I recently did a study of Cera Sanitaryware, a listed sanitary ware company. I find it to be a company with good financial performance over the past. I think that it should do well if you have a long-term horizon for investment.
My analysis consists of the following sections:
- Risk factors
1. What is the business?
Cera Sanitaryware Ltd. (CSL) is in the business of selling sanitary ware, faucets and other products like shower cubicles and bath-tubs. It has entered the high-end tiles segment recently.
The company was incorporated in 2002. CSL is the third largest sanitary ware maker in India.
They sell their goods via the institutional and the retail routes respectively. 90% of their sales are to the retail market. (Source: CARE report – Aug 2012).
|Vitreous China Sanitary ware|
|Capacity (in numbers)|
This does not give the right picture because the sales figure includes outsourced goods (which does not need raw materials) and manufactured goods.
Creditor days are fairly constant at around 2 months of sales. This takes into account the payables for traded goods in addition to the payables for raw materials respectively.
3. How is the company placed against competitors?
In the organized market brands, Cera Sanitaryware is the third largest after Hindware (HSIL) and Parryware (owned by Roca). CSL is gradually trying to increase its brand strength.
Market share of Cera is around 20%. Hindware is around 40%, Parryware is around 26%.
There are foreign brands like Toto, American Standard, Kohler and Grohe which make up the rest of the organized market. Foreign brands have premium positioning.
Primary checks also suggest that foreign brands are quite strong in Mumbai. Kohler was stated to be doing quite well by multiple people during conversations.
The unorganized market is made up of domestic manufacturers, predominantly from the Morbi area in Gujarat. Morbi has historically been a tile and sanitary ware manufacturing hub. There is also a trend of importers who buy Chinese tiles, re-brand and sell them in the market. Chinese tiles are bought by price-conscious customers. They have relatively poor quality as maintained by the people who were asked about them in primary checks.
The Indian sanitary ware market, which is currently pegged at Rs 2,500 crore, equally shared by branded and unbranded players, is growing at a compound annual growth rate (CAGR) of 15% according to newspaper reports.
4. What is the company’s bargaining power with customers?
CSL sells their goods in the market through distributors. Typically, retailers are not exclusive to Cera Sanitaryware.
Debtor days are relatively steady at around 2 months of sales.
5. Is the company innovative? Does it work on adding new product lines?
Management has been active in launching new product lines. They added a faucets production line a few years ago. They started importing wellness products like shower cubicles, luxury bath tubs and selling them under the CERA brand. They have started selling plastic cisterns and seat covers in the last year. They also sell kitchen sinks. Kitchen durables are experiencing high growth; 25% as per newspaper reports.
The core revenue is generated from sanitary ware products. But the fact that the company seems to be pushing new products into the market under the same CERA brand name is positive.
They have a wide range of products as can be seen from their website. Interestingly, one can order off their website. This is something that not even Hindware lets you do. One does not know how many people actually buy from the website but at least the management is pro-active.
Hitherto, they have not been strong in the institutional segment. They have invested in exclusive Cera Style Studios to target this segment. They have eight of these primarily in the tier I and II cities. They are adding three more by October 2013. Each costs Rs. 5 cr to Rs. 10 cr which is a sizable investment.
6. Is management compensation reasonable or too high?
As per the FY12 Annual Report,
Figures in Rs. cr
|Shared||Other unimproved||Open defecation||Shared||Other unimproved||Open defecation|
Source: UNICEF, 2012 update, Joint Monitoring Programme for Water Supply and Sanitation
I am not saying that one can read too much into this data with respect to Cera. But it is helpful to understand that there is a long way to go with respect to sanitation in India, especially outside urban areas.
13. What is the outlook for sanitary ware sector in the future?
Sanitary ware is a necessity. Volume growth will be dependent on real estate market growth primarily. Replacement demand is yet not high enough for the sector to be free from the direction of real estate growth.
Hindustan Sanitary ware (HSIL) management says that 25% of their sales come from metros. The balance sales are from tier II cities and beyond. The overall sanitary ware industry is growing by 15-16%, whereas the premium segment is growing by 20-25% (HSIL annual report).
14. What is the trend in return on equity?
RoE is healthy and has increased over the years.
Dupont Analysis shows that RoE increase can be traced to the Asset Turnover which has increased from 1 to 1.3 over the last 7 years.
CSL stopped reporting the sales of outsourced goods from FY10. But the available data shows that they are benefiting from greater sales without corresponding increase in capacity.
|Sales (in Rs. Cr)||FY06||FY07||FY08||FY09|
There is data on the outsourced purchases which suggests that they have doubled from FY09-12.
|(in Rs. Cr)||FY07||FY08||FY09||FY10||FY11||FY12|
Gross margin on outsourced goods was around 28-34% from FY07-09. Data after FY09 is not available.
Outsourcing has positive impact on the bottom-line. The brand-building expenditure is spread over increased sales.
There is a risk in outsourcing in that as Cera Sanitaryware might not be able to control its supply chain well and distributors can face supply outages (as mentioned in primary check) on outsourced product range.
15. How does the company manage working capital?
|All w.r.t sales||FY07||FY08||FY09||FY10||FY11||FY12||FY13|
Apart from an inventory flare-up in FY12, the working capital picture looks good for CSL. It is managed reasonably. FY13 has seen inventory stabilizing at past levels.
16. What is the company’s dividend paying history?
Dividend payout is relatively low. It is acceptable considering the capital expenditure needs. The company is re-investing profits at a healthy return on equity. Net worth has grown by over 25% CAGR over the last 5 years.
17. What is the dividend yield?
0.76% as of 14 Jun 2013. It is not much. One would be looking for capital appreciation in a stock like this.
18. What is the debt-equity profile?
Debt to equity has come down from 0.6 to 0.3 levels in the last 5 years.
19. What are the growth rates of sales, operating profit, net profit and EPS?
|Net sales growth||21%||23%||20%||28%||31%||49%|
Overall, it has delivered very healthy growth in a dull economic environment.
20. What is the trend in free cash flow?
A steady pattern does not exist because of capex which the company undertakes every 2-3 years (in the past 6 years).
21. Is net profit growth matched by EPS growth or is growth at the cost of dilution of equity?.
In FY07, the company allotted 0.15 mn shares to the promoters at Rs. 123 (Rs. 62.5 in today’s price adjusted for bonus in FY10), in pursuance of warrants issued to them. In the same year, the company allotted 0.55 mn equity shares at Rs. 155 per share (Rs. 75 in today’s price adjusted for bonus in FY10) to a Mauritius based investor to fund expansion project. The amount was Rs. 8.25 cr.
In FY08, the company allotted 0.11 mn equity shares at Rs. 123 to the promoters in lieu of the warrants mentioned earlier
In FY09, the company allotted 0.26 mn equity shares at Rs. 123 to the promoters in lieu of the warrants mentioned earlier.
The six year EPS CAGR over FY06-13 is around 28% while corresponding net profit CAGR is 31%. There is a slight lag in EPS as compared to net profit.
I consider this level of dilution acceptable.
22. What is the trend in operating and net margins respectively over the last 5 years?
In recent years, margin has come down because in recent years possibly because the contribution from outsourced goods has increased.
The management is planning an expansion in the coming three years which means more in-house production. I will not count on margin profile changing too much from these levels.
23. What risks does the company face?
Real estate slowdown
Considering that the bulk of CSL’s demand is new demand and not replacement demand, real estate slowdown will have an impact on the company.
A look at EID Parry’s past data is helpful. The period chosen is 1996-2002. This period covered the last protracted real estate slowdown in India. What happened in 2008-09 was not a typical slowdown because of the quick rebound due to central bank action.
|Value (in Rs. Lakh)||5,678||6,613||7,213||8,714||9,623||10,134||12,258||12,890|
|Avg. realization (in Rs.)||37,768||45,038||51,691||46,684||51,050||53,267||55,960||56,483|
|Avg. Realization growth||19%||15%||-10%||9%||4%||5%||1%|
Source: EID Parry Annual Report FY96-FY02, segment details
This is what a bad real estate market did to EID Parry more than 11 years back. Through the down-cycle it still had a value CAGR of 12%.
Today, the real estate in India in metros is stretched but interest rates today are nowhere near the levels seen in 1996-99. Recently they have been at around 7.2-8% levels for the 10 year G-Sec.
As a comparison the following chart shows G-sec rates over the last 20 years including the last real estate slowdown period studied for EID Parry.
I really do not know if real estate will crash. I have been pondering over it for many years but the black money in our country is something that cannot be underestimated. That and the builder-politician nexus.
Since bulk of the sales are outside metros I would draw comfort from the fact that the company will be potentially less exposed to frothy markets which will see a greater slowdown if there is a real estate market crash.
Chinese imports should matter more for domestic unorganized players and not the bigger branded players.
They are a small part of the market today. They are present mainly in metros. Cera does not compete with them as much as Hindware and Parryware. Cera looks better placed since they are somewhere in the middle of the market in the organized segment.
HSIL (owner of Hindware) and Roca (owner of Parryware).
Competition will continue to be relentless for Cera Sanitaryware but they have held their ground and increased their share in the last 5-6 years.
New domestic players
Domestic players like Jaquar who are market leaders in faucets have started selling sanitary ware. The balancing factor is that Cera is also entering into areas like faucets, fittings in which they were not present earlier. Overall market growth will be good for all branded players.
24. What is the outlook for CSL?
The biggest reason for my interest in CSL is the fact that the industry dynamics are changing. The fact that there is a shift from the unorganized market to the organized market is giving growth in excess of industry growth rates to the big branded players like Parryware, Hindware and Cera Sanitaryware.
The second reason is that the customer behavior is changing. People are spending more in comparison when they choose a Western toilet over an Indian toilet. Easily, a factor of 3-5 times more.
CSL has only 10% exposure to the institutional market. The company is trying to increase this share. In a counter-intuitive way, I feel CSL is better placed to handle a real estate slowdown than its competitors who have greater exposure to the institutional market.
On a conservative basis, I will not assume growth in market share from 20% to 30% as management expects to achieve.
If the market share increases, it will help the investment case. But this is not considered.
25. What is the valuation in terms of price-earnings ratio?
At a price of Rs. 520.8/- as of 14 Jun 2013, CSL trades at a P/E of 14.3 times on trailing earnings.
Average trailing price to earnings ratios (P/E) for Cera Sanitaryware from Jan 2008 to around May 2013 is approximately 7.
Cera is a good brand which is increasing market share in a sector which has favourable dynamics for branded players. The company has improved in terms of business profile over these last 7 years. Around 12 times trailing earnings is a fair price in my opinion for a company that has good growth potential in light of the sector dynamics discussed above, financial parameters, and management quality.
26. What are the results of the discounted cash flow analysis (DCF)?
This is a high growth company with lesser predictability of cash flows. There is greater chance of getting the DCF wrong than right.
I conservatively assume a 20% value growth over the next few years with similar margin profile. This compares to a 29% 6 year sales CAGR and a 36% 3 year sales CAGR (FY07-13). Recent years have seen acceleration in sales.
I have taken a growth in cash flows from operation at around 20% and 10% in multiple stages and a terminal growth rate of 3%. WACC works out to 13.5%. Capex growth has been kept at a reasonable level, slightly lagging the cash flows from operation as has been seen in the past. DCF analysis yields a per share value of Rs. 371.
This value includes a margin of safety because I am considering lower growth in cash flows as compared to past data.
27. What is the investment decision?
DCF valuation suggests Rs. 371 as a fair value with a margin of safety.
I have bought into this stock at around Rs. 456 levels, when it was around 12 P/E.
When I bought it, the blended value of DCF (20% weightage) and P/E (80% weightage) worked out to Rs. 425.
In this investment, my margin of safety is relatively lesser at the price I have invested in. I recognize this fact. It is a conscious call I have taken.
Sometimes trying to scrape the bottom of the barrel can lead to missed opportunities. You would be right in saying that it can create investment mistakes too.
That is a call one needs to take. Take as much risk as you are comfortable with. As usual, please read the disclaimer.
Take an independent decision. I am not responsible for any losses that you might bear. You can say that I have a bias as I am invested in this stock.
I will leave you with some other thoughts.
Vidush Somany’s death
This is purely conjecture but with the death of Vidush Somany at the age of 31 there remains the question of what happens with the ownership of this family run business. Vikram Somany, age 62, had groomed Vidush and his son was taking greater responsibility over the years. Considering Indian promoters, 62 is not an advanced age that forces Vikram Somany to call it a day. If the promoters decide to sell rather than continue running the show, there could be an M&A play in CSL.
There is a past transaction in this sector.
In 2008, Roca bought 47% of EID Parry’s stake in the 50:50 JV leaving EID Parry with 3%. They bought in at Rs. 705 crore for 47% when the FY08 sales of the JV were around Rs. 360 crore. The implied price to sales multiple was around four times sales.
The investment decision should not be based on this conjecture.
One might ask. Why not invest in HSIL, the market leader in sanitary ware?
HSIL is a listed entity and they are the market leader with Hindware brand. They also have a container glass division which is a low RoE business and a drag. There has been news of sale of the subsidiary which had container glass operations. Disclosures are not helpful at all in understanding the transaction. Until there is clarity, I will not consider HSIL.
I would love to hear your feedback. Views, counter-views are welcome. If you have thoughts to add please use the comments section below.
If you have any information that you have gathered through primary checks it will be helpful.
If you have purchased something for your home recently, that is excellent market information. You will have a view about consumer behaviour and market dynamics.
Do share your views.