat foods is going up in India. “Our ice cream [refrigeration] business is growing at 30% even in the downturn,” he says. Blue Star sells nearly 80% of its deep freezers to the ice cream industry which comprises 65,000 players, mostly local brands. With an annual per capita consumption of 350 ml, compared with 28 litres in New Zealand and 23 litres in the U.S., the Indian ice cream market of Rs 3,000 crore has a lot of catching up to do and is a destination for global players.
The cold chain segment, a Rs 2,000 crore market, is another space Blue Star is looking at. Nearly 30% of vegetables and fruits produced in India spoil due to the lack of cold chains. A study by the Associated Chambers of Commerce and Industry of India estimates the loss to be Rs 2 lakh crore every year. Clearly, cold chains are a vital solution, along with modern food processing units. The relaxation of foreign direct investment norms in retail could attract investments in cold chain.
Thiagarajan says the vegetable or fruit has to be of “high value so it can afford a cold chain”. Apples, for instance, are seasonal but available all through the year thanks to cold chains. Being a high-value fruit, it can bear a cost of Rs 10 per kg to pass through a cold chain. “I see cold chains developing in pockets [Kashmir and Himachal Pradesh in the case of apples],” says Thiagarajan. There’s even a price arbitrage model developing around cold chains. Carrots, harvested in Uttar Pradesh’s Bulandshahr in February, are stored and sold later at higher prices.
With Blue Star’s current managing director, Satish Jamdar, coming to the end of his term, all indications are that Advani will move into that role. He’ll now have to figure out how to pick up the reins of the various businesses and not focus on MEP alone.
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