Institutional Equities Initiating Coverage Reuters: KAJR.NS; Bloomberg: KJC IN Kajaria Ceramics Kajaria Ceramics: Floored We initiate coverage on Kajaria Ceramics (KCL) with an Accumulate, driven by attractive valuation, expected strong earnings growth from FY22 post recovery from Covid impact, comfortable balance sheet and strong cash flow. This is supported by high product quality, wide product range, robust distribution network, strong brand recall and high market share. The steep decline in KCL stock price by 26.7% from its 52 week high primarily highlights the concerns of slowdown in earnings growth due to the Covid pandemic. The continued weakness in the stock price implies that the market is not factoring in a recovery post Covid. In our view, the negative impact is overdone. We expect a sharp recovery towards normalcy from FY22. The stock is currently trading at PER of 26.2x on Sept FY23 EPS, which is below the five year trading range of 30-50x 1-year forward earnings. We initiate coverage on the stock with a target price of Rs501 based on 30x PER on Sept FY23E EPS. Revenue growth at CAGR of 19% (FY21-23E) after COVID–19 shock is absorbed in FY21: We expect revenue to decline by 22% in FY21 due to the impact from Covid. The decline in revenue comprises 14% decline in sales volume and 10% decline in realization. Post recovery from pandemic, we expect the sales volumes to grow at a 2 year CAGR (FY21-FY23) of 13%. The realizations are expected to grow at a 2 year CAGR (FY21-FY23) of 5%. The revenues are expected to grow at a 2 year CAGR (FY21- FY23) of 19%. Thus, the revenue growth is expected to be driven by sales volumes going forward. Revenue growth and cost optimization to drive earnings growth at 2 year CAGR of 46%: Earnings are expected to decline by 45% due to expected sharp loss in prices and decline in sales volume in FY21. We expect recovery from FY22 with revenue at a 2 year CAGR (FY21-23) of 19% on the back of revival in demand and improvement in prices. Further, we expect EBITDA to increase at 2 year CAGR (FY21-23) of 32%, supported by lower power and fuel costs. The earnings are expected to grow at a CAGR (FY21-23) of 46%. The earnings revival from FY22 will be driven by 1) Strong EBITDA growth; 2) Interest cost remaining flat on YoY basis 3) Depreciation increase at a relatively lower 2 year CAGR (FY21-23) of 6.5%. Strong operating cash flows has added to our comfort: Despite large capex, we note that the company has consistently shows strong free cash flows. We expect the operating cash flows to increase from Rs2bn in FY21 to Rs4.7bn in FY23. The growth in cash flows is driven by strong growth in earnings and improvement in working capital. Wide spread with distribution network: KCL has a strong network of dealers (9MFY20 – 1,500 dealers, FY14 – 900 dealers) pan India, which help it to have a deep penetration across India. Over the years, KCL has invested in various joint ventures and set up manufacturing units at different locations, which has helped it to strengthen its distribution channel. RoE and RoCE to increase sharply during FY21-23: The expected decline in pricing power and sales volume in FY21 are expected to drive net profit margin and asset turnover ratio lower, leading to lower RoE. We expect the RoE to bottom out in FY21 (7.8%) and increase to 13.9% in FY23. RoCE is expected to grow from pandemic inflicted RoCE in FY21 of 9.7% to 16.6% in FY23. Strong balance sheet; working capital to peak in FY21 and decline from FY22: KCL has a strong balance sheet with consistent decline in net debt to equity ratio despite addition of production capacity. We expect the working capital to peak in FY21 and improve from FY22. The net debt to equity stood at (0.07)x in FY20 and is expected to decline to (0.18)x in FY22 and (0.26)x in FY23. The cash conversion cycle (days) has increased from 25 days in FY12 to 111 days in FY20. We expect it to peak at 145 days in FY21 given the sharp impact of Covid-19 before improving to 120 days in FY22 and 85days in FY23. We recommend Accumulate with target price of Rs501: We have valued KCL at 30x PER on Sept FY23E EPS, which is at the lower end of the 5 year PER band, and arrived at a target price of Rs501. Our recommendation is supported by expected strong recovery in demand and pricing in FY22 followed by continued growth expectations in FY23, robust balance sheet, strong free cash flows, strong brand and attractive valuation. The stock has already declined by 26.7% from Rs606 to Rs444 due to rising concerns about the adverse impact of Covid. In our view, the stock is trading below the 5 year PER band and does not factor in the post Covid recovery. ACCUMULATE Sector: Building Materials CMP: Rs444 Target Price: Rs501 Upside: 13% Amit Agarwal Research Analyst [email protected] +91-22-6273 8033 Key Data Current Shares O/S (mn) 159.0 Mkt Cap (Rsbn/US$mn) 71.2/969.2 52 Wk H / L (Rs) 606/295 Daily Vol. (3M NSE Avg.) 467,699 Share holding (%) 3QFY20 4QFY20 1QFY21 Promoter 47.6 47.6 47.6 Public 52.4 15.1 16.4 Others - - - One Year Indexed Stock Performance 50 60 70 80 90 100 110 120 130 140 Sep-19 Nov-19 Jan-20 Mar-20 May-20 Jul-20 Sep-20 KAJARIA CERAMICS Nifty 50 Price Performance (%) 1 M 6 M 1 Yr Kajaria Ceramics 8.8 (18.5) (3.4) Nifty Index 6.0 2.2 7.0 Source: Bloomberg Y/E March (Rsmn) FY19 FY20 FY21E FY22E FY23E Net sales 29,562 28,080 21,971 26,073 31,117 EBITDA 4,495 4,159 2,903 4,009 5,018 EBIT 3,604 3,078 1,867 2,917 3,842 Adj. net profit 2,266 2,312 1,417 2,268 3,042 Adj. EPS (Rs) 14.26 14.54 8.92 14.27 19.14 EPS growth (%) 0% 2% -39% 60% 34% EBITDA margin (%) 15.2% 14.8% 13.2% 15.4% 16.1% EBIT margin (%) 12.2% 11.0% 8.5% 11.2% 12.3% PER (x) 31.14 30.53 49.79 31.12 23.20 RoE (%) 14.4% 14.9% 7.8% 11.4% 13.9% Source: Company, Nirmal Bang Institutional Equities Research 03 September 2020
Kajaria Ceramics
Apr 07, 2023
Welcome message from author
This document is posted to help you gain knowledge. Please leave a comment to let me know what you think about it! Share it to your friends and learn new things together.
Transcript
In s t itu tio n a l E q u it ie s
In iti
at in
g C
ov er
ag e
Kajaria Ceramics
Kajaria Ceramics: Floored We initiate coverage on Kajaria Ceramics (KCL) with an Accumulate, driven by attractive valuation, expected strong earnings growth from FY22 post recovery from Covid impact, comfortable balance sheet and strong cash flow. This is supported by high product quality, wide product range, robust distribution network, strong brand recall and high market share.
The steep decline in KCL stock price by 26.7% from its 52 week high primarily highlights the concerns of slowdown in earnings growth due to the Covid pandemic. The continued weakness in the stock price implies that the market is not factoring in a recovery post Covid. In our view, the negative impact is overdone. We expect a sharp recovery towards normalcy from FY22. The stock is currently trading at PER of 26.2x on Sept FY23 EPS, which is below the five year trading range of 30-50x 1-year forward earnings. We initiate coverage on the stock with a target price of Rs501 based on 30x PER on Sept FY23E EPS.
Revenue growth at CAGR of 19% (FY21-23E) after COVID–19 shock is absorbed in FY21:
We expect revenue to decline by 22% in FY21 due to the impact from Covid. The decline in revenue comprises 14% decline in sales volume and 10% decline in realization. Post recovery from pandemic, we expect the sales volumes to grow at a 2 year CAGR (FY21-FY23) of 13%. The realizations are expected to grow at a 2 year CAGR (FY21-FY23) of 5%. The revenues are expected to grow at a 2 year CAGR (FY21- FY23) of 19%. Thus, the revenue growth is expected to be driven by sales volumes going forward.
Revenue growth and cost optimization to drive earnings growth at 2 year CAGR of 46%: Earnings are expected to decline by 45% due to expected sharp loss in prices and decline in sales volume in FY21. We expect recovery from FY22 with revenue at a 2 year CAGR (FY21-23) of 19% on the back of revival in demand and improvement in prices. Further, we expect EBITDA to increase at 2 year CAGR (FY21-23) of 32%, supported by lower power and fuel costs. The earnings are expected to grow at a CAGR (FY21-23) of 46%. The earnings revival from FY22 will be driven by 1) Strong EBITDA growth; 2) Interest cost remaining flat on YoY basis 3) Depreciation increase at a relatively lower 2 year CAGR (FY21-23) of 6.5%.
Strong operating cash flows has added to our comfort: Despite large capex, we note that the company has consistently shows strong free cash flows. We expect the operating cash flows to increase from Rs2bn in FY21 to Rs4.7bn in FY23. The growth in cash flows is driven by strong growth in earnings and improvement in working capital.
Wide spread with distribution network: KCL has a strong network of dealers (9MFY20 – 1,500 dealers, FY14 – 900 dealers) pan India, which help it to have a deep penetration across India. Over the years, KCL has invested in various joint ventures and set up manufacturing units at different locations, which has helped it to strengthen its distribution channel.
RoE and RoCE to increase sharply during FY21-23: The expected decline in pricing power and sales volume in FY21 are expected to drive net profit margin and asset turnover ratio lower, leading to lower RoE. We expect the RoE to bottom out in FY21 (7.8%) and increase to 13.9% in FY23. RoCE is expected to grow from pandemic inflicted RoCE in FY21 of 9.7% to 16.6% in FY23.
Strong balance sheet; working capital to peak in FY21 and decline from FY22: KCL has a strong balance sheet with consistent decline in net debt to equity ratio despite addition of production capacity. We expect the working capital to peak in FY21 and improve from FY22. The net debt to equity stood at (0.07)x in FY20 and is expected to decline to (0.18)x in FY22 and (0.26)x in FY23. The cash conversion cycle (days) has increased from 25 days in FY12 to 111 days in FY20. We expect it to peak at 145 days in FY21 given the sharp impact of Covid-19 before improving to 120 days in FY22 and 85days in FY23.
We recommend Accumulate with target price of Rs501: We have valued KCL at 30x PER on Sept FY23E EPS, which is at the lower end of the 5 year PER band, and arrived at a target price of Rs501. Our recommendation is supported by expected strong recovery in demand and pricing in FY22 followed by continued growth expectations in FY23, robust balance sheet, strong free cash flows, strong brand and attractive valuation. The stock has already declined by 26.7% from Rs606 to Rs444 due to rising concerns about the adverse impact of Covid. In our view, the stock is trading below the 5 year PER band and does not factor in the post Covid recovery.
ACCUMULATE
Key Data
Mkt Cap (Rsbn/US$mn) 71.2/969.2
Share holding (%) 3QFY20 4QFY20 1QFY21
Promoter 47.6 47.6 47.6
Public 52.4 15.1 16.4
50
60
70
80
90
100
110
120
130
140
KAJARIA CERAMICS Nifty 50
Kajaria Ceramics 8.8 (18.5) (3.4)
Nifty Index 6.0 2.2 7.0
Source: Bloomberg
Y/E March (Rsmn) FY19 FY20 FY21E FY22E FY23E
Net sales 29,562 28,080 21,971 26,073 31,117 EBITDA 4,495 4,159 2,903 4,009 5,018 EBIT 3,604 3,078 1,867 2,917 3,842 Adj. net profit 2,266 2,312 1,417 2,268 3,042 Adj. EPS (Rs) 14.26 14.54 8.92 14.27 19.14 EPS growth (%) 0% 2% -39% 60% 34% EBITDA margin (%) 15.2% 14.8% 13.2% 15.4% 16.1% EBIT margin (%) 12.2% 11.0% 8.5% 11.2% 12.3% PER (x) 31.14 30.53 49.79 31.12 23.20 RoE (%) 14.4% 14.9% 7.8% 11.4% 13.9%
Source: Company, Nirmal Bang Institutional Equities Research
03 September 2020
In s t itu tio n a l E q u it ie s
Kajaria Ceramics 2
Key investment argument
We initiate coverage on KCL with a Accumulate rating and a target price of Rs501 based on 30x PER on FY22 earnings. Strong balance sheet, strong and consistent free cash flows, well known brand, strong distribution network and an anticipated recovery from FY22 are expected to drive the stock price. In our view, the current stock price does not factor in a revival from the impact of Covid. Valuation has declined from 58.9x 1 year forward P/E (Jan 2020) to 37.7x 1 year forward P/E in September 2020 due to concerns on the declining growth and the impact from Covid, which in our views are overdone.
We have assumed recovery from FY22 and expect the growth to follow in FY23. Despite conservative assumptions and valuing the stock at the lower end of the 5 year PER band, we have arrived at a target price of Rs501, implying an upside of 13%. While we expect weakness in the residential real estate to continue, we expect revival in FY22 to pre-covid levels.
The charts (Exhibit 1 & 2) below show that the stock is trading 26.7% below the peak price of Rs606, having declined and underperformed the Nifty in the past 1 year. In our view, the underperformance reflects the rising concerns about the changing environment for the sector due to the negative impact from Covid. However, the concerns are overdone. We expect the stock price to appreciate based on the anticipated earnings recovery post Covid from FY22, strong balance sheet, strong and consistent free cash flows, strong brand and attractive valuation. With the gradual re-opening of the economy by the Government, we expect the demand to improve sharply from FY22. Exhibit 1: Price performance compared to NIFTY 50 (Rebased to 100)
Exhibit 2: Price performance of KCL and NIFTY 50
40.0
50.0
60.0
70.0
80.0
90.0
100.0
110.0
120.0
130.0
Source: Company Reports, Nirmal Bang Institutional Equities Research
Source: Company Reports, Nirmal Bang Institutional Equities Research
Improved pricing and sales volume from FY22 to drive earnings to grow at CAGR of 46% (FY21-23)
We expect the earnings growth (FY21-23) to be driven by 1) Strong growth in sales volume (FY21-23 CAGR of 13%) post demand revival after the impact of pandemic 2) Growth in realization (FY21-23 CAGR of 5% 3) Reduction in cost of power due to lower gas prices. 4) Lower staff expenses due to rationalization of salaries as per management. 5) Lower other expenses. 5) Finally relatively lower growth in depreciation and interest expenses.
Historically, the earnings have grown at a 10 year CAGR (FY10-FY20), 5 year CAGR (FY15-FY20) and 3 year CAGR (FY17-FY20) of 22%, 8% and 0.3%, respectively. The growth rate in earnings has been tapering off because of the loss in pricing power and decline in sales volume, leading to decline in revenue and rise in power & fuel costs. However, post the slowdown due to Covid, we expect earnings to grow sharply with improvement in demand.
Historically, the revenue has grown at a 10 year CAGR (FY10-FY20), 5 year CAGR (FY15-FY20) and 3 year CAGR (FY17-FY20) of 14%, 5% and 3%, respectively. The sales volume has grown at a 10 year CAGR (FY10-FY20), 5 year CAGR (FY15-FY20) and 3 year CAGR (FY17-FY20) of 12%, 6% and 5%, respectively. The realization has grown at a 10 year CAGR (FY10-FY20), 5 year CAGR (FY15-FY20) and 3 year CAGR (FY17-FY20) of 1%, (4)% and (3)%, respectively. Thus, the growth rate in KCL’s revenue has been majorly supported by an increase in the volume of tiles sold.
In s t itu tio n a l E q u it ie s
Kajaria Ceramics 3
In FY23, the expected growth in sales volumes supported by steady growth in realizations are expected to drive revenue growth of 19% YoY. With the EBITDA expected to grow 25% YoY in FY23 and flat interest costs, the earnings are expected to grow 34% YoY in FY23. From its bottom in FY21, earnings are expected to grow at 2 year CAGR (FY21-FY23) of 46%. . Strong Balance sheet with net cash cash conversion cycle to start improving from FY22
The net debt to equity stood at (0.07)x in FY20 and is expected to decline to (0.18)x in FY22 and (0.26)x in FY23.
We note that the sustained increase in receivables and inventory days indicate pressure on the sales momentum. The cash conversion cycle (days) had declined from 89 day in FY09 to 45 days in FY14. However, with slowdown in the residential real estate and consequent pressure on sales, the cash conversion cycle again increased to 111 days in FY20. The CCC is expected to worsen in FY21 because of increase in receivable and inventory days. The CCC is expected at 145 days in FY21. It is expected to improve to 120 days and 85 days in FY22 and FY23 respectively because of improvement in receivable and inventory days.
Strong and consistent free cash flows gives us added comfort
The company has consistently shown strong operating cash flows. Despite large capex, we note that the company has consistently shows strong free cash flows. We expect the operating cash flows to increase from Rs2bn in FY21 to Rs4.7bn in FY23. The growth in cash flows is driven by strong growth in earnings and improvement in working capital
Return ratios to bottom out in FY21: strong growth from FY22; RoE of 13.9% in FY23 RoCE of 16.6%
The company’s RoE steadily declined from 29% in FY13 to 24% in FY16. Historically, KCL’s RoE has been driven by expansion in net profit margin, supported by rising asset turns. During FY09-FY13, the RoE growth was supported by increasing net profit margin and rising asset turnover but declining financial leverage. However, with the decline in asset turnover from FY14, the RoE remained flat during FY14-FY16 despite rising net profit margin. With the decline in net profit margin since FY17 due to pricing pressure, the decline in RoE got accentuated. The expected decline in pricing power and sales volume in FY21 is expected to drive net profit margin and asset turnover lower, leading to lower RoE. We expect the RoE to bottom out in FY21 and start a new growth trajectory from FY22, driven by rising net profit margin and improving asset turns. In FY23, the improving asset turnover and steady net profit margin is expected to support the RoE expansion to 13.9%.
We initiate coverage with a Accumulate and target price of Rs501
We have valued KCL at 30x PER on Sept FY23E EPS (at the lower end of the 5 year PER band) and arrived at a target price of Rs501. While the impact from Covid on residential sales will affect the sales of KCL in FY21, the slow but steady re-opening of the economy by the Government is expected to improve demand (including pent up demand), leading to sharp growth in sales volume FY22 onwards. We have valued the stock at 30x PER on Sept FY23E EPS (lower end of the 5 year band) and recommend ACCUMULATE with a target price of Rs501.
In s t itu tio n a l E q u it ie s
Kajaria Ceramics 4
From aspiration to necessity: Tile consumption remains a secular growth story
India’s tile industry has grown from Rs95bn in FY09 to Rs300bn in FY19, registering a CAGR of 12.2%. In the same period, volume has grown at a CAGR of 6.4% to touch 750msm. This indicates that as the market continued to absorb higher volume, it also migrated to better quality or more expensive tiles. We expect the trend to continue as per capita consumption of tiles in India is still abysmally low compared to various developing and developed countries.
In FY09, India’s per capita ceramic tile consumption stood at 0.35sqm. vs. China’s 1.88sqm. In FY19, while India’s per capita tile consumption increased to 0.55sqm, China’s consumption rose to 3.95sqm, indicating faster growth in China. The primary reason for faster growth in China was higher per capita disposable income, urbanisation and rising housing demand. We believe that India is at the cusp of such a growth trend as rising disposable income and urbanisation should change the consumer’s perception about tiles from being an aspirational product to one of necessity.
Rising urbanisation
64% of India’s population still resides in villages with a population of 5,000 or lower. Data from the 2011 Census and the Indian Institute for Human Settlement (chart below) suggests that in 1961 around 70mn people or 15% of the total population lived in Indian cities and towns, which rose to nearly 420mn (or 34%) in 2011. It is expected that 500mn people or 38% of the total population will live in cities and towns in 2021, which are major markets for tile manufacturers.
Exhibit 3: India’s urban population as a percentage of total population
0
5
10
15
20
25
30
35
40
1 2
4 6
7 8
10 11
2 2
Indian Urban Population as a % of Total
Class IV, V and VI towns (Population between 5k and 20k)
Class III towns (Population > 20k)
Class II towns (Population > 50k)
Other Class-I cities (Population > 1 lakh)
Million-plus cities (Population > 10 lakh)
Source: Census 2011 & Indian Institute for Human Settlement
Cyclical base for real estate getting prolonged due to Covid
In our view, demonetisation, Real Estate (Regulatory and Development) Act or RERA, GST, Bankruptcy Code and IndAS accounting have collectively changed the way the real estate industry operates in India. These disruptions have increased regulatory and customer scrutiny of developers, which in turn has hit their operating performance. While the real estate sector was bouncing back from its cyclical bottom, another headwind in the form of slowdown in launches and sales is expected because of Covid. We expect the slowdown in the industry to continue for few more years due to near term impact of weak economy and job losses amid the Covid outbreak.
The factors supporting the improvement in the tiles industry are:
Approval for the Real Estate Investment Trusts or REITs is already showing progress in attracting fresh investment in the sector. Developers have also started seizing this opportunity by selling large projects to PE funds and utilising the proceeds for reducing debt and strengthening the balance sheet.
In s t itu tio n a l E q u it ie s
Kajaria Ceramics 5
Rising FDI into the sector is also introducing a higher level of accounting and operational transparency. Hiring of professional management teams, centralised procurement processes, organised manpower and effective management systems are a few examples of the ongoing positive changes in the sector. These changes are essential to meet high due diligence standards maintained by foreign investors.
Terrible past experience has increased customers’ preference for completed/ready-to-move-in projects rather than under-construction properties. This is also supported by GST-related tax savings in the case of completed properties.
Interest rate subsidy under the Pradhan Mantri Awas Yojna has given the much-needed boost to demand, especially in the affordable housing segment.
Price correction in the past few years has increased affordability. We believe that realty prices will continue to erode as unsold inventory in the system remains high.
The factors which could lead to continued weakness in the tiles markets are:
Liquidity crunch post demonetisation created intense working capital problem for developers. This ultimately translated into slower project execution. The damage has been done and liquidity conditions are now easing.
Negative impact on the economy from Covid could lead to potential job losses as the economy opens. We expect this to affect the sales of residential units in the country, which implies lower demand for tiles.
Rising importance of flooring
Indian consumers in metro cities now no longer view tiles as a product for high-income individuals/families. Aspiration for better-looking homes, need for durable flooring and rising affordability (because of better household income) drive demand for tiles. We expect this trend to spread to smaller cities and towns where most of the houses still have mud/cement flooring. According to the Census 2011, nearly 47% of Indians live in houses with mud flooring, 37% with cement flooring and only 11% with mosaic and tile flooring. In cities, 26% houses had tile flooring while 46% houses had cement flooring in 2011. As urbanisation gains momentum, the demand for tile flooring should also rise.
Advantages over alternate flooring materials
Tiles have multiple advantages over other flooring options like marble/stone, cement, wood, PVC etc. Low water absorption, higher durability, termite-resistance and wide range of sizes and designs place tiles on top of the list among other options. While marbles and stones are worthy competitors, their high daily maintenance (increased cost of ownership), fragility and difficult application make them less appealing as compared to tiles.
GST + e-way bill: Strong push towards an organised market
Implementation of GST was expected to shift the odds in favour of organised players by eliminating the pricing advantage (because of tax evasion) enjoyed by the unorganised players. However, poor ground-level implementation, lax compliance regulation and increased tax differential led to the opposite effect with the unorganised players increasing their value and volume share from 49% and 67%, respectively in FY14 to 50% and 69%, respectively in FY18.
However, the government has started tackling the problems and reduced the GST on tiles from the initial 28% to 18% in November 2017. This has lowered the tax arbitrage enjoyed by the unorganised players. Implementation of e-way bill from April 2018 was expected to reduce tax evasion significantly, but it has failed to deliver the results. The unorganised players have resorted to under-invoicing to escape the tax net. All in all, business for a tax-evading unit has become difficult and this should…
In iti
at in
g C
ov er
ag e
Kajaria Ceramics
Kajaria Ceramics: Floored We initiate coverage on Kajaria Ceramics (KCL) with an Accumulate, driven by attractive valuation, expected strong earnings growth from FY22 post recovery from Covid impact, comfortable balance sheet and strong cash flow. This is supported by high product quality, wide product range, robust distribution network, strong brand recall and high market share.
The steep decline in KCL stock price by 26.7% from its 52 week high primarily highlights the concerns of slowdown in earnings growth due to the Covid pandemic. The continued weakness in the stock price implies that the market is not factoring in a recovery post Covid. In our view, the negative impact is overdone. We expect a sharp recovery towards normalcy from FY22. The stock is currently trading at PER of 26.2x on Sept FY23 EPS, which is below the five year trading range of 30-50x 1-year forward earnings. We initiate coverage on the stock with a target price of Rs501 based on 30x PER on Sept FY23E EPS.
Revenue growth at CAGR of 19% (FY21-23E) after COVID–19 shock is absorbed in FY21:
We expect revenue to decline by 22% in FY21 due to the impact from Covid. The decline in revenue comprises 14% decline in sales volume and 10% decline in realization. Post recovery from pandemic, we expect the sales volumes to grow at a 2 year CAGR (FY21-FY23) of 13%. The realizations are expected to grow at a 2 year CAGR (FY21-FY23) of 5%. The revenues are expected to grow at a 2 year CAGR (FY21- FY23) of 19%. Thus, the revenue growth is expected to be driven by sales volumes going forward.
Revenue growth and cost optimization to drive earnings growth at 2 year CAGR of 46%: Earnings are expected to decline by 45% due to expected sharp loss in prices and decline in sales volume in FY21. We expect recovery from FY22 with revenue at a 2 year CAGR (FY21-23) of 19% on the back of revival in demand and improvement in prices. Further, we expect EBITDA to increase at 2 year CAGR (FY21-23) of 32%, supported by lower power and fuel costs. The earnings are expected to grow at a CAGR (FY21-23) of 46%. The earnings revival from FY22 will be driven by 1) Strong EBITDA growth; 2) Interest cost remaining flat on YoY basis 3) Depreciation increase at a relatively lower 2 year CAGR (FY21-23) of 6.5%.
Strong operating cash flows has added to our comfort: Despite large capex, we note that the company has consistently shows strong free cash flows. We expect the operating cash flows to increase from Rs2bn in FY21 to Rs4.7bn in FY23. The growth in cash flows is driven by strong growth in earnings and improvement in working capital.
Wide spread with distribution network: KCL has a strong network of dealers (9MFY20 – 1,500 dealers, FY14 – 900 dealers) pan India, which help it to have a deep penetration across India. Over the years, KCL has invested in various joint ventures and set up manufacturing units at different locations, which has helped it to strengthen its distribution channel.
RoE and RoCE to increase sharply during FY21-23: The expected decline in pricing power and sales volume in FY21 are expected to drive net profit margin and asset turnover ratio lower, leading to lower RoE. We expect the RoE to bottom out in FY21 (7.8%) and increase to 13.9% in FY23. RoCE is expected to grow from pandemic inflicted RoCE in FY21 of 9.7% to 16.6% in FY23.
Strong balance sheet; working capital to peak in FY21 and decline from FY22: KCL has a strong balance sheet with consistent decline in net debt to equity ratio despite addition of production capacity. We expect the working capital to peak in FY21 and improve from FY22. The net debt to equity stood at (0.07)x in FY20 and is expected to decline to (0.18)x in FY22 and (0.26)x in FY23. The cash conversion cycle (days) has increased from 25 days in FY12 to 111 days in FY20. We expect it to peak at 145 days in FY21 given the sharp impact of Covid-19 before improving to 120 days in FY22 and 85days in FY23.
We recommend Accumulate with target price of Rs501: We have valued KCL at 30x PER on Sept FY23E EPS, which is at the lower end of the 5 year PER band, and arrived at a target price of Rs501. Our recommendation is supported by expected strong recovery in demand and pricing in FY22 followed by continued growth expectations in FY23, robust balance sheet, strong free cash flows, strong brand and attractive valuation. The stock has already declined by 26.7% from Rs606 to Rs444 due to rising concerns about the adverse impact of Covid. In our view, the stock is trading below the 5 year PER band and does not factor in the post Covid recovery.
ACCUMULATE
Key Data
Mkt Cap (Rsbn/US$mn) 71.2/969.2
Share holding (%) 3QFY20 4QFY20 1QFY21
Promoter 47.6 47.6 47.6
Public 52.4 15.1 16.4
50
60
70
80
90
100
110
120
130
140
KAJARIA CERAMICS Nifty 50
Kajaria Ceramics 8.8 (18.5) (3.4)
Nifty Index 6.0 2.2 7.0
Source: Bloomberg
Y/E March (Rsmn) FY19 FY20 FY21E FY22E FY23E
Net sales 29,562 28,080 21,971 26,073 31,117 EBITDA 4,495 4,159 2,903 4,009 5,018 EBIT 3,604 3,078 1,867 2,917 3,842 Adj. net profit 2,266 2,312 1,417 2,268 3,042 Adj. EPS (Rs) 14.26 14.54 8.92 14.27 19.14 EPS growth (%) 0% 2% -39% 60% 34% EBITDA margin (%) 15.2% 14.8% 13.2% 15.4% 16.1% EBIT margin (%) 12.2% 11.0% 8.5% 11.2% 12.3% PER (x) 31.14 30.53 49.79 31.12 23.20 RoE (%) 14.4% 14.9% 7.8% 11.4% 13.9%
Source: Company, Nirmal Bang Institutional Equities Research
03 September 2020
In s t itu tio n a l E q u it ie s
Kajaria Ceramics 2
Key investment argument
We initiate coverage on KCL with a Accumulate rating and a target price of Rs501 based on 30x PER on FY22 earnings. Strong balance sheet, strong and consistent free cash flows, well known brand, strong distribution network and an anticipated recovery from FY22 are expected to drive the stock price. In our view, the current stock price does not factor in a revival from the impact of Covid. Valuation has declined from 58.9x 1 year forward P/E (Jan 2020) to 37.7x 1 year forward P/E in September 2020 due to concerns on the declining growth and the impact from Covid, which in our views are overdone.
We have assumed recovery from FY22 and expect the growth to follow in FY23. Despite conservative assumptions and valuing the stock at the lower end of the 5 year PER band, we have arrived at a target price of Rs501, implying an upside of 13%. While we expect weakness in the residential real estate to continue, we expect revival in FY22 to pre-covid levels.
The charts (Exhibit 1 & 2) below show that the stock is trading 26.7% below the peak price of Rs606, having declined and underperformed the Nifty in the past 1 year. In our view, the underperformance reflects the rising concerns about the changing environment for the sector due to the negative impact from Covid. However, the concerns are overdone. We expect the stock price to appreciate based on the anticipated earnings recovery post Covid from FY22, strong balance sheet, strong and consistent free cash flows, strong brand and attractive valuation. With the gradual re-opening of the economy by the Government, we expect the demand to improve sharply from FY22. Exhibit 1: Price performance compared to NIFTY 50 (Rebased to 100)
Exhibit 2: Price performance of KCL and NIFTY 50
40.0
50.0
60.0
70.0
80.0
90.0
100.0
110.0
120.0
130.0
Source: Company Reports, Nirmal Bang Institutional Equities Research
Source: Company Reports, Nirmal Bang Institutional Equities Research
Improved pricing and sales volume from FY22 to drive earnings to grow at CAGR of 46% (FY21-23)
We expect the earnings growth (FY21-23) to be driven by 1) Strong growth in sales volume (FY21-23 CAGR of 13%) post demand revival after the impact of pandemic 2) Growth in realization (FY21-23 CAGR of 5% 3) Reduction in cost of power due to lower gas prices. 4) Lower staff expenses due to rationalization of salaries as per management. 5) Lower other expenses. 5) Finally relatively lower growth in depreciation and interest expenses.
Historically, the earnings have grown at a 10 year CAGR (FY10-FY20), 5 year CAGR (FY15-FY20) and 3 year CAGR (FY17-FY20) of 22%, 8% and 0.3%, respectively. The growth rate in earnings has been tapering off because of the loss in pricing power and decline in sales volume, leading to decline in revenue and rise in power & fuel costs. However, post the slowdown due to Covid, we expect earnings to grow sharply with improvement in demand.
Historically, the revenue has grown at a 10 year CAGR (FY10-FY20), 5 year CAGR (FY15-FY20) and 3 year CAGR (FY17-FY20) of 14%, 5% and 3%, respectively. The sales volume has grown at a 10 year CAGR (FY10-FY20), 5 year CAGR (FY15-FY20) and 3 year CAGR (FY17-FY20) of 12%, 6% and 5%, respectively. The realization has grown at a 10 year CAGR (FY10-FY20), 5 year CAGR (FY15-FY20) and 3 year CAGR (FY17-FY20) of 1%, (4)% and (3)%, respectively. Thus, the growth rate in KCL’s revenue has been majorly supported by an increase in the volume of tiles sold.
In s t itu tio n a l E q u it ie s
Kajaria Ceramics 3
In FY23, the expected growth in sales volumes supported by steady growth in realizations are expected to drive revenue growth of 19% YoY. With the EBITDA expected to grow 25% YoY in FY23 and flat interest costs, the earnings are expected to grow 34% YoY in FY23. From its bottom in FY21, earnings are expected to grow at 2 year CAGR (FY21-FY23) of 46%. . Strong Balance sheet with net cash cash conversion cycle to start improving from FY22
The net debt to equity stood at (0.07)x in FY20 and is expected to decline to (0.18)x in FY22 and (0.26)x in FY23.
We note that the sustained increase in receivables and inventory days indicate pressure on the sales momentum. The cash conversion cycle (days) had declined from 89 day in FY09 to 45 days in FY14. However, with slowdown in the residential real estate and consequent pressure on sales, the cash conversion cycle again increased to 111 days in FY20. The CCC is expected to worsen in FY21 because of increase in receivable and inventory days. The CCC is expected at 145 days in FY21. It is expected to improve to 120 days and 85 days in FY22 and FY23 respectively because of improvement in receivable and inventory days.
Strong and consistent free cash flows gives us added comfort
The company has consistently shown strong operating cash flows. Despite large capex, we note that the company has consistently shows strong free cash flows. We expect the operating cash flows to increase from Rs2bn in FY21 to Rs4.7bn in FY23. The growth in cash flows is driven by strong growth in earnings and improvement in working capital
Return ratios to bottom out in FY21: strong growth from FY22; RoE of 13.9% in FY23 RoCE of 16.6%
The company’s RoE steadily declined from 29% in FY13 to 24% in FY16. Historically, KCL’s RoE has been driven by expansion in net profit margin, supported by rising asset turns. During FY09-FY13, the RoE growth was supported by increasing net profit margin and rising asset turnover but declining financial leverage. However, with the decline in asset turnover from FY14, the RoE remained flat during FY14-FY16 despite rising net profit margin. With the decline in net profit margin since FY17 due to pricing pressure, the decline in RoE got accentuated. The expected decline in pricing power and sales volume in FY21 is expected to drive net profit margin and asset turnover lower, leading to lower RoE. We expect the RoE to bottom out in FY21 and start a new growth trajectory from FY22, driven by rising net profit margin and improving asset turns. In FY23, the improving asset turnover and steady net profit margin is expected to support the RoE expansion to 13.9%.
We initiate coverage with a Accumulate and target price of Rs501
We have valued KCL at 30x PER on Sept FY23E EPS (at the lower end of the 5 year PER band) and arrived at a target price of Rs501. While the impact from Covid on residential sales will affect the sales of KCL in FY21, the slow but steady re-opening of the economy by the Government is expected to improve demand (including pent up demand), leading to sharp growth in sales volume FY22 onwards. We have valued the stock at 30x PER on Sept FY23E EPS (lower end of the 5 year band) and recommend ACCUMULATE with a target price of Rs501.
In s t itu tio n a l E q u it ie s
Kajaria Ceramics 4
From aspiration to necessity: Tile consumption remains a secular growth story
India’s tile industry has grown from Rs95bn in FY09 to Rs300bn in FY19, registering a CAGR of 12.2%. In the same period, volume has grown at a CAGR of 6.4% to touch 750msm. This indicates that as the market continued to absorb higher volume, it also migrated to better quality or more expensive tiles. We expect the trend to continue as per capita consumption of tiles in India is still abysmally low compared to various developing and developed countries.
In FY09, India’s per capita ceramic tile consumption stood at 0.35sqm. vs. China’s 1.88sqm. In FY19, while India’s per capita tile consumption increased to 0.55sqm, China’s consumption rose to 3.95sqm, indicating faster growth in China. The primary reason for faster growth in China was higher per capita disposable income, urbanisation and rising housing demand. We believe that India is at the cusp of such a growth trend as rising disposable income and urbanisation should change the consumer’s perception about tiles from being an aspirational product to one of necessity.
Rising urbanisation
64% of India’s population still resides in villages with a population of 5,000 or lower. Data from the 2011 Census and the Indian Institute for Human Settlement (chart below) suggests that in 1961 around 70mn people or 15% of the total population lived in Indian cities and towns, which rose to nearly 420mn (or 34%) in 2011. It is expected that 500mn people or 38% of the total population will live in cities and towns in 2021, which are major markets for tile manufacturers.
Exhibit 3: India’s urban population as a percentage of total population
0
5
10
15
20
25
30
35
40
1 2
4 6
7 8
10 11
2 2
Indian Urban Population as a % of Total
Class IV, V and VI towns (Population between 5k and 20k)
Class III towns (Population > 20k)
Class II towns (Population > 50k)
Other Class-I cities (Population > 1 lakh)
Million-plus cities (Population > 10 lakh)
Source: Census 2011 & Indian Institute for Human Settlement
Cyclical base for real estate getting prolonged due to Covid
In our view, demonetisation, Real Estate (Regulatory and Development) Act or RERA, GST, Bankruptcy Code and IndAS accounting have collectively changed the way the real estate industry operates in India. These disruptions have increased regulatory and customer scrutiny of developers, which in turn has hit their operating performance. While the real estate sector was bouncing back from its cyclical bottom, another headwind in the form of slowdown in launches and sales is expected because of Covid. We expect the slowdown in the industry to continue for few more years due to near term impact of weak economy and job losses amid the Covid outbreak.
The factors supporting the improvement in the tiles industry are:
Approval for the Real Estate Investment Trusts or REITs is already showing progress in attracting fresh investment in the sector. Developers have also started seizing this opportunity by selling large projects to PE funds and utilising the proceeds for reducing debt and strengthening the balance sheet.
In s t itu tio n a l E q u it ie s
Kajaria Ceramics 5
Rising FDI into the sector is also introducing a higher level of accounting and operational transparency. Hiring of professional management teams, centralised procurement processes, organised manpower and effective management systems are a few examples of the ongoing positive changes in the sector. These changes are essential to meet high due diligence standards maintained by foreign investors.
Terrible past experience has increased customers’ preference for completed/ready-to-move-in projects rather than under-construction properties. This is also supported by GST-related tax savings in the case of completed properties.
Interest rate subsidy under the Pradhan Mantri Awas Yojna has given the much-needed boost to demand, especially in the affordable housing segment.
Price correction in the past few years has increased affordability. We believe that realty prices will continue to erode as unsold inventory in the system remains high.
The factors which could lead to continued weakness in the tiles markets are:
Liquidity crunch post demonetisation created intense working capital problem for developers. This ultimately translated into slower project execution. The damage has been done and liquidity conditions are now easing.
Negative impact on the economy from Covid could lead to potential job losses as the economy opens. We expect this to affect the sales of residential units in the country, which implies lower demand for tiles.
Rising importance of flooring
Indian consumers in metro cities now no longer view tiles as a product for high-income individuals/families. Aspiration for better-looking homes, need for durable flooring and rising affordability (because of better household income) drive demand for tiles. We expect this trend to spread to smaller cities and towns where most of the houses still have mud/cement flooring. According to the Census 2011, nearly 47% of Indians live in houses with mud flooring, 37% with cement flooring and only 11% with mosaic and tile flooring. In cities, 26% houses had tile flooring while 46% houses had cement flooring in 2011. As urbanisation gains momentum, the demand for tile flooring should also rise.
Advantages over alternate flooring materials
Tiles have multiple advantages over other flooring options like marble/stone, cement, wood, PVC etc. Low water absorption, higher durability, termite-resistance and wide range of sizes and designs place tiles on top of the list among other options. While marbles and stones are worthy competitors, their high daily maintenance (increased cost of ownership), fragility and difficult application make them less appealing as compared to tiles.
GST + e-way bill: Strong push towards an organised market
Implementation of GST was expected to shift the odds in favour of organised players by eliminating the pricing advantage (because of tax evasion) enjoyed by the unorganised players. However, poor ground-level implementation, lax compliance regulation and increased tax differential led to the opposite effect with the unorganised players increasing their value and volume share from 49% and 67%, respectively in FY14 to 50% and 69%, respectively in FY18.
However, the government has started tackling the problems and reduced the GST on tiles from the initial 28% to 18% in November 2017. This has lowered the tax arbitrage enjoyed by the unorganised players. Implementation of e-way bill from April 2018 was expected to reduce tax evasion significantly, but it has failed to deliver the results. The unorganised players have resorted to under-invoicing to escape the tax net. All in all, business for a tax-evading unit has become difficult and this should…
Related Documents
