Somany Ceramics: Value added products to drive growth

CRISIL Research has come out with its report on Somany Ceramics. The research firm, company's focus on the asset light model instead of greenfield expansion is expected to lower capital requirements and reduce lead time in getting access to the capacity. Somany is evolving as one of the leading players in the tiles industry. Its market share in the organised industry increased to 13% in FY12 from 8% in FY08. An established brand and an extensive pan-India distribution network place Somany favourably to reap the benefit of shift in consumer preference for branded products. Focus on valueadded products and expansion through an asset light model is expected to drive future growth. We retain the fundamental grade of 4/5, indicating superior fundamentals. However, slowdown in the real estate industry and rising operating costs could impact future prospects. Evolving as one of the leading players in the industry Somany is evolving as the one of the leading players in the industry after Kajaria Ceramics backed by its focus on brand building, growing distribution network, launch of innovative products and expansion through an asset light model. It has been able to maintain growth and remain profitable in the past one year when majority of its peers reported moderate growth and decline in profitability. Tiles industry has robust growth prospects; shift in consumer preference augurs well CRISIL Research expects the tiles industry to grow at a CAGR of 13-14% over the next two years. Usage of tiles has increased manifold in the past few years. Customers are shifting to digital tiles which look similar to Italian marble and wooden floorings but cost less. Also, there is a shift in preference for high end tiles to replace mosaic tiles. Shift in consumer preference for branded products augurs well for Somany. Increase in share of value-added products to aid margin expansion Key value-added products such as digital, Veilcraft (VC) and Duragres’ contribution to total revenues increased to 28% in Q2FY13 from 17% in Q1FY12. Due to the rise in demand, the contribution is expected to increase to 32% in FY14, which should aid margin expansion. Focus on asset light model to reduce capex, enhance return ratios Somany’s focus on the asset light model instead of greenfield expansion is expected to lower capital requirements and reduce lead time in getting access to the capacity. This is expected to reduce stress on balance sheet and enhance return ratios. Apart from low capex, Somany has reduced its working capital cycle to 37 days in FY12 from 54 days in FY11 due to faster inventory turnaround, reduction in receivable cycle and better credit period. As a result, net debt-to-equity declined to 1.2x in FY12 from 1.6x in FY11. Revenues to increase at a three-year CAGR of 16%, RoCE to increase Revenues are expected to increase at a three-year CAGR of 16% to Rs 13.7 bn in FY15 driven by 13% growth in volumes and 3% growth in realisations. PBT margin is expected to improve by 150 bps to 5.6% in FY15 driven by increase in contribution from value-added products. RoCE is expected to improve to 24% in FY15 from 19.6% in FY12. Valuations - current market price has strong upside We continue to use the discounted cash flow (DCF) method to value Somany. We have rolled forward our projections to FY15 and revised our fair value to Rs 120 per share from Rs 80. At the current market price, this translates to a valuation grade of 5/5.