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Edited Transcript of BLUESTARCO.NSE earnings conference call or presentation 31-Jan-20 5:30am GMT

Q3 2020 Blue Star Ltd Earnings Call

Mumbai Feb 8, 2020 (Thomson StreetEvents) -- Edited Transcript of Blue Star Ltd earnings conference call or presentation Friday, January 31, 2020 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

* Amber Singhania

Asian Markets Securities Private Limited, Research Division - Senior Analyst

* Ankur Sharma;HDFC Life Insurance;Analyst

* Arafat Saiyed

Reliance Securities Limited, Research Division - Assistant VP of Research

* Nirav Vasa

Anand Rathi Financial Services Limited, Research Division - Research Analyst

* Nitin Arora

Axis Asset Management Company Limited - Equity Research Analyst

* Nitin Bhasin

AMBIT Capital Private Limited, Research Division - Head of Research & Analyst

* Renjith Sivaram

ICICI Securities Limited, Research Division - Assistant VP

* Sandeep Tulsiyan

JM Financial Institutional Securities Limited, Research Division - Senior Research Analyst

* Shrinidhi Karlekar

HSBC, Research Division - Analyst

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and welcome to the '20 earnings conference call of Blue Star Limited. We have with us today, from the management, Mr. Neeraj Basur, Group Chief Financial Officer of Blue Star Limited. (Operator Instruction] Please note that this conference is being recorded.

I now hand the conference over to Mr. Neeraj Basur, Group Chief Financial Officer. 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 am happy to share with you that Blue Star has won 2 more prestigious recognitions during Q3 FY '20, namely Golden Peacock Award for Corporate Ethics for 2019. And we were also adjudged Best Governed Company listed category as medium at the 19th edition of the Institute of Company Secretaries National Awards for Excellence in Corporate Governance. We at Blue Star have always endeavored to adopt and implement best-in-class governance policies and practices, and these awards reaffirm our commitment to following the highest standards of professionalism and business ethics.

With that, I will now provide you an overview of the results for Blue Star for the quarter ended December 2019, financial highlights for Q3 FY '20 following other financial highlights of the company for the quarter ended December 31, 2019 on a consolidated basis. Revenue from operations for Q3 FY '20 was INR 1,235.91 crore as compared to INR 1,098.97 crore in Q3 FY '19, a growth of 12.5%.

EBITDA for Q3 FY '20 was INR 57.03 crore as compared to INR 42.37 crore in Q3 FY '19, an increase of 34.6%. PBT before exceptional items was INR 33.24 crore in Q3 FY '20 as compared to INR 21.39 crore in Q3 FY '19, an increase of 55.4%. Tax expense for Q3 FY '20 was INR 11.97 crore as compared to INR 0.99 crore in Q3 FY '19. Effective tax rate for Q3 FY '19 is 37.8% as against 7% in Q3 FY '19 primarily due to reversal of a deferred tax asset, which we created in FY '19, arising from higher profitability in Blue Star Engineering and Electronics. Net profit for Q3 FY '20 was INR 19.7 crores as compared to INR 13.23 crores in Q3 FY '19.

Carryforward order book as at December 31, 2019, was INR 2,812.40 crore as compared to INR 2,277.43 crore as at December 31, 2018, an increase of 23.5%. Site management of inventory and receivables resulted in reduction of capital employed to INR 1,020.52 crore as of December 31, 2019, from INR 1,173.53 crore as on December 31, 2018. Consequently, borrowings reduced to INR 127.62 crore as on December 31, 2019, resulting in a debt equity ratio of 0.15 as compared to a net borrowing of INR 375.94 crore as on December 31, 2018, with a debt equity of 0.47.

I will now move on to business highlights for Q3 FY '20. Segment I: Electro-Mechanical Projects and Commercial Air Conditioning Systems. Segment I revenue was INR 758.80 crore in Q3 FY '20 as compared to INR 655.47 crore in Q3 FY '19, a growth of 16.8%. Segment results was INR 39 crore or 5.1% of revenue in Q3 FY '20 as against INR 30.11 crore, 4.6% of revenue in Q3 FY '19. Order inflow during the quarter was at INR 550.49 crore as compared to an inflow of INR 684.71 crore in Q3 FY '19.

Electro-Mechanical Projects business. We were selective in bidding and booking new orders in view of the continuing liquidity stress in the real estate and infrastructure sectors, which slowed down the pace of order inflow in Q3 FY '20. The focus continues to be on cash flow and profitability and faster execution was witnessed in a few select jobs, resulting in good growth.

We maintain our leadership in integrated MEP projects in India. Some major orders won during Q3 FY '20 were from Phoenix MarketCity Indore, Chalet Hotels, Bangalore and Manyata Promoters, Bangalore. Carryforward order book of the Electro-Mechanical Projects business was INR 1,941 crore as on December 31, 2019, as compared to INR 1,573 crore as on December 31, 2018, an increase of 23.4%.

Commercial Air Conditioning Systems. The commercial air conditioning market, which witnessed phenomenal growth in the first 6 months of the financial year, slowed down during Q3 FY '20 in terms of billing. However, order inflows continue to be good. We continue to improve our market share in VRF and chillers, while maintaining leadership in ducted systems. Key segments that contributed to billing during the quarter were government, hospitals, builders and educational institutions. Major orders bagged in Q3 FY '20 were from Ambuja Cement, Jaipur, Telangana State Industrial Corporation, Hyderabad, (inaudible) and police headquarter, Mumbai.

International business. Our international business continues to focus on growth in the Middle East, Africa and SAARC countries. We continue to grow steadily in these markets. Our new showroom in Dubai is playing a significant role in demonstrating our product lines and capabilities in helping us in securing projects and maintenance jobs.

Our joint venture in Qatar that executes MEP projects continue to do well. However, order inflow and pace of execution were impacted in Malaysia due to politico-economic conditions. We continue to invest in strengthening our brand in select international markets.

I will now move on to Segment II: Unitary Products. Segment II revenue was INR 420.23 crore in Q3 FY '20 as compared to INR 391.52 crore in Q3 FY '19, a growth of 7.3%. Segment result was INR 7.65 crore, 1.8% in Q3 FY '20 as compared to INR 9.39 crore, which was 2.4% of segment revenue in Q3 FY '19.

Higher advertising spend during festive season impacted our Segment II margins. Room Air Conditioner business. After a slow start to the quarter due to muted festival demand, growth picked up in December '19, and we grew by 10% in Q3 FY '20 as against estimated market growth of 5%, but sustaining our purview to improve our market share.

In line with the trend observed in the first 2 quarters, demand continued to be there for affordable range of models for the close to 36% of the sale was through consumer finance teams. Lower penetration, coupled with higher demand in tier 3, 4 and 5 markets should continue to support growth.

Commercial refrigeration business. Good growth in the processed food, ice cream and hospitality segments contributed to the revenue growth. We maintained leadership position across market product -- major product categories such as deep freezers, storage water coolers and cold rooms. Our new product categories, namely commercial kitchens, health care and retail refrigeration products, gained good traction in the market. We continue to invest in brand building and business development to promote our new product range in this category. Major orders bagged in Q3 FY '20 was from Reliance Retail, top and down [Dairy fund], REBEL Foods and Jubilant FoodWorks.

Water Purifier Business. While the competition is intensifying, we are staying focused on establishing our brand as a structured one in the category with well-engineered and reliable products backed up by superior service. With over 1.1 lakh Blue Star water purifiers already in the market, the service revenue has begun to flow in. We have established ourselves as one of the leading brands in the e-commerce channels and on course to break even in the next financial year.

I move on to Segment III: Professional Electronics and Industrial Systems. Segment III revenue was INR 56.88 crore in Q3 FY '20 as compared to INR 51.99 crore in Q3 FY '19, a growth of 9.4%. Segment result was INR 17.99 crore, which was 31.6% of segment revenue in Q3 FY '20 as compared to INR 6.86 crore, which was 13.2% of segment revenue in Q3 FY '19.

Revenue growth was driven by certain high-value orders from data security solutions, health care and nondestructive testing business. Regulatory requirements on data localization and increased thrust on digital payment solutions created good short-term opportunities for data security solution business.

The government's programs for affordable health care are also creating various opportunities for the health care business. With a wide portfolio of products and solutions forming part of our offerings, the prospects for this business segment is positive.

Business outlook. Though the order book is healthy, pace of order inflow slowed down from the real estate and infrastructure sectors due to continued challenges on the flow of credit to these sectors. Low penetration coupled with increasing demand from tier 3, 4 and 5 towns will continue to support growth in the products business. We will continue to stay focused on driving revenue growth and profitability, with a close watch on margins, cash flow and capital employed.

With that, ladies and gentlemen, I am done with the opening remarks. I would now like to 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 Instruction] The first question is from the line of Renjith Sivaram from ICICI Securities.

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Renjith Sivaram, ICICI Securities Limited, Research Division - Assistant VP [2]

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Sir, just wanted to understand this un-allocable expenditure is higher this quarter. So what is that pertaining to? And where do you see that going forward?

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Neeraj Basur, Blue Star Limited - CFO [3]

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Yes. Thank you. So for everyone's information, so un-allocable expenses, last year, the INR 12 crore number that you see was net of certain income tax refund -- interest on income tax refund that we had got last year in Q3. That was around INR 8-odd crores. So barring that, in the current quarter, we've incurred certain one-time expenses on some office renovation and redoing some of the office infrastructure that we have across the country. So that's a little one time. Broadly, we maintain a run rate of INR 22 crores to INR 24 crores a quarter, about INR 80 crores to INR 90 crores a year. So there's no reason to feel concerned, and we think we'll be pretty much on that trajectory for the full year as well.

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Renjith Sivaram, ICICI Securities Limited, Research Division - Assistant VP [4]

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Okay. And in terms of room AC, last call, you told that this year, we are expecting around 9.5% kind of margin. So this quarter, the margins are low, the (inaudible) last quarter where we had this whole issue of inventories and other things we had to take a pricing thing. But despite being a better quarter compared to last year, same quarter, why the margins are still not improved?

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Neeraj Basur, Blue Star Limited - CFO [5]

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Yes. Good question. So again, for the benefit of all the listeners on this call, before this question comes up again, if you remember, in Q2, we had announced that we have tied up with Virat Kohli as our brand ambassador. And that was done with a very conscious intent to push our brand, and of course in preparation for the summer season, as we will approach it in Q4, we wanted to have a personality such as Virat as a brand ambassador.

So this arrangement with Virat was signed off towards the beginning of this quarter. And the related expenses that we have incurred and, of course, I am not at liberty to share the fee that has been paid because of confidentiality. But needless to mention that the expenses we have incurred have got fully been charged off into 1 quarter. Now this, of course, is a lower quarter from a sales point of view. So that's getting reflected in the overall margins. So that explains why the margin results, as you see, are a little subdued, not significantly though, despite the charge-off we have taken to support Virat's brand ambassadorship.

Due to the same reason, for the full year, we've been telling you that 9% to 9.5% is what we should normally be able to realize as margins in Segment II. After accounting for this additional brand spend, we expect the margins in Segment II to be somewhere in the range of 8.5% to 9%. So we will know as we get closer to March, but this is our current estimate on Segment II margins. I hope that clarifies.

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Renjith Sivaram, ICICI Securities Limited, Research Division - Assistant VP [6]

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Okay. And sir, lastly, if I may, how is the overall room AC market growth in FY '20, the full year, because there's only one -- couple of months remaining, so how do you see that panning out? How is the summer-related stocking up from the dealers?

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Neeraj Basur, Blue Star Limited - CFO [7]

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It's a little early to comment that, Renjith. I think we are still going through -- January is a lean month, as you're aware. The existing indications are that it should -- the summer is likely to set in as per the normal pattern, somewhere towards end of February. And if that happens, then, of course, you're looking for a good -- and you're hoping for a good summer. So we don't see any reason for a concern.

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Renjith Sivaram, ICICI Securities Limited, Research Division - Assistant VP [8]

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Okay. And in terms of market growth, how much you are expecting for FY '20?

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Neeraj Basur, Blue Star Limited - CFO [9]

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Renjith, I suggest you can go back to the queue because...

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Renjith Sivaram, ICICI Securities Limited, Research Division - Assistant VP [10]

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Okay. Sure. Yes.

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Neeraj Basur, Blue Star Limited - CFO [11]

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And I request the moderator to please take care of this.

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Operator [12]

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[Operator Instruction]

The next question is from the line of Sandeep Tulsiyan from JM Financial.

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Sandeep Tulsiyan, JM Financial Institutional Securities Limited, Research Division - Senior Research Analyst [13]

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Yes. My first question is pertaining to the Unity Products segment. I want to understand 2 aspects over here. One is, are you seeing any divergent trend between the ACs which are at entry-level and which are at a mid- to premium level where Blue Star plays? Have you seen a divergent growth?

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Neeraj Basur, Blue Star Limited - CFO [14]

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What do you mean by divergent growth? What are you exactly (inaudible)

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Sandeep Tulsiyan, JM Financial Institutional Securities Limited, Research Division - Senior Research Analyst [15]

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Is one segment growing significantly faster or slower than the other? And second aspect that I want to understand is the whole issue in China, is it creating any sort of sourcing issues for Blue Star?

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Neeraj Basur, Blue Star Limited - CFO [16]

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All right. So let me address the first one first. So as you rightly said, Blue Star's core focus continues to be -- must be, as we call it, which is the sweet spot for the range of products that we have. We really don't see any change or a shift in the demand pattern for that particular segment because inherent demand remains quite strong. Now there is indeed a market for the entry-level as well, which is catered to by us as well as some other players, but our predominant focus remains on this mid-premium because that was in line with the product range and the quality parameters that we have maintained over several years. So we don't see any issue. And overall penetration levels being what they are, there is enough and more room for the -- that segment to continue to grow. Of course, the biggest driver and enabler or constraint, if you may, remains the intensity of summer season. So once, let's say, the summer season sets in and continues all the way through till May, June, we don't see a reason why markets should not grow. And then in that context, our endeavor to grow as well in line with our plans.

Coming to your second question, the current ongoing issue in China around coronavirus, now as you're aware that the usual pattern for procurement in our industry is that we typically start placing the orders towards the middle or end of Q3, which is November, December, our POs are released, because usually the Chinese New Year, which sets in towards end Jan, beginning Feb, tends to bring a normal disruption in supply. So all we do is we try to stock up a little in advance in the normal course as well, which has also happened in the current year.

So as far as Q4 supplies are concerned, we have either received the raw material or some raw materials are at the sea, already shipped, and we expect the shipments to be received within February and early March. As it stands, the indications are that there will be an additional 10-day shutdowns across various factories, where currently there is impact or assessed impact. And I guess, we get to know more about what the situation is towards middle of February. And if it is -- it tends to be a very short-term phenomenon, then probably everything will get caught up in some ways. And quarter 4, for sure, we are not, at this point in time, visualizing a significant impact. But we have to wait and watch.

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Sandeep Tulsiyan, JM Financial Institutional Securities Limited, Research Division - Senior Research Analyst [17]

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Fair enough. Sir, second question is on the E&P segment that I wanted to understand. We do understand these liquidity issues were pertaining in first half also, but growth from few select segments like railways and government-related spends were driving inflows which have been fairly strong in first half. So incrementally, if you could highlight which specific segments other than the real estate and [info] that you mentioned, has seen a very sharp dip or is there probably some sort of a big curve from the government side to restrict ordering in the near term. And how does this change your order inflow outlook for the next year, that is FY '21.

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Neeraj Basur, Blue Star Limited - CFO [18]

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As far as the segment I is concerned, we've been maintaining that we are watching the current liquidity situation in the market very closely, particular concern being real estate and infrastructure sectors, not as much government order. With government, there is a different challenge of being able to collect pretty much as per schedule. Within those constraints and with a very, very clear eye on the working capital, as you can see from our balance sheet as well as the borrowings, we are selectively booking and closing orders, and we are continuing to execute jobs as well. So we have to continue to be on this mode until such time there is a little bit of easing out of market conditions in the customer segments that we operate in because we do not want to take on exposures which we feel may be a little excessive in the current market context.

There is indeed a sense of slowdown in the last few months. It could be in anticipation on the budget, and probably once the budget is released, we will know better what kind of measures get announced, maybe it's because of that. Or it's also probably a little bit of still -- people -- the companies are taking time to launch new projects or to push on with commitments on -- with the current set of projects. So that is the situation in Segment I. Our order book is quite healthy, as you can see. And though we got some big orders as well, early in Q1, mainly from Mumbai Metro. Even without that, the order book has grown quite reasonably. So we are quite satisfied with the order booked -- orders that we have booked. Pace of execution is what we have maintained and we continue to do is a close watch on how and how much we should execute with balance between billing, margins and cash flow. That's what we're trying to balance out. And as and when market conditions improve, we will definitely -- we will have the capability to accelerate growth in Segment I.

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Operator [19]

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I would request Mr. (inaudible) to join the queue. The next question is from the line of Nitin Arora from Axis Mutual Fund.

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

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One question -- just two questions from my side. The first one is, can you quantify what was -- you said about AC growth was about 10%. How much did you grow in the other 30% of your business, in the Segment II?

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Neeraj Basur, Blue Star Limited - CFO [21]

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Yes. So the room AC is about 10% -- yes, close to 10%. The others would have grown close to around 6% to 7%. So on a blended basis, we have gone to 7.5% growth.

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

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And correct me if I'm wrong, you're talking about AC from a secondary perspective?

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Neeraj Basur, Blue Star Limited - CFO [23]

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Primary.

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

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The primary, okay. So why I'm asking is that if you're talking about a 10% growth in primary in the season where generally primary grows or some of the players or some of the competitors are just pushing primary in this quarter because you have a new [TPS] coming next season, talk about the Samsung or the other 1 or 2 regional players. Is it deliberate move not to push primary in this quarter or it is more of a function of old inventory which is what channel tells us that the (inaudible) still not a product of (inaudible), but still the inventory is there?

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Neeraj Basur, Blue Star Limited - CFO [25]

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So -- yes. So as you recollect I talked about in the beginning that the festival season was a bit muted. I mean despite everyone's expectations, Diwali and related then later on it didn't really start in the same way as you would normally expect it to. So the sales actually picked up towards the end November, beginning December. And in -- again, an acceleration of new product portfolio launch, which we have done now in January, there are always some end-of-the-life products, which you want to again push away, push through the channel with some discounts and some schemes, which also was done.

So broadly, in that context, the way the quarter started and the way quarter ended, we are fairly satisfied with a 10% primary growth, which is somewhat higher than the market. It's the lowest quarter for the year. So in that context, it doesn't really make any material impact on the overall full year revenue growth, et cetera. But regardless of that, we are quite satisfied with how the quarter ended. And now of course, the channel stocking will determine what happen in Q4.

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

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And the second question is that we generally enter into a business. So for example, a water purifier, we lost the margins. We got Virat Kohli and we got an impact to our margin. Other companies also get the ambassadors and all but doesn't get impacted on the margins. Just wanted to understand, given a season where a lot of new players are coming and pushing the inventory very hard, where the market pricing itself in the last 2, 3 years has not gone up, doesn't concern you in terms of the way the strategy is getting driven? And the second is, if you can quantify the 9 months and the quarter 3 Water Purifying business. Those are the 2 questions.

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Neeraj Basur, Blue Star Limited - CFO [27]

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Yes. So the fact that the -- all this discussion is happening relative to last year. Last year, everyone will remember that the summer season was extraordinarily subdued. And everyone, including us, we had cut down reasonably heavily on advertising. So that's one context we need to bear in mind.

So in the current -- current year, 9 months, not just Q3, obviously, we have set upon advertising spend generally as compared to last year, both ATL and BTL. On top of that, which something we have not done for a long time and Blue Star is to sign up with a brand ambassador, which has its own commercial consequences, which we have consciously absorbed. And that is itself an indication about the positive sentiment we are carrying about the market potential and the normalized growth which the market should be able to realize. So these are all tactical moves in one way, but at the same time strategically positioned to make sure that there is a longer-term impact on the category in general.

Now of course, having said that, there will always be competitive pressures from different players. And the pricing will continue to play its own role. We, on our part, try to mitigate the pricing pressures by continuing to identify the cost-side optimization opportunities that are possible, right from the entire optimizing our own manufacturing. And then how do we -- which we have already started doing, how do we increase the share of our own manufactured products and components relative to fully imported ones? And then how do we keep managing the overhead structure in a manner where the margins remain reserved to the extent possible.

However, there will be quarters where, obviously, due to the timing of certain expenses that we may choose to incur, like this quarter is a case in point, we may see that short-term impact. But for the full year is what -- I mean when you read the year-to-date margin performance, last year we did some 7.2%. And this year, we are a tad below. So to that extent, like I said in the opening remarks, for the full year, our sense is that we should be pretty much tracking back on 8.5% to 9%, which is lower than what we initially said now because of this additional commitment we have made. But barring that, we are pretty much online in terms of what we said we should be looking at. So we are quite okay with that. Now the -- again, the big determinant of growth and therefore margins in this category will be how the season plays out. So we just wait and watch. Sorry, what was your second question, I didn't note that.

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

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The 9 months and the quarter 3 revenue of Water Purifier.

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Neeraj Basur, Blue Star Limited - CFO [29]

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So as far as Water Purifier is concerned, we are likely to close the full year with around INR 60 crores of revenue for FY '20 with around 2% market share. That's our current estimate. We are pretty much online to deliver it. It's lower than our own expectations. We would have been happier with some INR 80 crores or INR 90 crores revenue for the current year. So we will be below that by around INR 20 crores, INR 25 crores. That's fine because it's, again, a process of setting up a new category. Market share will be in the range of 2% to 2.5% for the full year.

And Water Purifier, next year, our expectation is that we should to breakeven this year. Again, we have an impact of close to 80 basis points in the segment margins, which next year should get neutralized fully.

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Operator [30]

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The next question is from the line of Ankur Sharma from HDFC Life Insurance.

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Ankur Sharma;HDFC Life Insurance;Analyst, [31]

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Neeraj, if you could just, one, remind us of your guidance for FY '20 on both sales and margins for the project business and also for the Unitary Products division.

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Neeraj Basur, Blue Star Limited - CFO [32]

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So Ankur, broadly, the growth expectation in Segment I continues to be around 10% to 12%. Segment II, our own (inaudible) market should be closing the year with around 10% to 12% growth, and we'll be happy to close the year with around 15% growth. So that's what we are maintaining as our own expectation at this point in time.

Margin profile for Segment I, we think -- we did some 5.1% in Q3. Our sense is Segment I full year margins should hover in the range of between 4.5%, 5.5%, kind of 5%, you can say, around -- in the range of 5%. And Segment II, I just said, 8.5% to 9% is our expected range.

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Ankur Sharma;HDFC Life Insurance;Analyst, [33]

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That's very helpful. And just the second question would be on the kind of competition you're seeing on the room AC side. And I think Nitin also mentioned about Samsung coming in. And we saw a lot of media articles also talking about Samsung refocusing on the room AC business, cutting prices, et cetera, et cetera. So I don't know if you can talk about a specific competitor or if you can talk about the industry as a whole? What are the pricing trends that you've seen at this point? And how are we versus, say, the last couple of quarters?

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Neeraj Basur, Blue Star Limited - CFO [34]

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Yes. So if there is -- again, as far as the market is concerned, the pricing has not come -- I mean continues to be in tremendous, I would say, competitiveness. There's not a let down on pricing competitiveness, regardless of Samsung's positioning at this point in time. So that doesn't change. And especially, we are coming out of 2 off-season quarters, the real test will be what happens in Q4. And then, not everyone has announced their pricing range for the new season. So we have to wait and see what that results in.

But having said all of this, we are not expecting any let down on pricing pressures. So at this point in time, we are not anticipating any great price correction. If we are able to hold down to the current level of pricing, I guess, we consider ourselves very lucky, because that's the nature of the market as of now. But you are also aware that this changes very quickly when the summer intensity picks up.

So a few weeks of high-intensity summer and some course correction on discounts and incentives can certainly change course on the overall pricing on margin realization or a combination of the two. So we just -- we are being nimble enough to course correct as required

(technical difficulty)

in context. The good news from a market point of view is, there is no inventory overhang, significant overhang, as far as our understanding goes, which was the case till 2 quarters ago. So now with inventory for -- fully not being a problem for most players, you can expect some degree of rational decision-making on pricing in Q4.

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Operator [35]

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The next question is from the line of Aditya Bhartia from Investec.

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Aditya Bhartia, Investec Bank plc, Research Division - Analyst [36]

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So you mentioned 8.5% to 9% UCP segment margins for the year, but that would imply over 12% margins for fourth quarter. I mean these kind of margins we haven't done for a while. So what gives you the confidence that there can be such a sharp jump in margins?

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Neeraj Basur, Blue Star Limited - CFO [37]

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Well, if you see last year as well, we -- see, quarter 4 is usually quite good because of the overall sales volume. And if you see our overall quarter 1 and quarter 4 performance and margins, typically, there is an element of catch that happens. So we are quite optimistic on that front.

And as you're also aware that there is a mix of what we do in segment 2, which is room ACs and nonroom ACs, other, there is a bucket of products. So on a blended basis, that's what we think we should be able to cover up and to do around that range that I just talked about.

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Aditya Bhartia, Investec Bank plc, Research Division - Analyst [38]

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Sure, sir. And sir, if I remember correctly, you had initially pointed out that you'll be looking to somewhere around 10% market share in water purifiers by FY '21, and it's around that time that you'll be breaking even. So now it appears that we have 2%, 2.5% market share currently. Maybe next year, we inch it up to 3.5%, 4%. Even at the 2% market share, breakeven looks possible?

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Neeraj Basur, Blue Star Limited - CFO [39]

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So first question first. Yes. We are somewhat behind our own plans as far as the scaling up of water purifier is concerned. So of course, we all wanted to have a 10% by FY '21 and something like that. So we will be behind that, that's for sure. But having said that, again, it's part of learning and growing and continue to improve. That's what we are aiming to do.

Now as far as -- now because there has been a little bit of a trajectory correction on our own expectation of growth, we have taken numerous steps to realign the entire operating structure of this business. And if you remember, we had spoken about this in quarter 2 where we are now getting our extended room AC selling arm to also sell the water purifiers. So that's resulting in quite a few cost efficiencies. And as a consequence, at around 3% or 3.5% probably market share we should be able to break even, which should happen next year. That we are fairly confident. And our own sense is now that brand is well-established, product portfolio is doing well, distribution is now over -- is spread over 1,000 stores with almost 200 cities. We think it should be -- we should be in a good place to now start scaling up that, next year, the overall profitability concerns will be behind us.

So we have kind of prioritized the profitability milestones ahead of scaling up. That's another reason why we have done this reorganization and a little bit of rejigging in our own plans. But that, as you can expect in any new business, is bound to happen. So overall, we continue to be quite supportive, optimistic and bullish on this category. It's just that it's taking us slightly longer than our own plans.

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Aditya Bhartia, Investec Bank plc, Research Division - Analyst [40]

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One more question, if I may. Just regarding the competitive intensity again on the room AC side, given that some of your competitors have reduced pricing or are maintaining similar pricing as last season, and given that growth is coming more from the affordable category, do you see that there's -- there could be a risk of getting outpriced? Or there is risk of you being required to cut down on pricing?

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Neeraj Basur, Blue Star Limited - CFO [41]

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It's a bit speculative at this point in time to consider that. I guess we just have to wait for the -- how the summer season sets in. I guess we'll be in a better position to have a view on this sometime towards end February, beginning March. It's a little premature to decide any which way at this point in time.

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Operator [42]

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The next question is from the line of Shrinidhi Karlekar from HSBC.

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

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Sir, first, I just want to understand the supply chain from China a bit more. So you said we order typically in the middle of Q3, that is around November and December. And would it be fair to say that the pricing of those contracts would be based on prevailing copper cost or a commodity cost? And if that is correct, would it be fair to say that the dollar cost of those purchased goods are kind of coming down over last 2 years?

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Neeraj Basur, Blue Star Limited - CFO [44]

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All right. So I hear a few questions. So firstly, I explained what's happening on China. So we are comfortably positioned as far as the current levels of inventories are concerned: raw material components and finished goods. So Q4, we are not in a (inaudible).

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

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I want to understand the cost part of the input goods, not worried about the inventory.

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Neeraj Basur, Blue Star Limited - CFO [46]

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On the component side, so far, the copper prices have been fairly stable, number one. Number two, the INR has also been fairly range bound, barring instances of very, very short-term volatility, which keeps happening as an outcome of someone announcing something and then markets react. But barring that, the volatility on INR has been fairly contained. It's not been over-volatile. So that has helped. But of late, we see copper prices firming up a little. And -- but again, like I said, probably that will be for us to watch out for quarter 1 because by the time we complete quarter 4, the inventory for quarter 1 will start building up. So for now, we are good as far as the overall component pricing is concerned. We don't see a reason to worry too much on that front.

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

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Sir, does this happen, like, I guess, you will be planning for almost entire summer and you would be placing order in somewhere in November and December. So the copper prices that goes into those products would be largely freezed based on prices which are driven in October and November, and the price rise that happens through, say, November to February shouldn't largely affect -- it should come in the next cycle of purchases. Is that correct, largely?

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Neeraj Basur, Blue Star Limited - CFO [48]

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To some extent. Not entirely. Because we -- this would be true if we commit to the offtake volumes in advance for probably 6 months, which we don't do, so we do aim to rate contracts which are valid for 3 to 4 months at a point in time and then we reserve the right to keep moderating the quantum and the volume of take over the course of next 3 or 4 months. So in case there's a degree of influence, we can exercise on the suppliers, persuade them not to resort to any immediate price corrections. But if the volatility is higher, then probably some renegotiations do happen. So I mean, it holds to both ways. If there's a price dip, then also we can do. So by and large, you can say, on an average, we don't see this to be a problem or a challenge for the next 3, 4 months.

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Shrinidhi Karlekar, HSBC, Research Division - Analyst [49]

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And last one, if I may, sir. So if you see, typically, we do 70% of business, like, invest in the first half of calendar year-end and 30% in the second half of the calendar year. And our margins are typically 6 percentage point different in first half versus second half in a calendar year. So apart from the scale of business, which is very different, are there any other reasons why -- what explains this margin difference in terms of business mix as well as the net realization that you get from the product?

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Neeraj Basur, Blue Star Limited - CFO [50]

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So it's purely scale. And as you're aware, Q2 and Q3 are the lowest, and Q3 is the lowest amongst all 4. So to that extent, it's largely scale-driven and nothing beyond that.

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Operator [51]

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The next question is from the line of Arafat Saiyed from Reliance Securities.

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Arafat Saiyed, Reliance Securities Limited, Research Division - Assistant VP of Research [52]

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Yes. So my first question is on ad spend. Can you quantify what amount you spent in Q3 and 9 month of (inaudible) last year?

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Neeraj Basur, Blue Star Limited - CFO [53]

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Arafat, we usually do not give that as a public disclosure.

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Arafat Saiyed, Reliance Securities Limited, Research Division - Assistant VP of Research [54]

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Okay. So can you just shed some light on how that's changed versus last year?

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Neeraj Basur, Blue Star Limited - CFO [55]

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So broadly, I think about it, I have already clarified that. Last year, because the summer season was quite below normal, and then that -- and we also had a huge amount of inventory pressure, obviously, one had to be on a cost-containment mode. So both ATL and BTL spends were fairly well-rationed last year. This year, because the year started with -- on a very positive note as far as fairly intense summer, so we've been quite encouraged to resume our normal trajectory of advertising spend, so which is what I have explained earlier in the call as well.

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Operator [56]

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The next question is from the line of Amber Singhania from Asian Markets Securities.

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Amber Singhania, Asian Markets Securities Private Limited, Research Division - Senior Analyst [57]

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Neeraj, sorry to have more on this China issue. Just wanted to understand, by and large, industry imports around 50% of the requirement from China, be it on a complete unit or be it on a component basis, (inaudible) completely comes from there. Now as you mentioned that Q3 made very normal (inaudible) and others. So supply must be coming throughout the Q4 or rather 4 months of the calendar year (inaudible) March until as such. Now if this virus issue prolongs for longer time a bit, how do we see the supply impacting for the industry and the company? Do we see any such things happening? Do we have sufficient inventory in the system to produce more units which will be consumed in the next few months?

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Neeraj Basur, Blue Star Limited - CFO [58]

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Yes. So I guess you joined the call a little late Amber. I clarified this already, and again, we isolating cost. As far as our quarter 4 selling plan is concerned, both what we need to import in terms of raw material components and our own production line, we have sufficient raw material and finished goods to cater to the overall supplies that are needed to fulfill sales for quarter 4. So we don't see a concern there. And equally, because this entire thing has happened when China normally would have stayed closed because of their New Year. As of now, this is looking like an extension of that New Year closure by about 10 days probably, and what other indication we're getting so far from a Chinese supplier, they are all indicating that by 10th of February, they expect to open up. Now we have to wait and watch and see what goes on over there, nobody can predict. So we will keep you posted. So for now, we are good for Q4. We -- as of now, we are not clear on what happens beyond, let's say, if it's a very long or very short or medium term. I think it will be a bit speculative. It's better that we post you again once there is no clarity towards middle of February.

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Amber Singhania, Asian Markets Securities Private Limited, Research Division - Senior Analyst [59]

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And would this be more or less similar for the industry as well?

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Neeraj Basur, Blue Star Limited - CFO [60]

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It should be because, for example, everyone imports compressors, most players import copper. So yes, there is to varying degrees it will be -- one good thing is that we've -- where we started manufacturing indoor units last year. So to some extent, there is -- we see a reduction in that pressure, whatever it means. So about 45% to 50% of our IDU consumption this year is all going to be in-house manufactured. That does reduce the dependence to some extent, but then doesn't take away fully. So it is a little mixed bag at this point in time.

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Amber Singhania, Asian Markets Securities Private Limited, Research Division - Senior Analyst [61]

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And secondly, I just wanted your sense on the overall costing and pricing front, as you know, that given the competition, it is difficult to increase the prices in the market as such. And we are also seeing that inverter, which used to be at a significant premium earlier, is now at a level at a significant -- the competitive price in the market as such across the brands. How do we see -- is there any further scope for cost reduction on inverters, given we have already crossed 65% kind of penetration as industry. Where do we see the cost of [currency] is possible to bring in for the industry as well as for the company on that part, in the event that it is difficult to increase the prices per se?

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Neeraj Basur, Blue Star Limited - CFO [62]

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Yes. So some of that is to be expected. If you remember, 4 years ago, inverters used to [grow] only 15% of the overall market. So from 15%, inverters are now touching 55%, 60%. And as the volumes grow, obviously, there are some procurement efficiencies and overall economies that can be expected, which needs to be translated back as price corrections as far as overall selling prices are concerned. So some of that is also happening, which is not a concern because of the corresponding material cost savings as well. So to that extent, we are okay.

Now like I explained before, the pressures really happen because if some players have certain short term or tactical reasons, could be because of inventory levels, could be because of market share that they may be wanting to achieve if there is a little extra push to course correct on prices, that does put pressure on everyone in terms of price realization. So that is also a usual phenomenon in this particular category. And we need to continue to moderate the course of our pricing and discounting pretty much on a monthly basis.

So that's what we do. Again, with the endeavor to, finally -- because we don't want to compromise on growth or growth opportunities. At the same time, we want to make sure that a reasonably stable margin profile is maintained. So that's where we are. And again, the biggest determinant being the summer intensity. And if that tends to be normal, then pretty much we see what we saw in quarter 1 of this year or year before last. And I don't expect it to be any different, even going forward.

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Amber Singhania, Asian Markets Securities Private Limited, Research Division - Senior Analyst [63]

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Sir, costing side, we have captured more or less whatever was possible buying (inaudible) basis points more.

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Neeraj Basur, Blue Star Limited - CFO [64]

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Well, not really, because that's a continuous exercise. Because one is, of course, on the procurement side. As you procure more, as your economies of procurement happens, with the assumption that, first, the commodity prices will remain stable. If commodity prices tend to harden up too fast too soon, then of course there's a different problem. But if commodity prices remain stable, then of course, there are procurement efficiencies that can be realized steadily.

In our case, because 60% of what we sell is manufactured by us, as you're aware, we also have opportunities to continuously do value engineering in our factories and push for a higher proportion of backward integration. For example, IDU production is a major initiative in that context. So when we do more of that, then there are further conversion cost efficiencies that can be expected. So we always have, alongside our sales plan, we also carry cost-management plans on the principle of TCM, which in a way, to some extent, do help us to mitigate the pricing pressures. Not entirely at times, but then one has to look at that pretty much in parallel. Otherwise, of course, you are worried it will be a one-sided challenge.

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Operator [65]

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I would request Mr. Singhania to come back in queue. The next question is from the line of Nirav Vasa from Anand Rathi.

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Nirav Vasa, Anand Rathi Financial Services Limited, Research Division - Research Analyst [66]

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Sir, I have a broad strategic question with regards to room air conditioners. So considering the fact that the competitive intensity is not slowing down, and it is not even expected to slow down, how do we intend to rebalance our supply chain with regards to own manufacturing, contract manufacturing and imports. And my second question would be pertaining to the tax rate that we can take for FY '20, considering the MAT credit that we have?

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Neeraj Basur, Blue Star Limited - CFO [67]

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Sure. Now as far as this own versus contract versus import, we are -- there's no change in terms of our thinking, plan, strategy, action. So pretty much the substantial part of what we sell, which is in the range of 50%, will be own manufactured. If at all, we are looking at deepening the extent of backward integration and related value that we capture through the supply chain, value chain, so that's pretty much the same.

Our second protocol always is contract manufactured. SKUs, where volumes do not justify us manufacturing it in-house are contracted out by us. We are pretty agnostic to whether we manufacture those ourselves or through contract manufacturers, wherever we get better economies. And pretty much the residual fulfillment happens through the import route.

That's the structure we follow. Now this structure gives us a fair degree of flexibility in terms of optimizing on capacity utilization. It gives us flexibilities around the entire cost structure as well that needs to be optimized from time to time.

So that I don't think will change. And we will be on the same trajectory for some more time. Of course, IDUs, for example, next year, instead of 50% this year, we devote about 70%, 75% own manufactured. So that will -- that proportion will go up. Similarly, there could be some other components which we will manufacture in-house.

As far as tax rate is concerned, this year, as I explained, there is a one-time impact of a deferred tax asset reversal. This is noncash. If you recollect in quarter 4 last year, we had taken a deferred tax credit because of certain tax loss benefits we had in our wholly owned subsidiary. Now the good news is, the subsidiary is producing some accelerated profits which are visible in Segment III. As a consequence, we've had to -- we would have reversed the deferred tax asset over 2 or 3 years is what [getting reversed] pretty much in a span of 1.5 years. So that's nothing to worry about. That's more of an accounting entry than anything else.

As far as the normalized expected tax rates are concerned, we should be in the range of 27% to 28%, once we come out of this (inaudible) binding. And once the MAT, if it's fully consumed, then, of course, we will -- we have said we will take the shelter of the lower tax rate. But that's probably a year away.

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Nirav Vasa, Anand Rathi Financial Services Limited, Research Division - Research Analyst [68]

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So what will be the pending MAT credit that we have at the end of third quarter?

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Neeraj Basur, Blue Star Limited - CFO [69]

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On a consolidated basis, we have close to INR 70 crores.

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Nirav Vasa, Anand Rathi Financial Services Limited, Research Division - Research Analyst [70]

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Sir, my last question is pertaining to the Water Purifier business. So as we are increasing the scale and size of operation, how do we intend to go about manufacturing of it? Like, would that be on a contract-out model, in-house manufacturing or imports?

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Neeraj Basur, Blue Star Limited - CFO [71]

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At this point in time, we don't intend to manufacture all of it ourselves because we are going step by step and I explained short while ago in the call. First, we are trying to ensure that we fall in the trajectory of the desired economics, and the economic model we are trying to follow first after having launched the brand, after having launched the product portfolio, after having made deep inroads in the -- on the distribution and wholesale servicing. If all that is done, now we are prioritizing the economics of this category. The next will be, of course, we have to scale it up. So unless we hit a scale where we believe that it makes economic sense to manufacture in-house, we will probably wait for some more time. So on the immediate horizon, we do not intend to manufacture Water Purifier in-house.

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Operator [72]

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I'd request Mr. Varsa to rejoin the queue. The next question is from the line of Nitin Bhasin from AMBIT Capital.

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Nitin Bhasin, AMBIT Capital Private Limited, Research Division - Head of Research & Analyst [73]

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Two questions. One is on the Segment I, which is the entire MEP business. Could you give us some sense on in terms of what's happening because we hear a lot about commercial real estate launches being very strong. So while that is good, but also we hear about the government projects being very slow, so if you could just give a sense in terms of how the order book pick up, inquiries of tenders, looking like right now? And because of this private equity backed retail space or real estate space, is there finally an integration of MEP happening or no?

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Neeraj Basur, Blue Star Limited - CFO [74]

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Well, that's multiple questions. So -- okay, because we are running out of time, I try and attempt that as quickly as possible. First, I'll attend the last one. So as far as integrating MEP is concerned, pretty much, that's been our differentiator for some years now, and that's helped us gain traction on the order bookings. So probably, we'll be amongst very, very few players in the country who offer a comprehensive integrated HVAC plumbing, HVAC ventilation, firefighting. So this is under one roof. So that anyway is a very strong differentiator, and we are doing well on that count.

Now as far as your question on what's happening in the market. Yes, of course, there are these sparse deals where -- which are backed by private equity players, and we are -- those are the ones pretty much we do participate wherever possible. The -- while, yes, there is -- that is the intent to launch projects, but you will appreciate that it takes -- there's a degree of lag after announcing a project and by the time the project is ready for MEP work. So probably, we have to just wait and see once they achieve finance closure and whether it's going on track and then the entire civil part, how it moves, before MEP can step in. So there will be a lag even once the market revives in terms of order growth.

On the government, your comment is absolutely on the dot. While the overall opportunity size looks good, there is indeed a pressure on collections. And again, we have to continuously moderate the pace of our execution to make sure that while government -- we don't run a credit risk, but there is a delay as far as collections are concerned. So one needs to be watchful if not overly careful as far as governments are concerned. So this segment has its own challenges. And if -- unless we keep an eye on the various parameters, it can spin out of control fairly quickly. So that's what we are doing at this point in time.

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Nitin Bhasin, AMBIT Capital Private Limited, Research Division - Head of Research & Analyst [75]

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So it's largely a muddle through segment in terms of 5%, 8% growth and the margins where they are, they remain there.

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Neeraj Basur, Blue Star Limited - CFO [76]

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I would not say muddle through. This is a fairly important segment. It's only that in Indian context, we've been going through an external environment which has remained challenged for a very long period of time. Having said that, at some point in time, whether it's the banking, NBFC, the economy has to come out of the current set of challenges because the country will need to grow. So once the growth resumes, this is -- this can be a very rewarding segment to be in. I guess we are getting tested out for our resilience in the challenged environment. And pretty much once the winds turn to blow on the positive side, we should be seen as a fairly -- we are already seen as a fairly stable player and so that becomes our advantage.

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Nitin Bhasin, AMBIT Capital Private Limited, Research Division - Head of Research & Analyst [77]

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So the second bit in this was, you are a very strong player when it comes to small and medium enterprises and ducted-packaged air conditioning system. And you're one of the leaders over there. So -- and we hear a lot of stress on the SME right now. So do you think that this segment actually can go -- become more weaker in the next 1 or 2 quarters if the SME stress remains?

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Neeraj Basur, Blue Star Limited - CFO [78]

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Well, it's not as much about SME. So it's not necessarily SME. These are all, you can say, small-sized projects where it could be a boutique store, a shop or showroom, a small restaurant or hospital. These are not necessarily SMEs. But they are also impacted by the liquidity concerns. So far, it has been reasonably good, barring quarter 3 where there is a degree of slowdown. But probably this sub segment or sub-category will be the fastest to rebound when the external environment starts to look better.

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Operator [79]

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Ladies and gentlemen, due to time constraints, that was the last question. I now hand the conference over to Mr. Neeraj Basur for closing comments.

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Neeraj Basur, Blue Star Limited - CFO [80]

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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 additional details by e-mail or in-person. Thank you.

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Operator [81]

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