Kajaria Ceramics

Investors with an appetite for risk can consider buying the stock of Kajaria Ceramics, a leading tile manufacturer, trading at 14 times the trailing 12-month earnings.

An annualised growth of 22 per cent over the last five years against the industry's 15 per cent, extensive distribution network, focus on the retail segment, cost-savings following the switch to low-cost fuel and commissioning of domestic production of vitrified tiles that will improve margins, make a case for investing in the stock.

The risk in investment arises from the fact that the interest cover of the company stands at just 2.3 times. Though sales may grow at a fast pace with rising demand in the consumer market and revival in the realty segment, savings on interest front may not be possible.

There has been a repayment of Rs 70 crore of debt (of the total Rs 325 crore) during last year; however, this may be offset by additional borrowings to meet the working-capital requirements.

In FY-10, Kajaria Ceramics' net profit rose four-fold to Rs 35.85 crore, following lower interest costs, foreign exchange gains on import deals (Rs 4.39 crore) and higher sales (up 11 per cent). Nitco Tiles, the closest comparable to Kajaria Ceramics among the listed tile manufacturers, has not declared March 2010 quarter numbers, but reported losses in the June and December quarters.

The tiles business

Kajaria Ceramics has been in the business of tile manufacturing since 1988. From just one million square metre (msm) of tiles per annum, the company's capacity has increased to 23.4 million square metres now.

With a pan-India presence, the company also exports its products to 20 nations across the Europe, UAE and Australia. There only a few listed players in the tile industry; organised players have a 40 per cent share of the market.

The growing demand from the housing segment, new construction in the commercial space, the increasing disposable income of the people, favour the industry's growth. The government's imposition of anti-dumping duty last year on ceramic tiles from China has also given relief to domestic manufacturers. Tiles from China had at one stage threatened domestic manufacturer's prospects with their price advantage.

The key input material for the industry is clay (indigenous as well as imported) in addition to the soluble salts, abrasives, binding materials, etc.

Fuel costs work out to almost 30-35 per cent of the manufacturing expense. Margins at the operating level stand around 12-15 per cent for the industry and, at the net level, at 3-4 per cent. For FY-10, Kajaria Ceramics' managed higher operating profit margins at 16 per cent and net margins of 5 per cent.

Sales strength

Kajaria Ceramics' sales have grown at a 22 per cent CAGR over the last five years. The company has 6,000 dealers and sub-dealers across the country. In 2008-09, the company ramped up its retail market presence significantly to counter the slowdown in orders from the institutional segment.

The company now sells 70 per cent of its products to retail clients. However, with revival in the realty demand, the company is witnessing good order inflows from the big builders, most of whom are the company's regular customers. After a 30 per cent growth in 2008-09, Kajaria Ceramics' net sales reported an 11 per cent growth in 2009-10; partly weighed down by a high base. The company sold 25.28 msm of tiles last year, a 12 per cent growth over the previous year.

In February, Kajaria Ceramics began operations at its newly-built vitrified tile unit (2.4 msm) at Sikandarabad, UP, and produced 0.22 msm of vitrified tiles in the past two months. Until now the company had only been importing vitrified tiles. The company is setting up another six million square metre vitrified tile unit at a capex of Rs 125 crore at its Galipur unit in Rajasthan. This unit will commission production by November 2010.

Margins to improve

Local manufacture of vitrified tiles is expected to improve margins; manufacturing margins (at 20 per cent) are higher than trade margins (8-10 per cent).

However, import of vitrified tiles will not be completely discontinued. Kajaria Ceramics proposes to continue imports for the coastal market as freight costs may wipe out savings in margins if they try to move products from their factories in Rajasthan or UP to these regions. The company's margins would also improve on savings in fuel cost.

Kajaria Ceramics' Rajasthan unit (which contributes to 70 per cent of the company's production capacity), which was all along running on propane fuel, has switched to natural gas with GAIL having completed laying the pipeline for the gas supply.

The change in fuel will result in savings of around Rs 20 crore (18 per cent of the last year's fuel cost) every year as per the company's estimates. In FY-10, operating profit margins improved two percentage points (to 16 per cent).

At the net level, cost-related relief does not appear possible at least this year as depreciation and interest costs will only be higher following new plant installations and higher working capital needs that will be fed by debt. However, margin expansion at the operating level will help net profit margins too. Sales growth and cash flow that will follow are expected to give some respite to the company on the cash front. Following part-repayment of the outstanding debt during the last year, the company's debt-to-equity ratio has come down to 1.39 from 2.09 in the previous year.