Sector Updates: Air Conditioner Sector Institutional Research Report | HDFC securities

1. SECTOR UPDATE – CONSUMER DURABLES 15 MAY 2018 Air Conditioners Value today, volume tomorrow! The air-conditioner industry has witnessed several headwinds during FY18, led by GST transition and the change in energy efficiency ratings. Additionally, the summer of 2018 started on a weak note, despite IMD predicting a harsh summer. Consumer offtake has thus been weak, as evident in Lloyd (Havells) and Blue Star’s Room Air Conditioner (RAC) volume growth in 4QFY18. However, value growth (19% for Blue Star) was boosted by a richer mix (inverter share rising and rating change in Jan-18) and a commodity-led price hike of 3-4%. Nevertheless, we stick to our longer term constructive view on RAC volume growth, which will drive up value growth even higher in future. revenue growth of listed players (Link to table). We noticed that directionally the trend is prevalent in previous years (FY13-18). This implies AC demand was softer during FY18 led by weak summer in 1QFY18 and the rating change disruption in 4QFY18. Interestingly, Inverter ACs continued to gain share at a handsome pace (now 28% volume share vs. 11% in FY17). ▪Industry grew by a modest 11% in value in FY18: Blue Star stated that the industry grew by 15/11% in value in 4QFY18/FY18. Blue Star believes inverter share in the industry will rise to 40% in FY19 (Blue Star's inverter mix will be ~45%). ▪Rating change pre-buying: Rating norms were revised from Jan-18, wherein the prevalent 5/3 star norms were downgraded to 3/1 star. This resulted in pre- buying during 3QFY18 (Link to table), as prices would rise at the consumer level in 2018. This has impacted Jan-18 consumer offtake. However, companies have filled the trade channels during Feb-Mar in line with bullish IMD vibes on summer 2018. Meanwhile, Voltas is down ~10% over the last month as the street is expecting a weak 4QFY18 show. However, given Blue Star’s show, Voltas can post double digit value growth (despite possibly muted volumes). The mix improvement is possibly being ignored by Voltas’ sellers. This throws open an opportunity to buy Voltas on dips. At 25x Mar-20E EPS, our TP of Rs 710 offers an entry point. ▪Lloyd reported flat growth in 4QFY18: Havells stated that growth was muted in 4QFY18 (11% in FY18). However market share was maintained ~10/13% in value/volume terms. This highlights the underlying weakness in primary sales. What transpired in FY18 and the way forward ▪Industry production (volume) grew in high single digits (Link to table): As per Bureau of Energy Efficiency (BEE), the Air conditioner industry grew at a modest pace of 7% in volume terms during FY18 to 6.9mn units vs. 37% growth in FY17. Slower industry growth was attributed to GST disruption, rating change (change in energy efficiency norms) and the high base of last year. In order to gauge the quality of data, we compared the AC industry production numbers with Naveen Trivedi naveen.trivedi@hdfcsec.com +91-22-6171-7324 ▪Blue Star RAC growth was driven by value growth: RAC value growth was 19/15% in 4QFY18/FY18 despite weak volume growth. Value growth was higher owing to a favorable mix (inverter share rising and rating change in Jan-18) and price hike of 3-4%. The company maintained its volume market share at 11.5%. Siddhant Chhabria siddhant.chhabria@hdfcsec.com +91-22-6171-7336 HDFC securities Institutional Research is also available on Bloomberg HSLB <GO>& Thomson Reuters

2. SECTOR UPDATE – AIR CONDITIONER ▪MNCs raised their game: As per our dealer checks, Daikin and LG have become more aggressive in terms of pricing and distribution. Both players are positioned in the premium segment (5 star and inverters). As the industry moves to more energy efficient products they will continue to benefit. ▪Summer 2018 did not live up to IMD’s expectations: IMD in their estimates for Summer 2018 stated that this year India will witness a harsh summer. As a result, AC players increased their production to make the most of it. However, several regions in India witnessed unseasonal showers. Blue Star believes that 45 days are still left in this season and offtake can pick up. ▪FY19 can start on a positive note: As per our dealer checks and management commentary consumer offtake has been weak so far, which can result in soft volume growth in 1QFY19. However, value growth will continue to play out driven by richer mix and price hikes along with favorable base for all AC & air cooler players owing to GST destocking and weak summer. ▪Our thesis on cooling products: We continue to believe that the AC industry will sustain its secular long term growth driven by (1) Rising demand for cooling products driven by growing disposable incomes, cheaper financing options and increasing up-country penetration of electricity, (2) Low penetration (~5%) and (3) Improving energy efficient products. Page | 2

3. SECTOR UPDATE – AIR CONDITIONER Air Conditioner: Industry Production Volume Volume Star 1 Star 2 Star 3 Star 4 Star 5 Inverter Total FY12 FY13 FY14 FY15 88,326 927,755 2,486,797 130,471 1,006,012 FY16 39,782 561,870 2,785,931 47,836 1,240,603 25,006 4,701,028 FY17 1,505 429,452 3,629,764 37,009 1,641,909 702,652 6,442,291 FY18 FY18 was a year marked by disruptions like 1) GST pre- buying (1QFY18), 2) Modest festive season due to GST pre- buying, 3) Rating change pre- buying (3QFY18), 4) IMD forecast for harsh summer in 2018 and 5) Pre-monsoon showers pan-India has resulted in a weak summer 107,525 1,064,021 894,352 147,176 541,648 260,019 1,286,143 1,017,074 245,353 458,976 223,016 1,131,687 1,342,260 207,138 578,454 415,913 538,926 2,846,892 99,109 1,038,727 1,964,640 6,904,207 - - - - 2,754,722 3,267,565 3,482,555 4,639,361 Growth YoY (%) Star 1 Star 2 Star 3 Star 4 Star 5 Inverter Total FY13 142% 21% 14% 67% -15% FY14 -14% -12% 32% -16% 26% FY15 -60% -18% 85% -37% 74% FY16 -55% -39% 12% -63% 23% FY17 -96% -24% 30% -23% 32% 2710% 37% FY18 27535% 25% -22% 168% -37% 180% Air conditioner production volumes grew by only 7% in FY18 19% 7% 33% 1% 7% Mix (%) Star 1 Star 2 Star 3 Star 4 Star 5 Inverter Total Source: BEE FY12 FY13 FY14 FY15 FY16 FY17 FY18 4 8 6 2 1 0 7 6 8 1 Star AC’s showed an unusual pick-up in growth in FY18. It could be a result of rating change norm (effective Jan’18) 39 32 5 20 39 31 8 14 32 39 6 17 20 54 3 22 12 59 1 26 1 100 56 1 25 11 100 41 1 15 28 100 - - - - 100 100 100 100 Page | 3

4. SECTOR UPDATE – AIR CONDITIONER Inverter Air Conditioners Gaining Share Inverter AC’s continued to gain share at an impressive pace (28% in FY18 vs. 11% in FY17) Inverter (Volumes) Star 3 Star 4 Star 5 Total FY16 15,072 4,990 4,944 25,006 FY17 FY18 560,866 70,018 71,768 702,652 1,634,398 85,676 244,566 1,964,640 Mix (%) Star 3 Star 4 Star 5 Total Source: BEE FY16 60 20 20 100 FY17 80 10 10 100 FY18 83 4 12 100 Volume production data is directionally in-line with value growth for most of the players during FY13-17 Industry Production Volume vs. Revenue Growth of Players FY13 19% 19% 17% 3% FY14 7% 12% 18% 12% FY15 33% 22% 43% 24% FY16 1% 2% 6% 18% FY17 37% 18% 20% 27% Industry Production Volume Voltas UCP Segment Growth Johnson (Hitachi) Revenue Growth Blue Star UCP Segment Growth Source: Companies, HDFC Sec Lloyd reported flat growth during 4QFY18 and stated that they did not lose volume market share in FY18 FY18 Industry growth vs. Expectation FY18E 7% 11% 17% 17% 11% Industry AC Production Volume Growth Industry AC Market Value Growth Voltas UCP Segment Growth* Blue Star UCP Segment Growth Lloyd Consumer Source: Companies, HDFC Sec * Estimate Rating norms were revised from Jan’18, wherein a 5 star/3 star were downgraded to a 3 star/1 star. This resulted in pre- buying during 3QFY18, as prices would rise at the consumer level in 2018. This is expected to impact secondary sales in 4QFY18 Pre-buying benefited 3QFY18 but impacted Jan-18 performance YoY Growth Voltas UCP Segment Growth Johnson (Hitachi) Revenue Growth Blue Star UCP Segment Growth Lloyd Consumer 3QFY17 -5% -8% 34% 43% 4QFY17 28% 41% 20% 29% 1QFY18 2QFY18 15% 11% 3QFY18 32% 34% 15% 16% 1% 6% 13% 20% 1% 11% Page | 4

5. SECTOR UPDATE – AIR CONDITIONER Disclosure: We, Naveen Trivedi, MBA & Siddhant Chhabria, PGDBM, authors and the names subscribed to this report, hereby certify that all of the views expressed in this research report accurately reflect our views about the subject issuer(s) or securities. HSL has no material adverse disciplinary history as on the date of publication of this report. We also certify that no part of our compensation was, is, or will be directly or indirectly related to the specific recommendation(s) or view(s) in this report. Research Analyst or his/her relative or HDFC Securities Ltd. does not have any financial interest in the subject company. Also Research Analyst or his relative or HDFC Securities Ltd. or its Associate may have beneficial ownership of 1% or more in the subject company at the end of the month immediately preceding the date of publication of the Research Report. 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6. SECTOR UPDATE – AIR CONDITIONER HDFC securities Institutional Equities Unit No. 1602, 16th Floor, Tower A, Peninsula Business Park, Senapati Bapat Marg, Lower Parel,Mumbai - 400 013 Board : +91-22-6171 7330www.hdfcsec.com Page | 6