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Edited Transcript of BLUESTARCO.NSE earnings conference call or presentation 14-Aug-19 5:30am GMT

Q1 2020 Blue Star Ltd Earnings Call

Mumbai Sep 17, 2019 (Thomson StreetEvents) -- Edited Transcript of Blue Star Ltd earnings conference call or presentation Wednesday, August 14, 2019 at 5:30:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Neeraj Basur

Blue Star Limited - CFO

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Conference Call Participants

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* Aditya Bhartia

Investec Bank plc, Research Division - Analyst

* Ajinkya Bhat

Macquarie - Analyst

* Ankur Periwal

Axis Capital Limited, Research Division - VP of Media and Logistics

* Jaikan Gustori

Way2Wealth Brokers Pvt. Ltd. - Analyst

* Naveen Trivedi

HDFC Securities Limited, Research Division - Research Analyst

* Nirav Vasa

Anand Rathi Financial Services Limited, Research Division - Research Analyst

* Nitin Arora

Axis Asset Management Company Limited - Equity Research Analyst

* Prashant Kutty

Sundaram Mutual Fund - Analyst

* Renjith Sivaram

ICICI Securities Limited, Research Division - Assistant VP

* Shrinidhi Karlekar

HSBC, Research Division - Analyst

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Presentation

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Operator [1]

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Ladies and gentlemen, good day, and welcome to Blue Star Limited Q1 FY '20 Earnings Conference Call. We have with us today from the management, Mr. Neeraj Basur, Group CFO. (Operator Instructions) Please note that this conference is being recorded.

I now hand the conference over to Mr. Neeraj Basur. Thank you, and over to you, sir.

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Neeraj Basur, Blue Star Limited - CFO [2]

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Thank you. Good morning, ladies and gentlemen. This is Neeraj Basur. I will be providing you an overview of the results for Blue Star Limited for the quarter ended 30th June 2019.

The financial highlights of the company for the quarter ended June 30, 2019, on a consolidated basis are as follows: revenue from operations for Q1 FY '20 was INR 1,575.45 crores as compared to INR 1,507.83 crores in Q1 FY '19, a growth of 4.5%.

EBITDA, excluding other income and finance income, for Q1 FY '20 was INR 114.85 crores as compared to INR 136.66 crores in Q1 FY '19. PBT before exceptional items was INR 107.96 crores in Q1 FY '20 as compared to INR 111.83 crores in Q1 FY '19.

Other income, including finance income, for Q1 FY '20 was INR 21.66 crores compared to INR 3.34 crores in Q1 FY '19. Other income in Q1 FY '20 was higher on account of receipt of an industrial promotion subsidy for our manufacturing facility at Wada.

Finance cost for the quarter decreased to INR 8.23 crores from INR 12.1 crores in Q1 FY '19 due to effective management of working capital and consequently lower borrowings in Q1 FY '20. There was an exceptional income of INR 15.18 crores in Q1 FY '19 on sale of a property. There was no such exceptional income in Q1 FY '20.

Our tax expense for Q1 FY '20 was INR 32.52 crores as compared to INR 32.5 crores in Q1 FY '19. Net profit for Q1 FY '20 was INR 76.84 crores compared to INR 91.58 crores in Q1 FY '19.

Carryforward order book as at June 30, 2019, was INR 2,841.1 crores as compared to INR 2,121.60 crores as of June 30, 2018, an increase of 33.9%.

Effective working capital management enabled a significant reduction in our capital employed to INR 949.20 crores as on June 30, 2019, from INR 1,301.29 crores as on June 30, 2018. Consequently, there was a net positive cash balance, though very small, of INR 0.74 crores as on June 30, 2019, compared to a net borrowing of INR 403.48 crores as on June 30, 2018, last year.

I will now talk about business highlights for Q1 FY '20. Segment I: Electro-Mechanical Projects and Commercial Air Conditioning Systems. Segment I revenue was INR 623.94 crores in Q1 FY '20 as compared to INR 619.36 crores in Q1 FY '19, a modest growth of 0.7%. Segment results was INR 33.53 crores, which is 5.4% in Q1 FY '20, as against INR 39.7 crores, 6.4% last year in Q1 FY '19.

Given the current liquidity situation in the market, our intention is to continue the capital employed. This has resulted in slower job execution in Q1 FY '20 despite a healthy order book. However, in certain segments, job closure and cash flows are encouraging. Further, order inflow during the quarter was higher by 55% at INR 966.9 crores as compared to an inflow of INR 622.83 crores in Q1 FY '19.

Our Electro-Mechanical Projects business. During the quarter, we won our largest tunnel ventilation system and environmentally controlled system contract from Mumbai Metro Rail Corporation valued at INR 253 crores.

Order inflow from factory and other office space segments also grew at a steady pace during the period. We continue to maintain our leadership in the electromechanical space in India. Some other major orders won during Q1 FY '20 are for MEP projects pertaining to Chennai Airport; India International Convention Centre, Dwarka; Embassy Group, Bangalore and Chennai; CEAT Ltd, Nagpur; DLF, Gurgaon and Secunderabad; and JSW Steel, Raigad.

Carryforward order book of our Electro-Mechanical Projects business was INR 2,013 crores as on June 30, 2019, as compared to INR 1,447 crores as on June 30, 2018, an increase of 39%.

Commercial Air Conditioning Systems. We continue to focus on developing our innovative product portfolio and rapid channel expansion. We also introduced new products in the market across all categories. Key segments that contributed to billing in Q1 FY '20 were industrials, hospitals, retail and educational institutions.

Major orders bagged in Q1 FY '20 were from JSW Steel Limited, Bellary; National Thermal Power Corporation, Gurgaon; Director General of Naval Purchases, Visakhapatnam; and ISRO, Chennai.

Our International Business. We continue to focus on market consolidation and growth in the markets of Middle East, Africa and SAARC countries with revisions in the product standards and certifications and through enhanced distribution reach. During the quarter, we witnessed steady order inflow in key markets with adoption of eco-friendly refrigerants as an option for our customers. The demand for inverter room air conditioners also increased during the quarter.

Our international projects executed through the joint ventures with -- at Qatar and Malaysia continue to do well. We continue to invest in strengthening our brand in selected international markets. Though the demand in UAE appears to be slowing down, the inquiry pipeline relating to Expo 2020 projects is healthy. The overall business outlook remains positive.

I'll now talk about Segment II: Unitary Products. Segment II revenue was INR 906.89 crores in Q1 FY '20 as compared to INR 830.76 crores in Q1 FY '19, a growth of 9.2%. Segment result was INR 98.91 crores, which was 10.9% of revenues in Q1 FY '20, as compared to INR 95.01 crores, which was 11.4% of revenues in Q1 FY '19.

Room Air Conditioner business. The summer was delayed, but in the short window, it was intense across most part of the country. Aided by this, the Room Air Conditioner business achieved a growth of 25% compared to the market growth of 22%, and this helped us improve our market share to 12.5% in Q1 FY '20. Q1 FY '19, we were at 11.7%. However, the demand was more for fixed-speed, 2- and 3-star models rather than 5-star inverter models, resulting in comparatively lower price realization and therefore, margins.

Moreover, due to late onset of summer, unlike last year, advertising expenses peaked in Q1 this year. We expanded the product portfolio and introduced newly -- new competitively priced inverter split AC models while retaining all the premium features.

Our Commercial Refrigeration business. Our commercial refrigeration products had witnessed strong growth during the preceding 2 sequential quarters driven by growth in the processed food, ice cream, e-tailing and dairy sectors. In fact, this business had peaked in the month of March 2019.

During the current quarter, we focused on enhancement of our product portfolio in preparation for migration to the new-age, non-ozone-depleting range of commercial products. Accordingly, we prioritized liquidation of existing inventory. And on the back of a larger base of last year, the current quarter's revenue was subdued and moderated.

However, we continued with our leadership position during the quarter, and back orders from some major ice cream players like Amul, Havmor, Hatsun and Hangyo during the quarter. Our new product categories of commercial kitchen refrigeration, medical refrigeration and supermarket refrigeration gained traction in the market. We continue to be market leaders in our major product categories, such as deep freezers, storage water coolers and cold rooms, and expect the growth trajectory to once again pick up soon.

Water Purifier business. The integration of Water Purifier business with our Room Air Conditioner business was completed, and the new range of products was launched for the forthcoming season. Both the businesses are complementary in nature in terms of seasonality. Further, the overall cost structure is expected to come down due to this reorganization.

Segment III: Professional Electronics and Industrial Systems. Segment III revenue was INR 44.62 crores in Q1 FY '20 as compared to INR 57.71 crores in Q1 FY '19. Segment results were INR 4.42 crores, which is 9.9% in Q1 FY '20, as compared to INR 8.28 crores, which is 14.3% in Q1 FY '19, due to lower billing in Q1 FY '20. The results are not comparable since there was a onetime revenue from supply of CT scanners to the Government of Uttar Pradesh in Q1 FY '19.

Our focus is on customized and automated solutions across industries with wider range of applications. Revenue from the nondestructive testing systems business improved from multiple high-value orders. The data security business performed well on the back of digitization initiatives of the financial sector. Growth potential of the Indian digital payment sector and rising focus of enterprises on data security created a huge opportunity for data security business, which we are hopeful will pan out in the subsequent quarters.

Spending in the health care sector was muted. However, post-elections, we expect growth in orders from both public and private players. During the quarter, large orders were received from Jindal Saw Limited, Tata Steel, Orange Business Services, Vedanta, Wheels India, HDFC Bank, Bhabha Atomic Research and MasterCard Technology.

Our business outlook. The macroeconomic conditions are weak and there are visible symptoms of slowdown in demand. Moreover, the demand for most of the product categories continue to remain for low-end products. Having said that, order inflow from select segments continues to be healthy and our pending order book is strong. We will stay focused on driving revenue growth and profitability with a close watch on margin and, most importantly, on capital employed and borrowings.

With that, ladies and gentlemen, I'm done with the opening remarks. I would like to now pass it back to the moderator who will open up the floor to questions. I will try and answer as many questions as I can. To the extent I'm unable to, we will get back to you via e-mail.

With that, we are now open for your questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) We have the first question from the line of Aditya Bhartia of Investec Capital.

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Aditya Bhartia, Investec Bank plc, Research Division - Analyst [2]

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Sir, you spoke about a subsidy received on Wada facility. I'm just wondering if that forms part of segmental profits as well for the UCP segment.

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Neeraj Basur, Blue Star Limited - CFO [3]

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So Wada facility, as I've explained, is included in other income, that number of INR 22 crores, that you see over there. The amount that we have received to date is around INR 14 crores, and that relates to largely Segment I. So about 60% is Segment I, while 40% will be Segment II.

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Aditya Bhartia, Investec Bank plc, Research Division - Analyst [4]

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Okay. And that would be a part of segmental profits that we have reported?

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Neeraj Basur, Blue Star Limited - CFO [5]

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That's correct.

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Aditya Bhartia, Investec Bank plc, Research Division - Analyst [6]

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Understood. Okay. Sir, my second question is just trying to understand a bit more on the room AC growth that we have seen this quarter. I mean our understanding was that the industry has grown at a fairly brisk pace, 25% to 30%. And within that, if I understood correctly, you kind of referred about volume growth for Blue Star being around 25%. Is my understanding correct?

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Neeraj Basur, Blue Star Limited - CFO [7]

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I talked about value growth. We always...

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Aditya Bhartia, Investec Bank plc, Research Division - Analyst [8]

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Oh, that was value growth. Okay.

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Neeraj Basur, Blue Star Limited - CFO [9]

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Yes. That's right.

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Aditya Bhartia, Investec Bank plc, Research Division - Analyst [10]

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Does that mean that Commercial Refrigeration business for the company has actually shrunk very, very sharply this quarter? And given that we have new offerings in kitchen and medical, what has really contributed to that?

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Neeraj Basur, Blue Star Limited - CFO [11]

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Okay. So let me try answering. This question will be there on the minds of other participants also. So let me address it upfront and for the benefit of everyone.

So as far as [what we see] for the room AC business, so as I explained, the market -- the summer started a bit late. Normally, the summer started on March. This year, the summer started actually well into April. But when it started, it was quite intense and it was quite strong across various parts of the country, which is more or less in line with what we normally experience in quarter 1.

So to that extent, we also benefited with the summer -- the spell of summer this year. Market, our assessment is on a primary market, business would have grown by around 22% as far as the value is concerned, and our growth has been 25%. So pretty much in quarter 1, we were able to reap the benefits of the summer season opportunity, which I presented.

Now you will also be aware that most parts of last year, in May until quarter 4, we were having inventory and one-offs, a key challenge area that we said we want to address. We substantially had addressed inventory issues by quarter 4 end. But now we wanted to significantly ensure that the inventory issues, as far as Segment II are concerned, are formally put behind us so that when we get out of the peak season, unlike last year when we ended quarter 1 with still inventory overhang, we were very conscious this year we must exit quarter 1 with fairly well-managed inventory balances.

So as you can see that the overall capital employed for Segment II has been shrunk quite significantly, which has helped us almost wipe our borrowings out. And the overall growth of room AC continues to be quite encouraging for us.

The margin profile tended to be a bit, I would say, under pressure because the demand, though the summer started, but the demand was not as much for high-end products, the premium products. It was more for 2- and 3-star-rated, fixed-speed products, where the margin profile is a little bit lower than the higher-end products. That's all the small margin dip that we see.

The commercial products that we have, you will again remember that we had a fairly good run with our commercial products over now sequential 3 or 4 quarters, starting quarter 1 last year. And there was a big days shift effect, which has already happened in that particular range of products that we have. Quarter 4, especially the month of March, we did very well on our commercial products. And to some extent, there was a cooling-down effect of that in quarter 1 this year. That's one reason.

The other reason is because of the fantastic response we've been getting on our commercial products, we wanted to migrate a majority of our product portfolio to a more eco-friendly, non-ozone-depleting-based refrigerants, which we have started.

So one consideration on our mind again was that before we end quarter 1 for commercial products, we must significantly deplete and liquidate the inventory of our old products before we start migrating to the new set of products.

So a combination of these reasons has resulted in a overall reduction in the growth for commercial products in quarter 1, which will be to the tune of around 28% to 30% as compared to quarter 1 last year. And the room AC kind of made up for that de-growth, giving us this blended growth of 9%.

So for your benefit and the benefit of everyone else on the call, I want to reiterate that we are pretty much on track and in a usual trajectory of growth as far as room ACs are concerned. The added advantage which we will now have is because of the thin inventory base. We will get into quarter 2, quarter 3 and quarter 4 on the normal business growth trajectory.

And our outlook for the market for the full year and our own growth prospects for the full year remains optimistic and quite encouraging. So I hope that should address your queries on the -- what has happened with us in quarter 1 as far as Segment II is concerned.

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Operator [12]

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We'll take the next question from the line of Renjith Sivaram of ICICI Securities.

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Renjith Sivaram, ICICI Securities Limited, Research Division - Assistant VP [13]

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Sir, just to follow up on the previous question. What we want to understand is that our cooling products have grown only 9%, while one of your competitors had shown 45% growth. So you have mentioned that your room ACs has grown by 25%. So then, what could have been the de-growth in the other segments so that the overall growth is only 9%? If you can help us understand the math.

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Neeraj Basur, Blue Star Limited - CFO [14]

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So Renjith, I just explained fairly in a detailed form. Let me explain it one more time so that this gets fully clarified. First, one clarification. The 45% that you're comparing is for secondary sales, okay? Now we -- when we report, we are reporting primary sales. Our secondary sales will also be significantly higher than 25%. That we know with our channel check and what's happened on the stores. But we report consistently primary sales. So our -- the number of 25% that I've talked about is the primary sales growth that we have experienced, okay? So that's the first clarification.

The second clarification is, again, I'm repeating, the blended growth of 9% that you see in Segment II comprises of around 25% growth that we have delivered as far as room ACs are concerned. And if you will remember, about 68% -- around 70% of our Segment II is room ACs, 30% is our commercial range of products and other smaller product categories that we have.

So the remaining 30% is where, for the reasons I explained, where we are switching over to a fairly different product portfolio on our commercial range of products and on the back of a significant growth we had delivered last year on a larger base. This year, quarter-on-quarter, there is a close to 13% de-growth.

But there's nothing to be concerned about because like I explained, it is partly intended that way because we wanted to make sure that by the time the commercial products get into the next season, our sales -- selling season which starts close to end of quarter 3, beginning quarter 4, we are ready with -- we are -- we should be able to capitalize on our market leadership further. So we needed to have 1 quarter of transition as far as commercial products are concerned.

And since the last point I'll make is our focus on liquidity inventory across the room ACs and commercial products, also ensure that we are taking calls in order to facilitate that product portfolio transition. So that's broadly the explanation for why a blended 9%, whereas the room ACs had this year a reasonable growth in line with -- in fact, better than the market growth as far as we are concerned.

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Renjith Sivaram, ICICI Securities Limited, Research Division - Assistant VP [15]

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Okay. And what is the kind of market growth we are factoring for FY '20, given last year, also second quarter was very bad, given the very big Onam from Kerala? So now the Onam sales seems to be good because there has been not the kind of -- the waterlogging which we had seen last year. So for the full year, what kind of growth of the room AC you are looking at?

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Neeraj Basur, Blue Star Limited - CFO [16]

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Yes. So unfortunately, again, we have floods in Kerala. We're aware of that. Very unfortunate, second year in a row. Of course, the intensity of flooding is relatively lower as compared to what happened last year. But still, how Onam will play out still remains to be seen. But we are also quite optimistic about the festival season, both in quarter 2, quarter 3 this year compared to quarter 2, quarter 3 of last year.

Our own assessment is that room ACs market -- the year has started off very well for the market. So that 20%-plus growth in quarter 1, our sense is for the full year, the market should be able to log anywhere between 12% to 15% growth this year. I'm talking room ACs. We believe we are still quite sharply focused on our stated goals of reaching, this year, we want to reach close to 13%-plus market share. We are at 12.5%.

So with our aspiration of reaching close to 13.5% by the time we end the year, it will mean that we will have to grow faster than the market. And that's exactly what we are targeting and we are planning for for the remaining 3 quarters. So we are optimistic we should be able to meet those aspiration targets goals.

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Renjith Sivaram, ICICI Securities Limited, Research Division - Assistant VP [17]

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Okay. And sir, just in inverter, what is the percentage of inverters in the current, because you told that 2-star and 3-star has sold more. So does that mean that inverter proportion has come down?

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Neeraj Basur, Blue Star Limited - CFO [18]

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No, not really. So for -- I'll give you both the data points. So as far as quarter 1 is concerned, market share of inverters was around 60%. Now in our case, since -- like I explained, we sold more of 2- and 3-star fixed-speed machines, our inverter share dipped a little bit to 52%. And our fixed speed share of sale was higher at 48% as compared to market share of market's fixed speed sale share of 40%. So 52% for us, 60% for the market, inverter.

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Operator [19]

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Our next question is from the line of Nitin Arora of Axis Mutual Fund.

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Nitin Arora, Axis Asset Management Company Limited - Equity Research Analyst [20]

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Maybe just one question on margins...

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Neeraj Basur, Blue Star Limited - CFO [21]

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Nitin, I'm sorry, your voice is not very clear. You need to get a bit closer to the...

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Nitin Arora, Axis Asset Management Company Limited - Equity Research Analyst [22]

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Yes, sure. Just one question on the margin. When we -- so assuming 40% of Wada subsidy is in the segmental EBIT of cooling product, so the margins end up to be about 9.9% for that segment. In similar way, the 3.6% for EMP...

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Neeraj Basur, Blue Star Limited - CFO [23]

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So that number, if you eliminate that onetime Wada subsidy benefit, will be around 10.5% for Segment II and close to 4% for Segment I.

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Nitin Arora, Axis Asset Management Company Limited - Equity Research Analyst [24]

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Got it. So just wanted your outlook, your sense on the margin because this -- where you guided us also in the previous analyst meet also that there was a little down trading in terms of ACs getting sold in this period...

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Neeraj Basur, Blue Star Limited - CFO [25]

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Nitin, I'm sorry, you will need to be closer to the mic.

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Nitin Arora, Axis Asset Management Company Limited - Equity Research Analyst [26]

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Sorry. I'm saying that where you have guided us earlier also that there was a down trading in terms of AC being sold, more -- less of inverters, more of 2-, 3-stars. We also saw your competitors selling more of those rather than inverters in the season, which affected the growth there.

What is your outlook on margins? Do you think it is sustainable here? Or do you think no, given that you started a very strong note in Q1? It seems like that we want to increase it from here or rather sustain it. Just wanted your view on that.

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Neeraj Basur, Blue Star Limited - CFO [27]

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All right. See, as far as the full year margin profile or margin expectation is concerned, I will use the word expectation at this point in time because the external environment is fairly volatile, and we are all aware of that. For Segment II, we are maintaining a margin expectation of anywhere between 9.5% to 10% for the full year.

The good news is that water purifiers, which sits in our Segment II, is on a reducing trajectory of cost burn. So that will start helping us now starting FY '20, though we are still a few quarters away from Water Purifier business breaking even.

But as relative to last year, where you will remember we had 160 basis points impact on our margins because of water purifier scale-up. That impacts us on the revenues and that will start showing up on the margin. So we are expecting 9.5% to 10% as the full year blended margin and, of course, backed up by the further growth in the market that I talked about in response to the previous question.

So we are bullish. We are bullish about the market. Gross profit, we are equally optimistic about the ability -- our ability to come back and maintain these margins.

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Nitin Arora, Axis Asset Management Company Limited - Equity Research Analyst [28]

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And just a follow-up on the cooling products. So the commercial, which saw a decline, I understand because of where you were growing in that market. Is that -- I'm asking a very short-term or near-term question -- is that, the bifurcation will probably remain the same for the next 1 or 2 quarters, the commercial is going to go down because of this transition into the...?

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Neeraj Basur, Blue Star Limited - CFO [29]

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Not really, because, like I said, we needed 1 quarter. And we didn't want to disturb this product portfolio in quarter 4. We were doing so well. We didn't want to take any decisions which upset the entire selling momentum. And that's why when in March '19, we peaked as far as commercial products are concerned, we decided it's time to make the switch. And we have taken already some 2 months to liquidate the stocks of our old product portfolio and start selling them. We already started to sell the new range of products.

The -- so the good aspect here is we -- the commercial products also have a seasonality where in quarter 2, typically, the sales tends to taper down because of primarily the ice cream manufacturers and the beverage suppliers. For them, the summer is when they would want to buy it. And that gives us the window of opportunity to fully restock the markets with the new range of products.

We will use quarter 2, quarter 3 to do that so that by the time quarter 3 sales momentum starts to pick up, we should be back on the sales trajectory, growth trajectory of our commercial products as well. So we don't expect, honestly, on the split between room ACs and the other products, we think will remain in the 70-30 range for the full year.

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Nitin Arora, Axis Asset Management Company Limited - Equity Research Analyst [30]

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And just lastly, on this unallocable, which has increased to INR 175 crores from a negative to a positive INR 175. Is there some classification got changed on cooling products coming down to unallocable? Can you (multiple speakers).

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Neeraj Basur, Blue Star Limited - CFO [31]

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So let me explain that. So as far as we're aware, Reg 33 [booking] is concerned, it is the straight format, the borrowings need to be classified as unallocable liabilities, okay? So this is what I spoke about in the opening question -- opening remarks.

We had borrowings of INR 404 crores as of -- net borrowings of INR 404 crores as of June 2018. We had borrowings of INR 250 crores as of 31st March 2019, which were getting grouped as part of unallocated liabilities. That's why you see this minus INR 191.2 crores as of 30th June 2018 and minus INR 80 crores as of March '19.

Now the borrowing has got paid off, and we are in a cash positive -- small INR 1 crores cash positive position as of June '19. That's why you will see the -- so it's a classification swing. Nothing to do with the -- and what remains here, in fact, that INR 175 crores, these are all corporate assets, like our offices, our R&D assets and so on, which have always been there. So there's no change as far as the corporate assets are concerned. It's really the swing in our borrowing performance which has caused that line to swing.

So the true operating improvement is what you will see in the Unitary Products, where we had INR 505 crores of net capital employed. As of June '18, we had INR 458 crores. As of March '19, it is now down to INR 229 crores. So that's why we have a quantum -- the massive swing in cash flows and hence, our ability to pay off the borrowing. I hope that clarifies it.

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Operator [32]

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(Operator Instructions) We'll take the next question from the line of Nirav Vasa from Anand Rathi.

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Nirav Vasa, Anand Rathi Financial Services Limited, Research Division - Research Analyst [33]

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I have 2 questions pertaining to the UCP segment. First, I would like to -- if you could just help me understand what's the kind of price hikes that we intend to undertake for the forthcoming season? And secondly, is what would be the outlook for the tenders for procurement of room air conditioners from EESL in this year based on your understanding?

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Neeraj Basur, Blue Star Limited - CFO [34]

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Okay. So first question, price hikes for the season. Unlikely. We are -- see, again, please keep in mind all of us are coming back into a normal growth trajectory from some fairly lean 3, 4 quarters and the competitive intensity is pretty high.

You will also be aware that while we have grown, a couple of our competitors have done very well, they have also grown. Equally, you'll be aware that there are a few competitors who have [been down] and whom might not have done that well. So to that extent, there is continued price competitiveness.

You'll remember, we had taken price increases in quarter 4 which we have carried through in quarter 1. We didn't want to upset the pricing equation so soon. We are maintaining our prices. We are aware there are 2 other players who have actually might have taken some price cuts, but we are comfortable with the current scale of pricing. We are aware we will be 6% to 8% higher than our nearest competitors, which is pretty much in line with what we have always been. So that's a comfort level for us.

We are not, honestly -- anyway, quarter 2 and quarter 3, there is very little price -- pricing change. So really we'll have to wait until quarter 3 end to see how the market is going to evolve in quarter 4 because quarter 4 is when really everyone might take a view on what kind of pricing they want to have. Unlikely any significant impact in quarter 2, quarter 3.

Now as far as your question on EESL is concerned. So there was this second round of tendering on EESL, which again, we evaluated quite closely. And we are still not comfortable with the commercial terms and conditions, and the margin profile is extremely low.

We are aware that one of our close competitors have indeed won an award of 3 lakh, 50,000 units or something like that, but we maintain our position where unless it becomes commercially viable, because our learnings from the first run of tendering, which happened I guess 18 months ago or almost 2 years ago, there were several challenges both in terms of fulfillment and price realization and recovery.

We do not want to be in that position and situation. So as of now, our -- we engage with them very closely, and we in fact are trying to influence to the extent possible whether it becomes a commercially a win-win. It has to become a win-win proposition where we are concerned, then it will be viable. So as of now, we have not participated. We may participate going forward. Again, it depends on the economic and commercial viability of a tender.

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Operator [35]

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We'll take the next question from the line of Naveen Trivedi from HDFC Securities.

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Naveen Trivedi, HDFC Securities Limited, Research Division - Research Analyst [36]

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Sir, one thing on the market growth which you talked about, it's around 22%, while Nielsen was saying that the market is growing by around [36%] last quarter. So why is there such a big difference between the 2 numbers?

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Neeraj Basur, Blue Star Limited - CFO [37]

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So Naveen, again, it depends on 2 factors, are you looking at a secondary growth versus primary growth. Again, like I isolated couple of minutes ago, is indeed higher. The secondary growth, which is the end sale at a store level, will be higher. This number of 22% is our understanding of the primary growth.

So obviously, again, you'll be aware that quarter 4, there were significant stock build-up which happened by all the players into the store and the market. A lot of that has got liquidated. So if you go to a store, and you ask at the store level their sales, indeed, they will be telling you this number of 35%, 40%, 45%, which is also correct. So secondary sales is higher, including us. For us also, but only thing is we do not track secondary because our primary focus is always on primary.

The other difference will be around the institutional sales. So a lot of these published reports, whether it's GfK or Nielsen, will not be able to factor in the impact of institutional sales. So it again doesn't give a complete picture. So that's the reason when we talk about market share and market growth, we are looking at primary because that's a more reliable way of measuring what has happened in the season in the market. So I hope that explains you the difference.

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Naveen Trivedi, HDFC Securities Limited, Research Division - Research Analyst [38]

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And when you give the 12% to 15% growth guidance for this year, that's in the volume terms or the value terms?

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Neeraj Basur, Blue Star Limited - CFO [39]

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It is value. And again, for primary sales.

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Naveen Trivedi, HDFC Securities Limited, Research Division - Research Analyst [40]

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Okay. And lastly, like you talk about this year, the price hike is unlikely. But I just want to check, is there any scope of tactical promotions control? Because we have seen the custom duty has also increased. So just wanted to know, is there a chance where we can control those side of expenses so that you can -- like margin, EBIT margin will be healthy in the following quarters?

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Neeraj Basur, Blue Star Limited - CFO [41]

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Okay. So again, one clarification. When I said price increases may not happen immediately, I was referring to quarter 2 and quarter 3. Quarter 4 pricing will get determined somewhere around December this year, okay? So that's under -- so there still could be some price increases, which we will, as of now, we're not thinking about that.

Now to your question on custom duty on IDU. Indeed, for the IDU, custom duty has increased from 10% to 20%. Now again, you will remember that we've been talking about the fact that Blue Star has been focusing now over the last almost 2 years of in-housing the production of IDUs. It is something we started last year and last year was pretty marginal. But this year, that number will start growing for us.

So partly, the impact of IDU custom duty increase will start getting mitigated for us because we are going to manufacture our own IDUs, not fully, but complete in-housing will happen probably over the next 8 quarters or so. So there's a part mitigation. Partly, we will need to -- at an opportune time, we will need to assess what kind of price increases may be necessitated to defray the custom duty increase, which we'll do in our context.

Now of course, players who are heavily dependent on probably CBU import may have that challenge of slightly higher price increases. But like I said, all these decisions and the new product portfolio from Q4, we will reassess somewhere in Q3 and then take these calls.

For now, the impact is not significant because we liquidated pretty much the inventory which was built up when the custom duty was still 10% on IDUs. So we don't expect too much of a significant EBITDA impact in quarter 2 as well as far as this factor is concerned.

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Operator [42]

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Our next question is from the line of Shrini Karlekar from HSBC.

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Shrinidhi Karlekar, HSBC, Research Division - Analyst [43]

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Neeraj, sir, I just, firstly, I want to understand the sensitivity of room AC product to USD/INR depreciation. So hypothetically, on a portfolio basis, I want to understand if, say, INR depreciates by 10%, what sort of price hike that kind of is needed to ensure similar kind of level of profits per each unit of air conditioner? I want to understand that.

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Neeraj Basur, Blue Star Limited - CFO [44]

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Okay. Let me answer this question first. So overall, we have an import contained of about, you can say, 40% to 50% in our overall materials consumption exactly -- or exactly half of our manufactured products. Now the -- so there are 2 sides to it.

We follow very active hedging factors and a policy as far as currency risk management is concerned. So while -- so we will always -- as soon as an exposure is incurred, we factor in a cost of hedging. So in our standard cost, we have factored in cost of hedging. So to a very large extent, we are able to -- any volatility after we have committed exposure, we are able to factor it in.

The shift in the entire, let's say, if rupee were to move from the levels of 70 to 71 or 72, will be -- whenever we do our pricing revisions, is when we do this adjustment all over again. And since I [said], since we are following our active hedging approach, any purchases that are made in the intervening period are pretty much kept hedged and -- so that the impact doesn't trickle down on the margins.

But clearly, so as of now, the good thing is, for the last 5 quarters or 4 quarters maybe, the rupee has been relatively stable as compared to what it was last year. So last year, the depreciation was indeed very, very sharp. Some 14% depreciation happened last year between April and October.

When that kind of depreciation has happened, then for sure, a price change is necessitated, which we did into our quarter 3 last year. We generally do not take a pricing revision decision very frequently on account of the INR and USD exchange rate changes because we are, like I said, we are keeping ourselves sufficiently hedged for the intervening period. So to that extent, you will not see a very volatile price impact of the currency change.

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Shrinidhi Karlekar, HSBC, Research Division - Analyst [45]

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Right. Just a follow-up on this, Neeraj, sir, so you said 40% to 50% is the import content, right, but there are a lot of like, admin costs and then there is a -- also a non-variable cost. So you said purely for, say, 10% depreciation, you said purely maybe product prices needs to hike by, say, 3 to -- maybe say 3% to 4%. Is that ballpark the right understanding?

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Neeraj Basur, Blue Star Limited - CFO [46]

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That's a little bit of a hypothetical. We don't expect rupees to depreciate that much.

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Shrinidhi Karlekar, HSBC, Research Division - Analyst [47]

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I understand that. We were just -- we just want to understand the risk part of it. So it would...

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Neeraj Basur, Blue Star Limited - CFO [48]

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So last year, I'm giving you a live example, when rupee indeed depreciated by 14% in the first half, we ended up taking a 4% to 5% -- 3% to 5% price increase on our products. We had to. There was an (multiple speakers) that followed. So pretty much, all this boils down to is what is the appetite to absorb the intervening impact in the currency changes?

Now we don't expect rupees to be volatile more than 2% to 3% a year. That said, when we do our pricing, we take this kind of an assumption. And generally, that's true. So rupee will remain -- it keep depreciating to the extent of about 3% a year. Now anything significantly more than that, we have no choice but to come back and do a repricing, else the margin really gets compressed. But like I said, it's some -- it's an industry problem. It is not a Blue Star only problem.

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Operator [49]

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We'll take the next question from the line of Ankur Periwal from Axis Securities.

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Ankur Periwal, Axis Capital Limited, Research Division - VP of Media and Logistics [50]

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A couple of questions. First thing, sir, you mentioned that you had 12.5% market share. So what is the total size of the industry, and how do you see this industry panning out in the next 3 to 4 years?

Secondly, these 2, that is Q1 and Q4, being the peak season, just wanted to understand if you analyze how is the demand for breakup from rural side, urban side, and have we seen increasing penetration in rural side, given that the earnings -- purchasing power is increasing? And thirdly, how much of our production -- our sales is produced in-house, and how much of that is outsourced?

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Neeraj Basur, Blue Star Limited - CFO [51]

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Okay. Many questions. Okay. So the market size, you asked, our sense of the market size is anywhere in the range of INR 11,000 crores to INR 12,000 crores.

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Ankur Periwal, Axis Capital Limited, Research Division - VP of Media and Logistics [52]

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I meant -- I wanted to ask a number, volume number.

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Neeraj Basur, Blue Star Limited - CFO [53]

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So like I said, volumes, we never track and capture because it will be very deceptive, because there are window ACs and [a split] AC cannot be equated, okay? And then the volumes will have an issue around IDUs, ODUs, and IDUs and ODUs together. So we, for consistency of our own monitoring, we always look at it on value terms.

So value is -- now in terms of very broadly speaking, again, this is a very top-down level of assessment. So in terms of overall -- all over the country, the volumes will be in the range of 5.5 -- 55 lakhs to 60 lakhs, something like that, in that range as of now, translating into the INR 12,000 crores of market size value.

Most of the demand is from tier 2, 3, 4 or even tier 5. So it's not strictly rural, but definitely upcoming cities, towns which are coming up on consumption. We see an uptick of demand. Metros, as you're all aware, are pretty well saturated, I would not say, but at least penetrated. Penetration are levels are reasonably good as far as metros are concerned. So we expect the same trends to continue because overall penetration continues to be in the range of about 5%, that's our own assessment.

Now as far as our own manufactured versus trade is concerned, we manufacture close to 60% of what we sell, and the remaining 40% of -- comprises of what we get or what we procure from contract manufacturers within India; what we buy out as a fully built CBUs, some SKUs, which are imported. So it's a mix of both.

But broadly, our own manufactured to traded remains 60-40. And as I explained in the previous answer, once IDU manufacturing starts to increase further, my sense is that 60% will become close to 65% or 70% over the next 6 to 8 quarters.

So we will -- quite intentionally, we are slowly ramping up our own manufacturer base and -- but even -- but at the same time, keeping options open of procuring from within India through OEM contract manufacturers, limiting or restricting the need to import as much as feasible as far as fully built products are concerned.

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Operator [54]

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Our next question is from the line of Prashant Kutty from Sundaram Mutual Fund.

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Prashant Kutty, Sundaram Mutual Fund - Analyst [55]

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Just a couple of questions over here. Firstly, on the project side of the business. You said ex of the Wada subsidy...

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Operator [56]

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Could you speak a bit louder? We're not able to hear you that well.

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Prashant Kutty, Sundaram Mutual Fund - Analyst [57]

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Is it audible?

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Neeraj Basur, Blue Star Limited - CFO [58]

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Yes, it's better now.

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Prashant Kutty, Sundaram Mutual Fund - Analyst [59]

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In that, the project business, you said that the Wada facility -- I mean the Wada subsidy, the margin is something like 4%. If you look at the trajectory for this project business for the last 3 quarters, it's been coming off a bit, I think. And when you started the year 2019, you were at about 6%, 7% and even 5.5%, it was clocked. Anything you'd like to publicly call out, specifically as to why the margin are probably starting to get under pressure despite the ordering activity is reasonably good?

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Neeraj Basur, Blue Star Limited - CFO [60]

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Okay. So we have this question. Firstly, let me explain what has happened in Segment I. So we are all aware of ongoing liquidity pressure and stress which a number of sectors are facing and undergoing currently.

Now as far as our projects are concerned, quite a few of our non-government customers do get impacted by the ongoing volatile liquidity and the current banking or NBFC-related issues, availability of money, availability of funds and liquidity. So we have been very, very cautious in the last -- certainly the last 3 months, a little longer than that though, when it comes to deciding the pace of a project and job execution.

So here, our approach is as follows. So while we are aware that, fine, maybe it's a temporary situation where in the next 1 or 2 quarters, things will ease out. Probably money supply will improve, credit flow will improve and customers will be able to pay us faster. Our entire project execution, hence billing and hence from the overall margin performance, we have consciously tapered off or tempered down to make sure that whatever we bill, we are able to collect.

So as a consequence, so this has been our call of having our balance sheet take precedence over the P&L as far as this quarter is concerned. Structurally, nothing wrong. I talked about the order book. I talked about order book growth. The entire -- we've got one big order as well. So it's quite healthy as far as our pending orders are concerned. It's only that we are taking a conscious call to align or realign the pace of execution with the ongoing current external market reality.

We don't want a situation where we accelerate growth or where we keep executing at a pace where customers are unable to pay up, which would only cause us stress and pressure, after a few quarters. It may not show up in this quarter, but then certainly we'll find that after 2 quarters, we have a working capital and a cash flow problem. So Segment I, that's the story.

Now coming to your margin question, we've always been maintaining that we will have truly those one-off quarters where a few better profit-making jobs got closed and hence, in that quarter, we have reported 6%-plus margin.

But if you remember from any conversations we had on the subject, we keep telling that, look, this is on a quarter-on-quarter basis, you will have quarters where better-performing jobs or better margin jobs will get closed, margins will be higher. There will be quarters where the margins will fall off to 4% or so.

Our annual -- again, I would say visibility at this stage for Segment I, we should get back to 5% to 5.5% margin profile for the full year, notwithstanding the current liquidity pressures. But with the caveat that should the external market turn further volatile or if the pressures only increase, we will not -- we will definitely take a very cautious view on the scale and pace of how fast we should be executing. And we don't want our balance sheet to come under stress.

In fact, probably, we will be amongst the few companies which have turned debt -- completely debt-free in this market, and we don't want to give up on that balance sheet strength. And we believe in this current external market, having a stronger balance sheet is preferred as compared to having a stronger P&L.

So in that context, we will continue with this approach. We will show that we -- while we want to and we continue to grow, but at the same time, we will be watching what's going on with our customers very, very carefully. Hopefully, by end of this calendar year, things will settle down and then we'll come back on this trajectory of 5%, 5.5%.

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Prashant Kutty, Sundaram Mutual Fund - Analyst [61]

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The only intent was just to know whether are the newer orders probably getting booked at lower margins or so, so that is probably (multiple speakers).

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Neeraj Basur, Blue Star Limited - CFO [62]

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No, no, no. That's not the reason. So that's quite healthy. Like I said, the order pipeline is healthy. The value is quite encouraging. It's only a question of aligning or calibrating the scale, rate and speed of execution. That's what, like I mentioned, we are carefully calibrating at this point in time.

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Prashant Kutty, Sundaram Mutual Fund - Analyst [63]

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Sure. And second question is on the room AC side of the business. You said that your -- just a clarification over here, in fact. You said that the 9.5% to 10% is the margin, this is including the Water Purifiers business?

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Neeraj Basur, Blue Star Limited - CFO [64]

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It is including the water purifier. It is just for the segment that I'm talking about. We always talk segment margin.

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Operator [65]

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Our next question is from the line of Ajinkya Bhat from Macquarie.

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Ajinkya Bhat, Macquarie - Analyst [66]

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Sir, one question I had which is for the commercial products segment, on the commercial products part of your UCP segment. You mentioned that you have liquidated inventory of your old products and have started selling the new range of products. So can you elaborate on what is the price -- are you charging any price premium to this new range of products for this? How will be the outlook for volumes as well as margins because of this new range?

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Neeraj Basur, Blue Star Limited - CFO [67]

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Right. So Ajinkya, there is not too much of a price change as far as the entire product portfolio pricing. In fact, there is a little bit of additional value-add and a differentiator we want to position. So again, this entire segment has encouraged us a lot. And in the last 1 year, we have been quite pleasantly surprised with the growing.

It seems that the consumption of our products are now filtering down to kirana stores. So while traditionally, we've been selling a lot of these through OEMs and through the more organized dealers, it is the retail format where these products are getting positioned now.

So we have done 2 things. One, we have rejiggered the entire product portfolio to add more products to our entire portfolio, which meet the needs of the, probably, a small store format also. At the same time, like I said, we are taking these product portfolio technology changes because the -- we want to make sure that -- so not only are these friendlier as far as the entire refrigerant is concerned, the new range of products will be lower on power consumption also.

So that adds further differentiated value to our customers. And you will also be aware that we do have quite a few unorganized players in this market. And for us to stay differentiated and stay ahead in the game, we had to do this entire product portfolio changes.

So at this point in time, since the momentum is quite encouraging, the demand seems to be, when the season starts again, so the inquiries, demand and the feedback that we're getting is quite encouraging, we have taken a call not to tamper too much with pricing. We will make some minor adjustments on a blended basis, but we will try and do it in a way where we stay price competitive yet product comprehensive as far as our offerings are concerned. So -- but this will again kind of restart in Q3 as far as this category is concerned.

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Ajinkya Bhat, Macquarie - Analyst [68]

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Okay, okay. Sir, a related question. Have your competitors also moved to this more ozone-friendly refrigerant as far as commercial cooling and chilling products are concerned? I mean is that why you may not actually be able to charge a premium for the value that you are offering to the customers? Or is it a conscious decision on the company's part in order to maybe grow your penetration in the market or to grow the market in the smaller kirana stores and such establishments?

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Neeraj Basur, Blue Star Limited - CFO [69]

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So our understanding is we are -- anyway, we are market leader, and our understanding is that probably we are leading the market here as far as these technological advancements are concerned, but we are sure competitors will follow. We want to maintain the lead position that we already have.

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Operator [70]

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Our next question is from the line of [Jaikan Gustori] from Way2Wealth.

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Jaikan Gustori, Way2Wealth Brokers Pvt. Ltd. - Analyst [71]

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Sir, in terms of your UCP segment, you said that the ad spend was high. Can you give -- quantify a number in comparison to ad spend to sales for this quarter and Q1 FY '19?

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Neeraj Basur, Blue Star Limited - CFO [72]

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So broadly, I can quantify for you. So last year, again, the context is that we had [to do it] from a poor offtake. So very conscious call was taken largely in quarter 1 to clamp down on all the spending and advertising tends to be the first such item on the list. So we did clamp down reasonably on advertising.

So broadly, between last year and this year -- and obviously, the other factor which you need to keep in mind is when we start advertising. So if it is an encouraging quarter 4, some part of advertising starts in the quarter 4 and then goes up to quarter 1.

Whereas this year, summer started not exactly early March, it started towards middle and end of March and went on to be stronger in April, May and June -- April and May. Not a lot in June. So a lot of our advertising has flowed into quarter 1 this year when compared to last year. The delta will be approximately in the range of INR 18 crores, the increase that we have had this year.

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Operator [73]

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Our next question is a follow-up from the line of Renjith Sivaram of ICICI Securities.

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Renjith Sivaram, ICICI Securities Limited, Research Division - Assistant VP [74]

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Sir, just wanted to clarify on one more thing like -- we also have a good order book. So in that sense, the project here, you are very conscious on the liquidity from that. Given the order book and what kind of growth we are -- we can expect from the project segment for this year?

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Neeraj Basur, Blue Star Limited - CFO [75]

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So let me clarify the remarks and the comments I made about being cautious is in the context of private sector orders. So that's the first point of clarification. Our order book also comprises of orders from public companies or directly from [the issue of government] itself. For example, Mumbai Metro will not be in that category, though the work is yet to start. So on a blended basis, we will continue to execute orders based on which customer category we are looking at.

Our own sense is that we should be able to achieve anywhere between -- I mean, first thing we want to get on to a 12%-plus kind of growth rate as far as the segment is concerned. But again, the caveat and the caution being that the external market, we are very, very sensitive, and we do not see ourselves being aggressive in terms of taking those risky calls of executing where the customer is unable to pay. So it's a wait-and-watch, or watch-and-then-execute kind of approach. Still we expect around 12%-odd because of the mix of order book that we have.

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Renjith Sivaram, ICICI Securities Limited, Research Division - Assistant VP [76]

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With around the 5% -- 5% to 6% margin range, which you...

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Neeraj Basur, Blue Star Limited - CFO [77]

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I have indicated, 5% to 5.5%, which is a -- kind of a more realistic aspiration to have. It's not a guidance, I keep reminding everyone. We just give our aspirational view.

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Renjith Sivaram, ICICI Securities Limited, Research Division - Assistant VP [78]

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And sir, any indication regarding table change? Because I think this year won't be possible, but do we expect any table change in the next year?

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Neeraj Basur, Blue Star Limited - CFO [79]

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Table change is happening from January '21, so nothing is going to happen in 2020.

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Operator [80]

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Ladies and gentlemen, that was the last question. I would now like to hand the floor back to Mr. Basur for closing comments. Over to you, sir.

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Neeraj Basur, Blue Star Limited - CFO [81]

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Thank you very much, ladies and gentlemen. With this, we conclude this quarter's earnings call. Do feel free to revert to us in case any of your questions were not fully answered, and we will be happy to provide you any additional details, via e-mail or in person. Thank you very much.

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Operator [82]

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Thank you. Ladies and gentlemen, on behalf of Blue Star Limited, that concludes this conference. Thank you for joining us. You may now disconnect your lines.