The air-conditioner cometh

SMARTSHARE

The Budget reduced excise rates for air-conditioners from 24 per cent to 16 per cent. It is assumed that the industry will pass on cuts to consumers.

The decision to buy an A-C is definitely dictated by affordability. On the face of it, the cut should expand demand. It is also likely to induce a bias in favour of brandname, since the differential versus assembled units will narrow.

The industry size is about Rs 4,000 crore. Household penetration is pathetic "" just 1.2 per cent of households use A-Cs and 65 per cent of sales come from 7 urban centres. Unsurprisingly, it's a seasonal business. Most sales take place in the first half of the fiscal and last quarter sales see a surge in March.

The market is expanding fast. The 2004-05 fiscal will see 25 per cent growth and 2005-06 is likely to see 35 per cent growth. In gross terms, that's still just 13-15 lakh units per annum.

The excise reduction will lead to maybe 5 per cent cuts across ranges (between Rs 500-2,500 per unit depending on price range). It will certainly aid high-end growth.

But the cut must be balanced against rising steel prices because A-Cs have very high steel content. Also, much capacity is located in excise-free zones neutralising the cut. Overall, prices may rise despite the cut.

Several big players like LG, Samsung and (effectively) Carrier are unlisted. But there are also many listed companies such as Voltas, Whirlpool, Hitachi-Amtrex, Bluestar, Kelvinator-Electrolux, Videocon, etc. There's fierce competition. It's a tough task picking winners.

But A-Cs all use condenser and evaporator coils; the twisted copper or aluminium piping through which gas is piped, cooled and evaporated. That market is a little less crowded. Growth in the A-C market will trigger growth in the coils industry.

The largest local coils manufacturer is Lloyd Electric & Engineering (LEE), a company with a client list that includes Samsung, LG, the Railways, Carrier, Voltas and Bluestar. LEE has a plant at Bhiwadi and a new, not fully-functional unit in Himachal with a total capacity of 10 lakh units. The Himachal plant also makes A-Cs (it's an excise haven).

In FY 2003-04, LEE registered net sales of Rs 159 crore and cash profits of Rs 8 crore. In FY 2004-05, it has registered Rs 170 crore net sales in nine months (Q1 to Q3) with cash profits of Rs 6.75 crore. Margins have been hit by input costs.

But it could end 2004-05 with Rs 240 crore net sales and Rs 15 crore cash profits, assuming a normal March surge. In FY 2005-06, once the Himachal plant is fully operational, net sales might move up past Rs 350 crore with cash profits of Rs 26 crore or more.

By end 2004-05, the balance-sheet will have a high debt component "" estimated at around Rs 87 crore of debt versus an equity of Rs 17.8 crore and estimated reserves of Rs 45 crore. But interest costs could actually decline as high-interest loans are refinanced.

At an estimated 2004-05 PE of Rs 6, the current price of Rs 75 is discounted 12-13 times. The stock's gone ballistic since the Budget with massive trading volumes and a 50 per cent price rise. Is it still worth a punt? In this market, with these valuations, probably.