Blue Star data-centre MEP opportunity offsets near-term RAC margin pressure

Investment View and Valuation

Motilal Oswal Financial Services (MOFSL) retains a Neutral rating on Blue Star after a weak 1QFY27, when profitability was materially below both the broker’s and consensus expectations. The broker expects a gradual near-term earnings recovery as the room air-conditioner (RAC) industry enters a seasonally soft period amid intensified competition and an uncertain macro environment.

MOFSL’s constructive medium-term view is supported by Blue Star’s electro-mechanical projects and services (EMPS) order book and the expanding data-centre mechanical, electrical and plumbing (MEP) opportunity. At the report CMP of Rs 1,514, the broker considers Blue Star fairly valued at 54 times FY27E earnings and 40 times FY28E earnings. Its target price of Rs 1,580 is based on a sum-of-the-parts valuation using 45 times UCP, 40 times EMPS and 25 times Engineering Products and Services FY28E EPS.

Weak 1QFY27 Results

Blue Star reported consolidated 1QFY27 revenue of Rs 33.8 billion, up 13 per cent year on year but around 4 per cent below MOFSL estimates. EBITDA declined 13 per cent year on year to Rs 1.8 billion, missing estimates by around 30 per cent. Operating profit margin contracted 1.5 percentage points year on year to 5.2 per cent, 1.9 percentage points below the broker’s estimate. Adjusted PAT declined 21 per cent year on year to Rs 957 million, around 38 per cent below estimates.

Depreciation and interest costs increased around 37 per cent and 34 per cent year on year, respectively. Net cash stood at Rs 9.0 billion as of June 2026, compared with Rs 1.75 billion as of March 2026.

RAC Margin Pressure Weighs on UCP

The Unitary Cooling Products (UCP) segment was the principal weakness. UCP revenue grew around 13 per cent year on year to Rs 16.9 billion, but EBIT declined around 43 per cent to Rs 497 million. EBIT margin fell 2.9 percentage points to 2.9 per cent.

Management said Blue Star could pass through only around 5 per cent of approximately 13 per cent input-cost inflation. Delayed summer demand, intense competition and peers’ lower-cost inventory constrained price increases. The company prioritised market share, resulting in higher spending on consumer finance schemes, dealer incentives, advertising and field marketing.

RAC market share fell 50 basis points in April 2026 but recovered by 10 basis points in May and 50 basis points in June. This limited the 1QFY27 decline to 30 basis points. Management now expects market share of around 14 per cent, compared with its earlier expectation of 14.25 per cent.

Path to UCP Margin Recovery

Management expects industry pricing to improve as lower-cost inventory is exhausted. Blue Star is rationalising its product portfolio, using alternate components, outsourcing select models and redesigning products. Around 90 per cent of the portfolio is targeted at competitive price points while retaining premium positioning.

Management expects sequential margin improvement in 2QFY27 and a stronger recovery in the second half of FY27. It guides for UCP EBIT margin of around 6.5 per cent in FY27, compared with a long-term aspiration of 7.0-7.5 per cent. Channel inventory is elevated but not alarming; management considers 45-50 days of trade inventory normal and expects normalisation before Onam, with faster progress during Ganesh Chaturthi.

EMPS Order Book and Data-Centre MEP Opportunity

EMPS revenue rose 15 per cent year on year to Rs 16.3 billion. However, EBIT declined around 1 per cent to Rs 1.1 billion and EBIT margin contracted 1.1 percentage points to 6.8 per cent, reflecting high commodity prices and adverse currency movements. Management guides for EMPS margin of 6.5-7.0 per cent.

Data-centre MEP generated Rs 15 billion of 1QFY27 order inflows, taking the total EMPS order book to Rs 77 billion at June 2026. Management expects data-centre MEP order inflows of around Rs 30 billion and revenue of around Rs 14 billion in FY27. It targets revenue of Rs 40 billion, or around 20 per cent of revenue, from this business by FY29.

Ducted systems, VRF and chillers all registered growth in inquiries and order inflows. Engineering Products and Services revenue declined around 10 per cent to Rs 636 million, while EBIT rose around 26 per cent to Rs 96 million and EBIT margin expanded to 15.1 per cent.

Earnings Estimates and Cash Flow Outlook

MOFSL cut FY27E and FY28E EBITDA estimates by 17 per cent and 11 per cent, respectively, because of lower margin assumptions. This resulted in EPS cuts of around 19 per cent and 13 per cent.

The broker’s forecasts are from a low base, with overall operating margin expected to remain broadly range-bound near 7 per cent. MOFSL estimates cumulative operating cash flow of Rs 12.8 billion and free cash flow of Rs 7.0 billion over FY27-FY28. It estimates net cash of Rs 893 million in FY28.

Key Risks to Recovery

• Competitive intensity, particularly in the RAC market.
• Volatile commodity prices and adverse currency movements.
• West Asia-related uncertainty and an uncertain macro environment.
• Soft RAC demand and elevated channel inventory.
• Continued margin pressure and slower-than-expected earnings recovery.