ambit building materials thematic 01 dec 2015

BUILDINGMATERIALS

Analysts:

Time to build for tomorrow

Nitin [email protected]: +91 22 3043 3241

Achint Bhagat, [email protected]: +91 22 3043 3178

That's old school, Try our new range

I ve been selling thisfor last 10 years No, I want only

that BRAND!

In a day!In a week

Not as commoditizedas it seems

Girisha [email protected]: +91 22 3043 3211

December 2015

Do you want acheaper product?

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Building materials

December 01, 2015 Ambit Capital Pvt. Ltd.

CONTENTS

Building materials …………….………….........................................................3

Structural resets caused the slowdown …………………………………………….5

It’s uncertain but certainly not over …………………………………………………6

Learnings from the decade gone by ………………………………………………10

It’s (not) all the same ……………………………………………………………….13

Who is treading towards greatness? ………………………………………………19

Valuations - More than meets the eye ……………………………………………25

Pipes …………………………………………………………………………………..28

Tiles ……………………………………………………………………………………34

Wood panel products (ply and laminates) ……………………………………….41

Sanitaryware …………………………………………………………………………46

COMPANIES

Supreme Industries (BUY) - True to its name ……………………………………51

Century Plyboards (BUY) - Warming up for the marathon …………………….59

Kajaria Ceramics (NOT RATED) - Good quality but expensive……………….. 65

Astral Poly Technik (NOT RATED) - “Flow” and “Fix” guard……………………69

Somany Ceramics (NOT RATED) - Sailing through tough times ………………75

Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit Capital may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decision.

Time to build for tomorrow

Building materials demand recovery may be uncertain but the impending low inflation/interest rate regime keeps our recovery hopes alive (akin to 1996-99). In our view, the narrative should be ‘longevity of growth’, rather than ‘when will demand recover?’ Pipes is set to become an even larger category as new applications will increase the addressable market; only three established leaders/innovators have the ability (capacity, reach and reputation) to harness the opportunity. Tiles and ply are large categories with limited credible competition but little scope for product innovation constricts competitive advantages of present leaders. We turn BUYers on Supreme Industries and retain BUY on Century Plyboards. We highlight Astral as the other unique franchise operating across two fast growing/evolving categories. Kajaria is an exemplary but relatively expensive franchise.

Current slowdown akin to FY96-99 Liquidity challenges of the channel, decline in real estate construction, weak consumer sentiment and the resultant deceleration in growth of building materials in FY16 is very similar to FY96-98 (Asian Paints annual reports). Low inflation/interest rate regime and access to credit, could again be the saviors over next 12-18 months similar to FY99. Amid this severe slowdown, we still hear cities outside top-20 remaining stable, indicating much larger opportunity Leaders have no other choice but to build Whilst the opportunity is large in most “new-age” building material categories, only a few companies are building a champion franchise. Building sustainable long-term franchises will require relentless product innovation (often disruptive), superior channel servicing (efficient last mile transportation), intermediary education and clear communication with channel/consumers. Asian Paints and Pidilite have been doing this for last two decades whilst most others have recently focused on the same; Supreme, Astral, Kajaria started 10 years back Think innovation/disruption for longevity of advantages Rather than size of the present market, the growth potential and opportunity to build sustainable competitive advantages around innovation leads to pipes scoring over other categories; laminates/engineered wood and adhesives also display similar traits. Whilst competitive intensity from unorganised players is receding in tiles, limited avenues to further reduce capital intensity or innovate make tiles next best. Ply is most exposed to product disruption while sanitaryware/faucets could see competition from all over (tiles, global brands). All are rich; which one to BUY? Valuation measures based on near-term earnings are of limited use, as most building material categories/companies are still evolving. Accounting quality, capital allocation and corporate governance are the first-level filters, followed by sustainability of growth/advantages and re-investment opportunities. Whilst we find ply not the best category, Century Ply’s (BUY) cost and reach/brand leadership drive our BUY implying 21x FY17E EPS. We turn BUYers on Supreme given abundant scope/capacities to innovate and reinvest, akin to last decade

THEMATIC 01 December 2015

Building MaterialsPOSITIVE

Key Recommendations

Supreme Industries BUY

Target Price: 785 Upside 21%

Century Plyboards BUY

Target Price: 230 Upside: 20%

Analyst Details

Achint Bhagat, CFA

Tel: +91 22 3043 3178

[email protected]

Nitin Bhasin

Tel: +91 22 3043 3241 [email protected]

Girisha Saraf Tel: +91 22 3043 3211

[email protected]

Positioning of building material categories on Porter’s Five Forces

Competitive

intensity Barriers to entry

Threat of substitution

Bargaining power: with Supplier

Bargaining power: with Buyer

Pipes (plumbing) Moderate High Low Moderate High

Laminates Low High Moderate High Moderate

Tiles Moderate Moderate Low High Moderate

Plyboard Moderate Low High Moderate Low

Sanitaryware High Moderate Low Low Low

Source: Company, Ambit Capital research

Building Materials


Exhibit 1: Decision making framework to invest in building material companies

Source: Ambit Capital research

OPTION 1 OPTION 2

Well-known factsDecelerating growth

Real-estate slow-down

Do Nothing

Delve a bit depeerGenuine housing shortfall/demand

Lower interest rates is a tailwind (see FY96-99)

Top brands have low exposure to real-estate

How to choose my category?Scalable oppurtunityScope for innovation

Strategic assets (Reach, reputation) Top quality franchises/management

BUY IDEASSupreme, Century Ply

Order of preferencePipes, Laminates, Tiles, Ply,

Sanitaryware

Other strong franchisesSomany, Kajaria, Greenply,

Greenlam

Home building materials

Building Materials


Structural resets caused the slowdown For the first time in the last decade, the growth of building materials has been lower than the nominal GDP growth in India (in 1HFY16). Slowdown in housing construction and weak consumer sentiment (and rural stress) only partially explains the slowdown in building materials. The reset/structural change that has changed the business setting has been the severe clamp-down by the NDA Government on black money, which has not only impacted end-user demand but has also constricted channel liquidity.

The director of one of the largest building material company in India highlighted: “Generic reasons such as rural stress and real estate slowdown only partially explains the slowdown. It is the first time that we are seeing a slowdown like this and there is something more to it; we have not been able to exactly figure out what”.

Exhibit 2: Revenue growth of building material companies was lower than nominal GDP growth of India in 1HFY16

Source: Company, Ambit Capital research. Note: This chart depicts the performance of 12 building material companies across categories, barring cement

Mid-single-digit revenue growth (on a low base) vindicates the challenges faced by the industry, and our discussions with the managements/channel partners suggest that the demand slowdown could extend for another 2-3 quarters at least.

Exhibit 3: Growth rates of the building material companies have fallen off the cliff

Source: Company, Ambit Capital research. Sum of 15 building material companies

The thread which connects the entire theme is that black money had little re-investment opportunity and hitherto it found application in real estate, consumption growth or unorganised financing. The sharp and sudden clamp-down surprised not only the companies but also the channel partners and led to the biggest slowdown in the last decade. Ambit’s thematic on the topic (Modi hits the 'reset' button and Real Estate: The unwind and its side effects) explain in detail the above-mentioned resets.

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The severe clamp-down on black money and low channel liquidity have been the major reasons for the slowdown

http://reports.ambitcapital.com/reports/Ambit_Economy&Strategy_Thematic_Resetbutton_23Mar2015.pdf

http://reports.ambitcapital.com/reports/Ambit_Economy_Thematic_RealEstate_14Jul2015.pdf

Building Materials


It’s uncertain but certainly not over Slowdown in sales is clear from the weak numbers posted by the incumbents (as explained above), but the uncertainty (and the favourite investor question) is when will demand recover? The managements of a few building material companies expect demand recovery in 2HFY16 on the hope of a recovery in housing construction. However, our detailed channel checks across India suggest that it could take at least 3-4 quarters for demand to recover. Also, channel inventory remains high (and liquidity low), which will take a few quarters to unwind.

Could FY15-18 be akin to FY96-99? Whilst it is difficult to time the recovery, we think that the current phase is akin to 1996-99, wherein the demand for building materials (paints) declined sharply but recovered after a couple of years, as low interest rate (and inflation) regime alongside a decline in housing prices spurred housing demand and demand for building materials. Interestingly, after FY96, 1HFY16 is the only period, wherein Asian Paints’ revenue growth was in single digits.

In the section below, we compare the current period to the management commentary of Asian Paints and Berger Paints in FY96-99.

#1: Problems faced by the channel Unorganised financers are starved for liquidity: Distributors flushed with black money used to act as the intermediary between the unorganised manufacturers and dealers. They would pay the unorganised manufacturers on time and provide extended credit to the smaller dealers for a higher margin/spread (in effect acting as financers). This mechanism is failing given that the government has implemented strict control on black money since transactions over `20,000 will require PAN card, hence bringing the distributor under the tax net.

Challenges faced by the channel: From our checks, we understand that the black money clamp-down reduced liquidity, and the sudden and swift implementation did not give the channel the requisite time to adapt in the new setting. In an already weak demand environment, rising liquidity constraints have led to stuffed channel inventory and stretched working capital cycles.

Exhibit 4: Asian Paints’ commentary in FY97 - Similar to the challenges faced by the channel now

The paints market was sluggish during the year. The poor availability of credit and its high cost adversely affected dealer offtake. Protests by the trading community against new levies and legislations in different parts of the company also affected sales. Source: Company, Ambit Capital research

#2: Real estate slowdown Sharp decline in land deals, stagnating land prices: One of the major sources of wealth generation in India in the last decade was an unprecedented increase in land prices and rising land deals with increase in urban agglomerations. The resultant wealth effect of inflation in land prices led to a sharp spike in housing construction (individual home builders) and aspirational consumption in tier II/III markets. However, land deals have declined and land prices have stagnated, which is resulting in unwinding of the wealth effect, in turn impacting consumption

Decline in new launches: Whilst the decline in real estate launches in major markets is well understood (see the exhibit below), we hear that small-ticket housing has also dropped materially, as the smaller/unorganised builders could borrow large sums of black money at 3-4%, which has now nearly stopped.

Demand recovery could take 3-4 quarters to take shape

After FY96, 1HFY16 is the only period, wherein Asian Paints’ revenue growth was in single digits

Low channel liquidity and stress of the real estate vendor is akin to the 96-98 period

Building Materials


Exhibit 5: Sharp decline in new launches in key urban markets

Source: Media articles, Ambit Capital research

Exhibit 6: Asian Paints’ commentary in FY98 - Crash in real estate prices and builder facing liquidity issues

The crash in the real estate prices and the acute liquidity problem faced by the builders, discouraged new investments in the construction industry. The market for consumer durables was stagnant and in line with this trend, the paints market remained sluggish and the growth for paints is estimated at around eight per cent. Source: Company, Ambit Capital research

#3: Factors that could drive the demand recovery in the short-to-medium term A low inflation and interest rate regime: With a low inflation and interest rate regime and with real interest rates turning positive, demand for aspirational consumption should improve as household savings increase. Note in the exhibit below that interest rates have dropped sharply in CY15 (thanks to a lower inflation regime), which could drive demand for housing and aspirational consumption. Improvement in credit availability and lower interest rates historically boded well for housing and aspirational consumption, evident from Asian Paints’ commentary in its FY99 annual report.

Exhibit 7: Asian Paints’ commentary in FY99 - Rebound in growth rates

Credit was easy, interest rates softened and the inflation year on year basis was as low as 3%. In the given encouraging market conditions, the demand for paints was good and is estimated to have grown between 14 to 15%. Source: Company, Ambit Capital research

Exhibit 8: Lending rates and inflation declined in CY96-99…

Source: RBI, Ambit Capital research

Exhibit 9: …which is visible again in CY15 as well

Source: RBI, Ambit Capital research

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Lending rate CPI (RHS)

Low inflation regime could drive the demand for building materials as seen in FY99

Building Materials


Financial inclusion: PMJDY is the flagship programme of the National Democratic Alliance (NDA) Government which has been supervised by Prime Minister Narendra Modi. Launched on 28 August 2014, the number of accounts opened under the scheme has already crossed 190mn (original target was 150mn), thereby making it one of the most successful financial inclusion drives in the world. As a result, almost 90% of total households in India now have at least one bank account. Lower housing interest rates and availability of credit in smaller towns/villages could drive housing demand and resultantly spur growth in consumption of building materials in the credit-starved smaller towns/villages.

Fast-track execution of under-implementation real estate projects: We hear that several real estate developers have fast-tracked execution of under-implementation projects to free up stuck capital and to earn milestone linked payments. The clamp-down on black money has led to lower land transactions and a sharp decline in new launches and hence cash-strapped developers are finishing projects to accrue cash to meet their interest and debt commitments.

Pay commission led increased salaries: The Seventh Central Pay Commission has recommended a 24% increase in remuneration for government employees. These recommendations will benefit 4.7mn serving employees and 5.2mn pensioners (i.e. ~2% of India’s workforce). Unlike the previous Sixth Pay Commission, there will be no major arrears this time, and hence high-ticket durables spending will be lower, but mid-low-ticket spending could witness a spurt given higher disposable income.

#4: Factors that bode well for the long term Despite the strong growth in the last decade, branded building materials penetration remains very low; for example only 11% of the overall households in India have mosaic or tile flooring and less than 10% of houses have wooden furniture penetration. We believe that the future growth drivers could be:

Decline in real estate prices: A sharp increase in real estate inventory and the government’s move to tighten the strings on real estate developers through taxing unsold units on annual letting out value, irrespective of whether the property is rented out or not, should lead to a decline in prices of real estate (refer to Ambit’s detailed thematic on this). This will increase affordability and lead to transfer of residential units from investors to end users. Decline in housing prices and lower interest rates would lower the mortgage payments to monthly income and increase the spending capability on interiors.

Exhibit 10: Real estate prices have dropped in multiple cities in India

Source: PropTiger, magic bricks and 99 acres, Ambit Capital research. Note: The YoY fall in prices is from April 2014 to April 2015.

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http://reports.ambitcapital.com/reports/Ambit_Economy_Thematic_RealEstate_14Jul2015.pdf

Building Materials


Low cost/affordable housing: The Cabinet has approved the Smart Cities Mission and the Atal Mission for Rejuvenation and Urban Transformation of 500 cities (AMRUT) with outlays of `480 billion and `.500 billion respectively. However, these initiatives such as Housing for All by 2022 and Smart Cities are yet to take any meaningful shape, and face challenges such as absence of an effective policy and inadequate reach of micro financers. However, if these initiatives are implemented at a later period, it could drive a significant increase in demand for building materials.

A low inflation phase will erode pricing power increasing affordability: Several companies have not passed on RM savings in the bleak demand environment; as the companies pass on the savings and limit price hikes, the affordability of building materials should increase in the long term.

GST implementation: The unorganised sector in India has hitherto avoided paying indirect taxes on inputs and outputs and hence has had cost advantages of around 13-30% relative to its organised counterpart. If GST is able to capture the unorganised sector in the tax net, then this competitive advantage for this sector will be eroded. As a result, in the Goods sectors in which unorganised accounts for the majority of the market share (e.g. light electricals, paints, pipes and plyboards), the organised players stand to be benefit regardless of the rate at which GST is introduced. We expect GST to be passed in the Nov-Dec 2015 parliament session. Reduced cost advantage for unorganised goods manufacturers GST is likely to increase market share gain of the organised segment, as the unorganised segment stands to lose under the new world of GST. This will happen, as:

GST will bring scale economies in distribution logistics and help players with greater financial strength.

The unorganised sector will become less competitive under the GST, as input taxes will be available for set off and the price differential between organised and unorganised will decrease (see the exhibit below).

Exhibit 11: Product pricing divergence between organised/unorganised

Home building segments

Market size

Organised share

Organised market

size

*Price difference

(organised vs unorganised)

Price difference explained by

(` bn) (%) (` bn) (%) Production costs

**Taxes Labour payments

A&P/ others

Light Electricals 379 67% 254 30% 9% 8% 6% 7%

Paints 314 65% 204 13% 1% 3% 1% 8%

Tiles 230 40% 84 25% 8% 6% 5% 6%

Pipes 160 65% 78 25% 12% 10% 0% 3%

Plyboards 160 30% 45 30% 7% 15% 4% 4%

Sanitaryware 35 60% 14 20% 4% 9% 3% 4%

Source: Ambit Capital research, management meetings, Note: * As a percentage of market prices of organised players, ** Most important component of the price difference is excise duties

GST will wipe out the competitiveness of the unorganised players

Building Materials


Learnings from the decade gone by The last decade exemplifies the large opportunity in building materials in India. Most categories grew significantly higher than the nominal GDP growth (see the exhibit below). Whilst the growth in housing units, higher urbanisation and rising aspirational consumption (especially in mid-ticket categories) drove the growth for the industry, the organised players grew much faster than the industry, due to investments in brand, distribution and processes.

As shown in the exhibit below, we gross the revenues of the major companies across categories, which account for >50% of the overall revenues of the sector.

Exhibit 12: Home building materials exhibited strong growth in the last decade

Sectors Size of the industry ( mn) CAGR Sector multiplier to nominal GDP

FY05 FY10 FY15 FY05-10 FY10-15 FY05-15 FY05-10 FY10-15 FY05-15

Paints 45,958 98,198 225,796 16% 18% 17% 1.1 1.1 1.1

Pipes 11,710 40,704 91,800 28% 18% 23% 1.9 1.2 1.5

Tiles 21,918 46,201 95,196 16% 16% 16% 1.1 1.1 1.1

Plyboards 5,348 20,735 47,640 31% 18% 24% 2.1 1.3 1.6

Light electricals 48,009 89,342 167,475 13% 13% 13% 0.9 0.9 0.9

Adhesives 6,518 17,415 40,231 22% 18% 20% 1.4 1.3 1.3

Sanitaryware 3,016 10,078 26,420 27% 21% 24% 1.8 1.5 1.6

Total Size ( mn) 142,477 322,674 694,559 18% 17% 17% 1.2 1.1 1.2


The key observations from the above analysis are:

#1: Multiplier to nominal GDP is high initially but recedes as organised players’ market share increases

Note that in most of the underpenetrated and high unorganised share categories the multiplier to the nominal GDP was much higher over FY05-10 than FY10-15, with improving penetration in tier II/III/IV towns and market share gains from the smaller players. The growth inches closer to the nominal GDP growth after the organised share expands.

Exhibit 13: Rising market share of the organised brands


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Tile Ply Sanitaryware Pipes

Organised share

FY10 FY15

Most home building categories grew significantly higher than nominal GDP growth rate

Building Materials


#2: Leaders grow significantly higher than the industry/peers’ growth rate

Note that the leading players across categories have grown significantly higher than the industry growth rate and also the growth of its peer-set. Note in the exhibits below that the top-2 players have grown significantly higher than industry growth consistently across categories.

What explains the outperformance of the top 2-3 players?

The building material companies started at broadly the same base but the competition was left digging in their heels by the leaders, since: (a) leaders invested in differentiated products and developed products across the price spectrum; for example: Asian Paints launched the tractor emulsion to grow in the smaller markets; (b) once they gained scale their ability to invest in branding, distribution (last mile transportation) and intermediary education was much higher than peers, which further helped them accelerate their market share; and (c) their ability to attract and retain talent and build a process ecosystem was also materially higher than peers, post scale expansion.

Exhibit 14: Asian Paints and Berger grew significantly higher than peers…

Source: Company, Ambit Capital research. Note: Others includes three paints companies

Exhibit 15: …so did Supreme, Astral and Ashirvad…

Source: Company, Ambit Capital research. Note: Others includes six other pipe companies

Exhibit 16: …Kajaria and Somany…

Source: Company, Ambit Capital research. Note: Others includes eight tile companies

Exhibit 17: …and Century and Greenply

Source: Company, Ambit Capital research. Note: Others includes six other ply companies

- 200 400 600 800

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Anpt+Brgr Others*

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Supreme + Astral + Ashirvad Others

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Century+ Green Others

In most categories, the top-2-3 players grew much faster than peers

Building Materials


Shifting composition of the overall pie

The pie charts below show that: (a) the share of organised paints and tiles has remained broadly similar in the overall organised home building material market over the last decade; (b) the share of pipes, plyboards and sanitaryware has increased, whilst the share of light electricals dropped materially.

Paints maintained its share as repainting cycles shortened and companies launched cheaper priced products to increase penetration; another way to look at it would be that the companies have taken price hikes and also added new products such as chemicals;

Pipes share expanded led by launch of new products such as CPVC and column pipes which increased the applications and the addressable market. Also the shift from both unorganised to organised and GI to plastic pipes accelerated;

Tiles’ share remained flat despite strong growth of the top-2 players, since the smaller players (based in Morbi) maintained their market share whilst established players such as Nitco and RAK lost ground;

Plyboards’ share increase was mainly on account of market share gains from the unorganised players, as excise duty for the larger players was cut sharply; moreover, there was also an increase in the sales of aspirational product such as laminates which is a high value product with relatively lesser share of unorganised players; and

Sanitaryware’s share increased with rising penetration of sanitation in the country in residential and non-residential buildings. However, lack of data for companies other than Cera and HSIL limits a clear analysis.

Exhibit 18: Whilst paints retained its share…


Exhibit 19: …light electricals’ share dropped


Paints, 32%

Light Electricals,

34%

Pipes, 8%

Tiles, 15%

Adhesives, 5%

Plyboards, 4%

Sanitaryware, 2%

FY05

Paints, 32%

Light Electricals,

24%Pipes, 13%

Tiles, 14%

Adhesives, 6%

Plyboards, 6%

Sanitaryware, 4%

FY15

Building Materials


It’s (not) all the same We believe that each category has different characteristics and hence they are not directly comparable. We ascertain the positioning of the categories based on Porter’s Five Forces and find that Pipes is relatively the best category amongst the new age home building brands. We find similar characteristics of rising new application areas in laminates and adhesives, which could be the other two rising categories. Tiles stands out as the second best category.

Pipes: Pipes is a large addressable market (`160bn), wherein the top-3 brands are led by fanatic promoters, who are the innovators, whilst others are largely “me-too” brands. Given with the sharp drop in the price of PVC resin and improved distribution in smaller towns, the shift from GI pipes to plastic pipes has accelerated. Pipes is evolving from a basic utility product to application-based water management systems, as the housing pattern in India is changing, which leaves room for innovators to strengthen their franchise. Pipe use in organised housing is becoming more water/sewage management from transportation, increasing the per housing unit installation intensity by 4-8x in many cases.

Laminates/Veneer: This is a `70bn market, wherein the top-4 companies (Greenlam, Merino, Royal Touche and Century Ply) account for 40% market share, and the smaller players do not have the scale to innovate or improve distribution, given a high number of SKUs. The key competitive advantage of a leading brand is distribution and SKU management. Moreover, we see that players such as Greenlam and Merino are expanding into newer products such wooden flooring, post form laminates.

Tiles: This is a large category, wherein the top-5 brands have sales higher than `10bn, but most others are much smaller in size and leading brands (Kajaria and Somany) have much superior balance sheet strength and are adding scale through partnering with smaller 1bn-2bn companies, alongside building strong management teams. The application of tiles has increased from bathroom tiles to floor and wall tiles and the addressable market is rising with growth in commercial spaces.

Plyboards: This is a `16bn market wherein the top-2 players are significantly ahead of peers, in terms of scale and control on critical raw material inputs (face veneer). The unorganised share is the maximum in ply which means that the market share gain potential of the leaders is much higher than other category, if structural changes such as GST materialise.

Sanitaryware: The risk of rising competitive intensity is the highest in this category, since it is a relatively small market, wherein unorganised share is low and several other manufacturers have entered both in the affordable and premium category. As per HSIL’s management, volumes are more in the affordable or low-value categories and even the global brands have launched affordable categories increasing competitive intensity; related category leaders (from tiles) are also expanding into this category.

Exhibit 20: Positioning of building material categories on Porter’s Five Forces

Competitive

intensity Barriers to entry

Threat of substitution

Bargaining power: with Supplier

Bargaining power: with Buyer

Pipes (plumbing) Moderate High Low Moderate High

Laminates Low High Moderate High Moderate

Tiles Moderate Moderate Low High Moderate

Plyboard Moderate Low High Moderate Low

Sanitaryware High Moderate Low Low Low


Pipes stands out as the best category amongst the new-age building material categories

Building Materials


(I) Competitive intensity We ascertain competitive intensity based on the size of opportunity, unorganised share (beneficiary of structural changes such as GST), cross category competition (entry of players from other categories) and threat of imports. #1 - Size of the opportunity: In our view, a large category which is fragmented, but the smaller players do not have any major competitive advantage leaves room for the brand leaders/innovators to gain significant scale leadership. Tiles is the largest industry in terms of market size, followed by pipes (including agriculture) and plyboard. Laminates and sanitaryware are relatively small markets ( 7bn and `4bn, respectively). Sanitaryware is largely an organised sector and is facing increased competition from global players, other building material categories such as tiles and previously dormant players such as Parryware, which means that the size of the opportunity of the incumbents is the least in sanitaryware. #2 - Unorganised share: Unorganised market share has dropped across categories in building materials, as the organised players gained scale and invested in branding and logistics. The unorganised share remains high in categories such as plywood and laminates, given the challenges faced by the unorganised players such as stretched cash conversion cycles and regulatory resets such as GST; the market share shift in favour of the organised manufacturers will accelerate in the coming years.

Exhibit 21: Tiles is the largest market followed by plyboards


#3 - Cross category risk: The key reason for the cross category competition is channel fungibility, as the companies already have the distribution network/ brand and with little capital intensity they can establish a presence in other categories. We believe that the cross category risk is the highest in Sanitaryware given the entry of multiple tile manufacturers in the affordable segment and global players in the premium segment. The key risk in tiles is the entry of larger categories such as paints in using Morbi as the outsourcing hub. Whilst certain players such as HSIL and Skipper are expanding in CPVC pipes, we do not see it as a major risk to growth of the established players, as the existing players are (especially the leaders) significantly ahead of brand and product portfolio and have an unmatched focus on innovation. We do not see risks from other categories in ply/laminates, since the channel is not fungible. Lastly, note that pipe manufacturers (such as Astral) are entering into adhesives through acquisitions of smaller players; we find the adhesives and pipes channel overlapping for ~40-50% at the retail level but in the institutional client base the clients are common.

Exhibit 22: Channel fungibility mapping

Category Tiles Ply Pipes Laminates Sanitaryware/ Faucets

Tiles Plyboards Pipes Laminates Sanitaryware Source: Company, Ambit Capital research

50%

70%

40% 40%

30%

0%

20%

40%

60%

80%

0

5

10

15

20

25

Tiles Ply Pipes Laminates Sanitaryware

Size (Rs bn) Unorganised share (RHS)

Sanitaryware is facing rising competition from global players and tile manufacturers

Cross category risk is low in pipes, since setting up the distribution is a challenge and leaders are way ahead in innovation and product launches

Building Materials


#4 - Import threat: Chinese imports garnered 10% market share in Indian tiles industry in the last two years; however, the recent implementation of the anti-dumping duty will significantly reduce competition. Import is not a major threat in laminates, given the difficulty in SKU management and after-sales service. Imports in Sanitaryware are restricted to the super-premium spectrum which drives less than 5% of overall sales of Indian manufacturers. Imports in ply and pipes are limited given their low value, high volume characteristics.

(II) Barriers to Entry We believe that the key barriers to industry in building material categories are capital intensity, strength of brand/distribution and capability of innovation and product differentiation. The classic question that investors should ask whilst determining this is - Can another Asian Paints be created if an aspirant has access to capital and talent? #1 - Branding and distribution: Most companies have spent aggressively in the last decade to build their brands, and despite the slowdown in recent quarters, they continue to invest in branding. Tiles and laminates have relatively higher customer connect, given multiple designs/sizes and hence companies incur higher expenditure in direct advertisement to the end-consumers. Intermediaries (carpenters, plumbers) have a high influence on plyboard and pipes and hence the advertisement/publicity expenditure in these categories is largely to influence the intermediaries through mason meets, seminars, etc. However, few brands have undertaken direct advertisement in these categories (Century and Green in Plyboards and Astral in pipes) with reasonable success. Brand recall is the highest in sanitaryware, followed by laminates. Brand plays an important role in tiles in tier III/IV markets, but no so much in the urban markets. In pipes and ply, branding is largely below the line, through influencing the intermediary, although Astral has been able to build its CPVC brand through television advertisements and celebrity brand ambassadors. Distribution is a major barrier to entry in most building materials given their low- value high-volume traits, but is more so in products with multiple SKUs such as laminates.

Exhibit 23: Most of the companies spent significant sums on branding

CAGR % of sales

FY05-10 FY10-15 FY05-15 FY15-10 FY10-15 FY05-15 Astral 5% 52% 26% 2.1% 1.9% 2.0% Century NA 13% NA 5.8% 4.7% 5.0% Cera 30% 9% 19% 9.3% 5.0% 5.6% Finolex -5% 20% 7% 1.0% 0.8% 0.9% Green(ply+lam) 64% 14% 37% 3.9% 3.4% 3.4% HSIL 24% 40% 32% 2.1% 2.5% 2.4% Kajaria 9% 24% 16% 3.8% 2.9% 3.1% Somany 16% 27% 22% 2.1% 1.9% 2.0% Supreme 19% 47% 32% 0.7% 2.1% 1.8%


Exhibit 24: Levels of influence of the channel spectrum


Cement

Paints

Electricals

Pipes

Tiles

Adhesives

Plyboards

Sanitaryware

Sub-Segment

B2B B2I B2C

Brand recall is the highest in sanitaryware followed by laminates

Building Materials


#2 - Innovation and product differentiation: In seemingly commoditised businesses, a few companies have managed to differentiate themselves through continuous innovation and product launches ahead of competition in the past.

In tiles, most organised manufacturers have a large design inventory and most of them manufacture all sizes/formats, which leaves little room for an incumbent to innovate. Whilst a manufacturer may have a temporary early mover advantage in a specific category, in a relatively short period it is replicated by competition.

Plumbing pipes: Whilst basic CPVC/PVC pipes are largely commoditised and manufactured by most companies, players such as Astral and Ashirvad continuously launch premium and differentiated products through global technological tie-ups, which are finding acceptance in India. This is a key competitive advantage that is not easily replicable by competition; Supreme led the way and now Astral and Ashirvad are doing better than Supreme.

Surface products (laminates) have significant scope of innovation through changing formats (exterior grade laminates, doors etc) and new products such as the new wooden flooring range launched by Greenlam.

Sanitaryware has little room for further innovation as most of the products are standard and available across brands; designs have a limited shelf life with competition catching up gradually.

In our view, pipes and laminates are the two categories wherein companies have built their franchise through innovation and differentiated product launches.

#3 - Capital intensity and manufacturing complexity: Capital intensity has historically been high in tiles, but it has reduced in recent years, owing to the JV model manufacturers partnering with the Morbi-based players, which is a key risk since larger players such as Asian Paints could enter this category. Capital intensity is moderate in laminates but low in pipes and plyboards.

Exhibit 25: Capital intensity is the least in plyboards


(III) Threat of substitutes “But one thing about business is that if you're not willing to attack your own business model, you can't expect other people not to attack it.... You have to be willing to disrupt yourself because others are going to disrupt you.”

- John Mackey, Whole Foods The threat of a disruptive product launch is the highest in plyboards, wherein products such as MDF, particle boards and wood particle composites can eat into the market for plywood. These new-age products require training the intermediaries such as carpenters (since it requires new machine tools), which will happen over a period of time. The threat for plastic pipes is now only the new kind of polymers and systems unlike the earlier sales of basic plastic pipes; CPVC pipes which are very successful in India are getting replaced by PEX pipes in the US and these will enter India too. This does not create risk for the incumbents such as Supreme and Astral, as they have been handling multiple polymers for a long time.

-

1.0

2.0

3.0

4.0

Plyboards Laminates Sanitaryware Pipes Tiles

Average GB turnover FY09-15

Innovation capability is the highest in pipes, since multiple globally accepted products are yet to be launched in India

“Alternative materials are increasingly replaced by easy to install sustainable plastic solutions” Wavin Annual Report

Capital intensity is high in pipe and tiles

Building Materials


A media article (http://goo.gl/oX59X4) summarises the changing trends in the plastics industry “There’s no place like home to illustrate how plastic products have pushed the envelope when it comes to changes in the building industry over the last quarter century. Plastics have grown to dominate the residential markets for plumbing fixtures. In the built world, plastics continue to displace copper, wood, aluminum and other materials, including older polymers, sometimes as the cheaper alternative and sometimes as the premium product.” Wood paint (Duco) and pre-laminated board are a substitute to laminate sheets. The substitute for tiles is other flooring materials such as marbles, wooden flooring, slurry and granite, which are natural deposits and are much more expensive than ply. Moreover, as the installation technologies improve, the threat could become real albeit marginal. Sanitaryware does not have a substitute.

(IV) Bargaining power with suppliers Bargaining power of the companies suppliers in most categories is low-medium, as the suppliers are global entities, much larger in scale than the incumbents. For example, there are few manufacturers for CPVC resin and domestic pipe manufacturers are largely price takers. Note that the creditor days of sanitaryware are lower than most other categories, which suggests lower bargaining power.

Exhibit 26: Bargaining power with suppliers across categories Category Suppliers Bargaining power with the supplier of the company

Tiles Gas distributors, ceramic miners Large gas distributors supply gas to the tile companies based on contracts and hence bargaining power of the companies is low. However, incumbents have a high bargaining power with the ceramic miners.

Sanitaryware Gas distributors, ceramic miners Similar to tiles, the bargaining power with the gas distributors is low

Pipes Plastic resin manufacturers Bargaining power with PVC/CPVC plastic resin suppliers is low but a few companies such as Astral have entered into partnerships with large global players, which positions them better.

Plyboard Indian timber plantations, South East Asian plantations of face timber/veneer and chemicals manufacturer

Bargaining power of the companies with timber suppliers is low given the lobby of the timber manufacturers. Also, bargaining power with international timber traders (for face veneer) is declining timber reserves and strict regulations globally

Laminates Paper and chemical manufacturers The laminate companies purchase paper and chemicals from multiple manufacturers which are smaller in size than them, which increases their bargaining power


Exhibit 27: Creditor days of sanitaryware is the lowest, indicating weaker bargaining power

Category Creditor Days

FY12 FY13 FY14 FY15

Pipes 33 35 31 30

Sanitaryware 29 31 27 25

Tiles 48 45 39 44

Panel products NA 43 44 43


(V) Bargaining power with buyers Since most of the categories have fairly large unorganised competition, the bargaining power of the manufactures is low which limits realisation growth to 3-4% at best. Moreover, in categories wherein institutional sales are meaningful, pricing power is further limited. Bargaining power in specific categories is higher where there is scope for innovation and product differentiation, such as pipes. Designs and established brands alongside unmatched reach can also establish pricing power/ bargaining power; the leading tiles/ply brands are able to exploit these in some regions/ periods.

Bargaining power with the channel is a function of brand and distribution architecture. Note that debtor days of pipes are the least, indicating high bargaining power with the channel (most players follow cash and carry or short payment cycles). Bargaining power is medium in tiles but low in sanitaryware followed by wood pane products (especially ply).

Bargaining power of buyers is the least in pipes, which is evident from low debtor days

Building Materials


Exhibit 28: Debtor days of sanitaryware is the highest

Category Debtor Days

FY12 FY13 FY14 FY15

Pipes 22 19 19 21

Sanitaryware 50 61 72 71

Tiles 40 40 41 41

Panel products NA 45 56 58


Building Materials


Who is treading towards greatness? In our view, the real-estate/housing recovery is uncertain, and hence timing the recovery is futile. Instead, we urge investors to understand the strategies of companies that are strengthening their franchise and gaining market share (in large but fragmented categories) which will support sustainable earnings and profitability growth. At the recent building material exhibition in Mumbai, we were impressed by Kajaria and Somany in tiles, Astral and Ashirvad in pipes and Greenlam in panel products, wherein the focus was on product distinction/ innovation, reach expansion and importantly, building a strong mid-level management to strengthen their organisations. Investors should focus on how these companies are trying to improve upon capital employed turnover and cash conversion rather than margin expansion, which could be difficult for most categories given input deflation and rising competitive intensity/customer down-trading. Most of the categories have sufficient room for an innovator and a leading brand with a well-built architecture to grow sustainably not for the next 1-2 years but for the next decade.

Our discussion with industry experts with over 20 years of marketing experience of building materials suggests that the key differentiating factors of a champion franchise and a mid-rung franchise are: (a) ability to cater to all types of customers which requires product range and pricing from premium to affordable category, (b) distribution infrastructure to ensure fast last-mile connectivity; (c) ability to launch disruptive and innovative products ahead of competition; and (d) clear communication reaching/impacting the user/ intermediary.

What determines greatness? The ‘greatness’ framework (see Exhibit 29 below) essentially hinges on using publicly available historical data to assess which firms have, over a sustained period of time (FY09-14), been able to relentlessly and consistently: Invest capital;

Turn investment into sales; Turn sales into profit; Turn profit into balance sheet strength; Turn all of that into free cash flow; and

Invest free cash flows again.

As per our greatness analysis, Astral appears the best on the greatness parameters mentioned below, followed by Supreme, Greenply and Kajaria. Finolex Industries and HSIL score lower than peers due to weak sales growth, flat earnings and no major improvement in profitability ratios over a period of time.

Exhibit 29: The Greatness scores on the building materials companies

Company Investment Sales Improve

Pricing discipline

EPS and CFO increase

BS Discipline

Ratios improve

Total Score-using Adj PAT

Astral 17% 17% 17% 17% 8% 17% 92%

Supreme 8% 17% 17% 17% 17% 8% 83%

Greenply 8% 8% 17% 17% 8% 17% 75%

Kajaria 8% 17% 17% 8% 8% 17% 75%

Cera 17% 17% 0% 17% 0% 17% 67%

Somany 8% 17% 0% 17% 17% 8% 67%

Finolex Ind 0% 8% 17% 0% 17% 8% 50%

HSIL 17% 8% 0% 0% 8% 0% 33%

Source: Capitaline, Ambit Capital research. Note: We exclude Century Ply from this since the historical numbers include cement, which hampers comparability

The key greatness determinant of a champion franchise vs a mid-rung franchise is: (a) product range across price, (b) distribution architecture, (c) innovative launches, and (d) communication with the consumer and intermediary

Building Materials


Exhibit 30: The ’greatness‘ framework


Exhibit 31: Factors used for quantifying greatness

Head Criteria 1 Investments Above median gross block increase (FY12-14 over FY09-11)*

Above median gross block increase to standard deviation 2 Conversion to sales Improvement in asset turnover (FY12-14 over FY09-11)*

Positive improvement in asset turnover adjusted for standard deviation

Above median sales increase (FY12-14 over FY09-11)*

Above median sales increase to standard deviation 3 Pricing discipline Above median PBIT margin increase (FY12-14 over FY09-11)*

Above median PBIT margin increase to standard deviation

4 Balance sheet discipline Below median debt-equity decline (FY12-14 over FY09-11)*

Below median debt-equity decline to standard deviation

Above median cash ratio increase (FY12-14 over FY09-11)*

Above median cash ratio increase to standard deviation

5 Cash generation and PAT improvement Above median CFO increase (FY12-14 over FY09-11)*

Above median CFO increase to standard deviation

Above median adj. PAT increase (FY12-14 over FY09-11)*

Above median adj. PAT increase to standard deviation

6 Return ratio improvement Improvement in RoE (FY12-14 over FY09-11)*

Positive improvement in RoE adjusted for standard deviation

Improvement in RoCE (FY12-14 over FY09-11)*

Positive improvement in RoCE adjusted for standard deviation Source: Ambit Capital research. Note: * Rather than comparing one annual endpoint to another annual endpoint (say, FY09 to FY14), we prefer to average the data out over FY09- 11 and compare that to the averaged data from FY12-14. This gives a more consistent picture of performance (as opposed to simply comparing FY09 to FY14).

For each of the parameters discussed in Exhibit 29 above, we look at both the absolute improvement as well as the consistency in improvement over the last six years.

Further, we assign a score of 17% to each of the parameters discussed above such that the company that does well across all the parameters receives a score of 100% whilst the company that does not fare well across all the parameters receives a score of 0%.

Thus, a score of 17% on investments would mean that the company does well on both absolute investment in gross block as well as the consistency with which it has invested in its gross block.

b.Conversion of investment to sales (asset turnover, sales)

c.Pricing discipline (PBIT margin)

d. Balance sheet discipline (D/E, cash ratio)

a. Investment (gross block)

e.Cash generation (CFO)

Building Materials


Financial comparison across categories (1) Revenue growth and EBITDA margin

Most of the building companies have grown in mid-teens or higher, barring Finolex Industries. The companies that posted superlative growth (20% revenue CAGR over FY11-15) are Astral, Somany, Kajaria and Cera.

EBITDA margin for most of the companies are in mid-teens, barring Somany ceramics, since the company follows as asset-light model and a large proportion of its sales is trading (low margin but high asset turns).

Exhibit 32: Revenue growth and margin comparison

Company Revenue growth EBITDA margin

FY12 FY13 FY14 FY15 CAGR FY11-15 FY12 FY13 FY14 FY15 AVG

FY11-15

Pipes 15% 13% 18% 8% 14% 14% 16% 16% 13% 15%

Astral 42% 41% 31% 32% 37% 15% 14% 15% 12% 14%

Finolex 6% 2% 15% 0% 6% 12% 18% 18% 9% 14%

Supreme 18% 16% 17% 7% 15% 16% 16% 15% 16% 16%

Sanitaryware 33% 26% 12% 11% 20% 18% 15% 14% 16% 16%

HSIL 34% 20% 5% 7% 16% 17% 15% 14% 17% 16%

Cera 32% 52% 35% 24% 35% 18% 17% 15% 15% 16%

Tiles 31% 20% 18% 21% 22% 13% 13% 12% 13% 13%

Kajaria 38% 21% 16% 19% 23% 16% 16% 16% 17% 16%

Somany 22% 20% 20% 22% 21% 9% 8% 7% 7% 8%

Wooden Panel 25% 17% 11% 13% 16% 11% 12% 12% 14% 12%

Century 12% 12% 15% 15% 13% 11% 10% 12% 17% 13%

Green (ply+lam) 35% 20% 8% 12% 18% 11% 13% 12% 12% 12%


(2) Profitability analysis

Note in the table below that pre-tax RoCE of most of the companies has improved over the last few years. Supreme, Astral, Cera and Century plyboards stand out with 20%+ average pre-tax RoCE over FY12-15

Exhibit 33: Profitability analysis

Company EBIT Margin CE turnover Pre-tax RoCE

FY12 FY13 FY14 FY15 FY12-15 FY12 FY13 FY14 FY15 FY12-15 FY12 FY13 FY14 FY15 FY12-15

Pipes 11.5% 12.4% 12.4% 9.9% 11% 2.0 2.0 2.2 2.2 2.1 23% 25% 28% 22% 24%

Astral 12.4% 12.0% 12.5% 9.4% 11% 2.5 2.7 2.7 2.2 2.5 31% 33% 34% 21% 29%

Finolex 8.1% 11.1% 12.3% 5.6% 9% 1.4 1.3 1.6 1.7 1.5 11% 15% 20% 10% 14%

Supreme 13.8% 13.4% 12.4% 12.5% 13% 2.8 2.8 2.8 2.7 2.8 38% 38% 34% 34% 36%

Sanitaryware 13.5% 11.8% 9.3% 11.4% 11% 1.1 1.0 1.1 1.1 1.1 15% 12% 10% 13% 12%

HSIL 12.9% 10.9% 7.9% 10.6% 10% 1.0 0.9 0.9 0.9 0.9 13% 10% 7% 10% 10%

Cera 16.1% 15.1% 13.3% 13.1% 14% 1.9 2.3 2.6 2.4 2.3 31% 35% 35% 31% 32%

Tiles 10.3% 10.3% 9.7% 10.4% 10% 2.7 2.9 2.9 2.9 2.8 27% 29% 28% 30% 29%

Kajaria 12.8% 12.9% 13.1% 13.7% 13% 2.5 2.6 2.5 2.5 2.5 31% 33% 33% 34% 33%

Somany 6.5% 6.4% 4.9% 5.7% 6% 3.1 3.5 3.6 3.7 3.4 20% 22% 17% 21% 20%

Wooden Panel 9.6% 9.9% 10.0% 11.5% 10% 2.0 1.9 1.7 1.8 1.9 20% 19% 17% 21% 19%

Century 12.6% 8.1% 10.5% 14.4% 12% 2.5 1.9 1.7 1.9 2.0 31% 16% 18% 27% 23% Green (ply+lam) 7.8% 10.9% 9.8% 9.7% 10% 1.7 1.8 1.8 1.8 1.8 13% 20% 17% 17% 17%


Astral, Kajaria, Somany and Cera grew faster than peers

Building Materials


(III) Cash conversion cycle

The cash conversion cycle of sanitaryware is the highest amongst building material companies, followed by wood panel products. HSIL’s and Century’s cash conversion is significantly higher than their peers Cera and Greenply. The cash conversion cycle of pipes and tiles is largely comparable (except Finolex Industries is higher due to higher inventory days of its PVC resin business).

Exhibit 34: Cash conversion cycle

Category Creditor Days Debtor Days Inventory Days Cash conversion cycle

FY12 FY13 FY14 FY15 FY12 FY13 FY14 FY15 FY12 FY13 FY14 FY15 FY12 FY13 FY14 FY15

Pipes 33 35 31 30 22 19 19 21 52 53 56 55 40 37 43 47

Astral 89 75 60 57 56 46 42 48 67 61 58 59 34 32 41 49

Finolex 32 26 22 23 15 7 6 7 62 68 72 78 45 49 56 62

Supreme 24 30 29 25 20 20 20 20 41 42 44 41 38 32 36 37

Sanitaryware 24 27 27 25 50 61 72 71 68 72 76 75 94 107 120 121

HSIL 26 29 31 27 51 65 79 77 66 74 83 84 91 110 132 134

Cera 18 17 18 19 47 47 52 59 79 68 54 51 108 98 88 91

Tiles 46 43 39 38 40 40 41 41 45 43 37 35 39 41 39 38

Kajaria 48 40 32 33 30 30 31 31 47 47 41 41 29 37 40 39

Somany 43 47 49 45 56 54 56 56 41 38 30 27 54 45 38 37

Wooden Panel 22 31 41 41 31 45 56 58 36 50 67 67 45 64 82 84

Century NA 26 22 16 NA 56 53 56 NA 71 72 75 NA 100 103 115

Green (ply+lam) 36 41 53 56 51 55 59 59 58 58 64 62 72 71 70 65


(4) Accounting score

The table below ranks the various building material companies on accounting score based on Ambit’s forensic screener. Supreme ranks the best due to high cash conversion, high FCF generation and no instances of cash pilferage. HSIL ranks the last due to its relatively poor cash conversion, high outstanding debtors, low FCF and cash yield and volatile other income.

Exhibit 35: Supreme ranks the best on our accounting checks

Company name

Accounting checks

CFO EBITDA

Cont Liab-% of NW

CWIP: Gross Block

Change in depr

rate

CAGR in auditor's

remn/CAGR in consol revs

Non-oper exps-% of total revs

Cash yield

PFD-% of Debtors

more than six months

Cum. FCF/ median

revs

Vol. in Non-operating

income

Change in reserves (ex-Sec-

prem)/(PAT ex-dividend)

Supreme Industries 91% 3% 0.01 25 (0.43) 2% 4.4% 13% 0.20 15 1.00

Somany Ceramics 97% 13% 0.01 15 (0.17) 2% 4.9% 23% 0.07 12 1.00

Astral Poly Technik 64% 1% 0.05 34 (0.59) 2% 7.5% 41% (0.02) 38 1.00

Finolex Industries 84% 36% 0.03 28 0.04 1% 8.2% 12% 0.41 19 1.00

Cera Sanitaryware 85% 4% 0.02 12 (0.50) 4% 5.5% 0% 0.16 27 1.00

Kajaria Ceramics 85% 5% 0.00 41 (0.01) 2% 1.5% 3% 0.04 5 1.00 Greenply Industries 53% 61% 0.02 43 0.59 3% 15.0% 1% (0.15) 3 1.00

HSIL 71% 9% 0.03 49 (0.06) 3% 1.8% 58% (0.45) 32 1.00

Source: AceEquity, Ambit Capital research

Cash conversion cycle is the highest in sanitaryware followed by ply

Building Materials


Exhibit 36: Intermediary education and new launches (over last three years)

Intermediary education initiatives Product launches

Pipes

Astral

Detailed technical manuals and training videos on YouTube

Plumber awareness and training seminars to educate plumbers on the company'’s product and train them for installation

In the PVC segment: Astral Wire Guard and Astral AquaSafe In the CPVC segment: Astral BlazeMaster Fire Sprinkler systems Special products: FirstPlast channel drains used for indoor and outdoor

bathroom fittings Adhesives and Sealants: Resinova and Seal IT (acquisitions)

Supreme

Set up a Knowledge Centre in Gadegaon to train the piping fraternity i.e. plumbers, plumbing contractors, architects, engineers, consultants etc

Structured a training programme for the plumbers for installation of plumbing products into various segments

Tied-up with International Association of Plumbing and Mechanical Officials (IAPMO) and training imparted at the knowledge centre is in line with Uniform Plumbing Code (UPC).

Introduced Silent Pipe System, Bath fittings, Solvents, several varieties of Pipe fittings, Premium range of furniture, overhead storage tanks and cost effective solutions in the Protective Packaging Division, CPVC Fire Sprinkler system

Composite LPG cylinder launched Insulation vertical: introduced higher ID chiller pipe insulation

material 4 layers insulated water tanks in 500ltr and 1000ltr capacity In Q3FY16, plans to launch chrome plated bathroom fittings, along

with various unplated varieties Plans to add more than 100 varieties of Plastics Pipe Fittings for various

applications In Cross Laminated film products: launching six colour printed film on

9 feet width Roll (around Jan/Feb 2016) Launching new varieties of Special type of Pallets and Crates along

with installation of a 3000 ton Injection Moulding Machine during Q4FY16

Ashirvad Factory visits in collaboration with the Builders Association of India

Introduced Pan Connectors, Grease and solid interceptors, Air Admittance Valves, Fire Collars, Chambers and Manholes

In early 2015, a full range of underground drainage pipes and fittings was introduced with the support of REDI (Italy)

Introduced two acoustic SWR product lines, developed in collaboration with the product development teams in France

Cooperation with Aliaxis Latin America has led to the launch of a range of concealed valves in the hot & cold water supply segment

Collaborated with specialists from FIP in Italy to develop a full range of ball and butterfly valves in uPVC as well as cPVC.

Tiles

Kajaria

Exhaustive training sessions for dealers and masons

Routine training, lab and factory visits, along with demonstrations of key manufacturing processes

Hold frequent mason meets

Introduced The Beast, 1200x2400mm tiles Launched the new digital 40x80cm tiles Introduced The Slim, light weight-8mm slim tiles New product line, Kerovit faucets, providing complete bathroom

solution Launched Grande, 800x1200 mm Polished Vitrified Tiles Introduced Woods, decorative wooden-texture floor tiling

Somany

Somany Tile Master, a 3-day program to train semi-skilled masons

Two schools of training, one at each, the Kassar and the Kadi plants

Introduced digital printers to manufacture digital tiles Introduced large format Glazed Vitrified Tiles for the first time in

India (sizes of 800x800 mm and 600x1200 mm) in FY13

Launched Glosstra, digital wall tiles Launched friction resistant tiles under the brand name ‘Slip Shield', a

patent for which has already been applied for Introduced large format Glazed Vitrified Tiles of 800x1200 size in FY14 Launched of 800x1200 mm Polished Vitrified Tiles with ultra-charge

RAK Ceramics

Nationwide roadshow (covering 50 cities), providing a platform to meet prospective dealers, distributors, architects, engineers, developers and the end consumers in Tier II and Tier III cities

Nanopix Crystal Lapato Slabs, pearl finish digital tiles RAK Styler, vitrified wall tile hilighter concepts RockSurface, toughest 16mm thickness tiles Introducing RAK Slim, tiles with only 4.8mm thickness

Building Materials


Intermediary education initiatives Product launches

Sanitaryware

Parryware

Set up the Roca learning center at its Bhiwadi plant to enhance the skill set amongst the plumbers and the trade

The training program is designed to ensure that the workman and the plumber fraternity have the ability to deliver a complete bathroom installation and maintenance service

Brand re-launch in July 2015, with a product range comprise of Sanitaryware, Bathroom Vanity/Furniture, Faucets, Fittings, Kitchen Sinks, Electronic Toilets, Plastic Cisterns, Plastic seat covers and Wellness Products

The new refreshed brand identity offers high-quality and aesthetically –appealing bathroom solutions for the mass segment

HSIL

Invested in training designers and plumbers in partnership with the Indian Plumbing Skill Council (IPSC) and NAAC

Committed to improve the skills of plumbing contractors and plumbers with installation guide of high-end products such as LED showers, wellness products and bath tubs

New brand launch - Amore, 'bathroom as a spa' theme Launched Hindware tiles, HD digital Enhaced portfolio of Hindware Kitchen Appliances Introducing premium range of faucets

Cera

Plumber education program: Every month, several plumber meets are organised in different towns, where small groups of plumbers are given hands-on training by Cera’s technical experts

Launched new contemporary faucet series - Gayle Forayed into the stylish wall and floor tile arena Launched a new one piece EWC with twin innovation - rimless

with nano glaze

Plywood

Greenply

Knowledge sharing sessions with dealers Attempts to make MDF a part of All India

Centre for Technical Education (AICTE) curriculum for the benefit of interior designers and architects

Green Edge: Launched sales training workshops for ASM to ensure uniformity of selling skills and enhance effectiveness

Green Mantra: Organisational and product orientation programmes at the manufacturing units

Erudition: A knowledge transmission platform to act as a linking point amid knowledge seekers and transmitters

KAT Boot Camp: Knowledge sharing on product refreshes, along with outbound experience with holistic management and learning

Entry into laminated flooring solutions under the brand Green Floormax

Diversification into the economical MDF segment by launching Ecolite and Ultralite

Plans to foray into UV Coated boards Launched a wide range of pre-laminated MDF (easier to install

and time saving) Introduced innovative high-end veneer engineered flooring

Centuryply Regular carpenter meets and training programmes to educate the intermediary

Starke: new generation green and durable engineered material; can replace conventional building material

Zykron: Zykron Fibre Cement Boards and Sidings are highly durable as they are made from Fibre Cement Composite; they are easy to install and have a great finish

Novatech: a termite, borer and weather resistant product Introduced Wood and Plastic Composite (WPC), a new product in

the plywood segment Source: Company, Ambit Capital research

Building Materials


Valuations – Evolving, hence perceived expensive The two exhibits below indicate the relative positioning of several home building categories. Whilst ascertaining the valuation multiples for the building material categories/companies, we believe it is prudent to ascertain the size of the opportunity and the ability to increase the capital employed turnover alongside maintaining/improving margins (function of scalability and pricing power). Whilst the multiples of most companies have re-rated in the last 1-2 years, the sustainability of the rich multiples hinges on the aforementioned parameters. Considering that we find pipes to be the best category in these new age home building material and the high score on greatness framework and accounting screens, we believe Astral and Supreme should be trading at relatively the highest multiples.

Tiles: The opportunity is large and the multiples of the leaders can sustain as they further enhance scale at low capital intensity but the inherent risk here is the entry of another major player such as Asian Paints and limited chances for further improvement in capital employed turnover.

Pipes: Multiples have room for further expansion from hereon unless innovative launches increase and the size of the addressable market or penetration of plastic pipes increases materially. Astral has a much higher scope to grow at a faster pace given the entry into a product category (adhesives) which also has similar characteristics of rising applications, high innovation potential, strong intermediary dependence and high cash conversion. Average multiple for the sector is lower than other sectors given that Supreme’s other than pipes business deserve lower multiples and investors are underestimating the competitive advantages of this category given lesser relevance for final customer.

Ply and lam: Multiples of plyboards and laminates have room for further expansion, given that the leaders face little credible competition and has a large unorganized market is susceptible to regulatory changes and liquidity issues

Exhibit 37: Most categories have a long way to go

Source: Company, Ambit Capital research. Note: Size of the bubbles denotes sales CAGR for five years. *IHBM - internal home building materials

Exhibit 38: …however, comparable profitability to several other sectors would drive a rerating as scale increases

Source: Company, Ambit Capital research. Note: Size of the bubbles denotes RoE

Paints

PipesTiles

Plyboards

Electricals

Adhesives

0%

10%

20%

30%

40%

50%

60%

20% 40% 60% 80% 100%

Sha

re in

IH

BM

*

Organised share

Paints

PipesTiles

Plyboard

Electricals Adhesives

Sanitaryware

1.0

1.5

2.0

2.5

3.0

5.0% 15.0% 25.0% 35.0%

CE

Turn

ove

r

EBIT margin

We find pipes the best category which means that multiples should be higher vs other categories

Building Materials


Scale increase + RoE elevation = Sustainable multiple expansion History suggests that multiples of a home building category expand as scale increases alongside RoE improvement. Hence, although a few categories look expensive based on their historical multiples, a further re-rating is possible as categories gain in scale. As explained above, the organised tile industry has ample room to grow, as industry growth rates pick up alongside likelihood of market share improvement.

Exhibit 39: With rising scale, the P/E re-rated for paints…

Source: Company, Ambit Capital research, Bloomberg

Exhibit 40: …tile majors…


Exhibit 41: …light electricals


Exhibit 42: ..and also plastic pipe companies; these seems to be trading at the lowest amongst all


14.6 16.1

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1014182226303438

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Paints (Asian and Berger) Tiles (Kajaria and Somany)

Electricals (Havells and Bajaj Electricals)

Pipes (Supreme and Astral)

Building Materials


Relative Valuation Exhibit 43: Home Building materials - Relative valuation sheet

Companies Mcap EV/EBITDA (x) P/E (x) P/B (x) RoE (x) CAGR (FY15-17E)

Rating US$ mn FY16E FY17E FY16E FY17E FY16E FY17E FY16E FY17E Sales EBITDA EPS

PAINTS 14,360 26.5 22.1 43.6 35.5 12.2 10.2 29.7 30.5 13.9 21.1 27.5

Asian Paints SELL 12,032 28.2 23.8 44.5 37.0 14.1 11.8 33.9 34.0 13.8 21.0 24.1

Berger Paints SELL 2,329 24.7 20.4 42.8 34.0 10.3 8.6 25.6 26.9 14.0 21.2 30.8

ELECTRICALS 3,790 14.1 11.5 25.0 19.2 4.9 4.3 19.8 22.8 8.0 17.5 21.7

Havells India BUY 2,779 19.9 16.5 35.2 27.6 8.9 7.6 26.5 29.2 6.3 19.3 31.4

Bajaj Electricals SELL 350 10.1 7.6 20.0 13.8 2.9 2.5 14.8 19.3 7.4 15.7 NA

Finolex Cables BUY 614 12.2 10.5 19.7 16.3 3.0 2.6 18.2 19.8 10.5 17.5 12.0

V-Guard BUY 420 17.3 14.1 28.7 22.3 6.1 5.1 22.4 24.1 13.9 21.8 32.4

ADHESIVES 4,280 26.0 23.1 40.7 33.9 9.2 8.0 26.4 24.9 6.7 6.1 9.5

Pidilite Industries SELL 4,280 26.0 23.1 40.7 33.9 9.2 8.0 26.4 24.9 6.7 6.1 9.5

PIPES 1,955 17.1 12.7 31.7 22.6 6.3 5.3 22.0 25.7 21.5 28.6 35.8

Astral Poly NR 752 20.5 15.5 37.9 26.5 6.8 5.7 18.9 22.7 27.3 40.1 54.4

Supreme Industries BUY 1,203 13.7 9.9 25.6 18.6 5.8 4.9 25.1 28.7 15.8 17.2 17.3

Berry plastics (USA) NR 4,382 6.8 6.6 16.2 14.2 (143.2) 23.4 NA 90.9 18.3 25.6 89.2

Mexchem (Mexico) NR 5,375 7.7 6.6 329.2 254.3 28.2 26.4 8.3 9.9 9.9 21.1 74.9

China Lesso (China) NR 2,496 5.1 4.4 8.8 7.4 2.0 1.7 20.4 21.2 23.7 27.6 29.8

Polypipe (UK) NR 1,014 8.9 8.2 1,409.4 1,239.0 250.6 225.5 17.3 17.6 19.2 37.6 98.1

Wienerberger AG NR 2,071 6.7 6.1 25.1 17.5 1.1 1.0 4.5 6.3 6.9 111.1 NA

PLYBOARDS 924 12.6 10.2 19.9 15.5 NA NA 29.9 29.0 11.6 15.2 18.3

Century Plyboard BUY 597 14.9 11.8 22.4 17.0 7.6 5.8 37.4 35.9 15.4 21.1 24.8

Green Ply NR 327 10.3 8.6 17.4 13.9 3.6 3.0 22.4 22.2 7.9 9.4 11.8

TILES AND SANITARY WARE 26,419 10.4 9.1 17.8 14.9 3.6 3.1 19.5 20.3 11.2 15.4 18.1

Kajaria Ceramics NR 1,101 17.0 14.1 32.2 25.9 7.9 6.3 26.7 26.8 16.4 23.1 24.8

Somany Ceramics NR 202 11.4 9.0 21.8 16.3 4.3 3.6 21.3 23.7 17.5 23.2 33.1

RAK (UAE) NR 759 8.0 7.6 9.1 8.6 1.0 0.9 10.3 10.6 8.0 15.8 8.2

Mohawk (USA) NR 14,215 10.7 9.9 16.2 14.7 2.8 2.4 16.0 14.8 10.5 24.8 33.7

Saudi Ceramic (UAE) NR 717 7.1 6.9 7.9 7.9 1.4 1.3 17.8 16.7 8.1 6.7 4.8

Dynasty (Thailand) NR 712 12.3 11.2 17.4 15.1 8.5 8.1 49.0 52.5 5.3 9.2 17.1

Al-Anwar (UAE) NR 251 7.5 6.9 10.9 10.9 2.2 2.0 19.7 19.8 11.8 8.8 (5.1)

Nichiha (Japan) NR 512 5.4 5.1 11.1 10.0 1.1 1.0 9.3 9.8 4.2 10.9 12.9

SANITARY WARE 7,269 10.3 8.7 20.8 17.1 3.1 2.7 14.6 15.6 10.5 14.0 20.9

Cera Sanitaryware NR 365 16.8 13.2 30.0 23.3 5.7 4.7 20.6 22.1 20.7 22.1 22.3

HSIL NR 316 8.2 7.0 18.3 14.1 1.6 1.5 9.3 11.0 10.5 10.9 26.0 Villeroy and Boch (Germany) NR 399 5.2 4.8 12.4 11.0 2.2 2.0 17.1 17.4 4.9 8.6 14.8

Toto (Japan) NR 6,189 11.1 9.9 22.4 20.0 2.8 2.5 11.5 11.7 6.0 14.5 20.5

Source: Bloomberg, Company, Ambit Capital research

Exhibit 44: Century Ply and Supreme Industries appear attractive relative to most companies

Source: Bloomberg, Company, Ambit Capital research. Note: Size of the bubble denotes EPS CAGR over FY15-17

Asian

Berger

Havells

Bajaj

Vguard Pidilite

Astral

Supreme

Century

Kajaria

Green CeraSomany Akzo

HSIL10

15

20

25

30

35

40

10 15 20 25 30 35 40

RoE

FY1

7 (%

)

FY17 PE

Attractive

Expensive

Building Materials


Pipes An evolving market, large enough for fanatics The plastic pipes market over the next decade will evolve from pipes-cum-fittings to piping systems to solutions for building services for diverse applications, which are currently not even apparent today; high-quality players in the developed world are continuously innovating products and applications are evolving. Against this backdrop, we believe there is enough opportunity for the three quality and leading players (Supreme, Astral and Ashirvad) that have built their organisations/brand on innovation, quality and connect with users/ intermediaries. Lack of entry barriers, fragmentation and high competitive intensity should not worry long-term investors, as Supreme’s and Astral’s competitive advantages are built around distinct products and we see little disruption risks to pipes albeit chemical compounds may change. We expect Supreme to evolve into an engineered plastics company (such as Berry Plastic and George Fischer) and Astral into a home building brand. We turn BUYers on Supreme and believe that the large cylinder opportunity will supplement mid-teen growth for extant portfolio.

Rising replacement demand drove volume growth in 2Q

Plastic pipes sales have remained weak for the last 4-5 quarters; however, our recent channel checks suggest that replacement demand (shift from GI pipes to plastic pipes), led by a sharp price reduction of PVC pipes, has increased, which has partially offset the demand adversity from new construction. Moreover, in larger cities, some real estate developers have fast-tracked completion of under-construction projects to improve their cash flows, and hence, pipe demand has grown reasonably well.

As a result, Supreme and Astral posted >20% volume growth in 2QFY16 as against 10% in 1QFY16. EBIT margins dropped in recent quarters due to volatility in raw material (PVC and CPVC resin) prices, leading to inventory write-downs.

Exhibit 45: Volume growth improved in 2QFY16, led by replacement demand…

Source: Company, Ambit Capital research; above includes Astral and Supreme

Exhibit 46: …but EBIT margin dropped due to volatility in RM prices

Source: Company, Ambit Capital research; above includes Astral and Supreme

Plastic pipes—A fast-growing `225bn market with 40-50% contribution from agriculture

Over the last decade, organised plastic pipes players have expanded at a CAGR of 23%, one of the fastest amongst the home building materials industry. We believe volume growth was marginally lower than the revenue growth, as rising input prices, evolving applications (especially plumbing) and rising share of organised players would have helped realisation increase. Amid this fast growth, there has been high fragmentation with hundreds of players (unbranded /non-descript brands) manufacturing PVC/CPVC pipes; Supreme’s management indicated that the market size is `225bn (including agriculture pipes) and our analysis suggest around 50% of the market is with well-known brands. Further, our quick analysis suggests that

-5.0%0.0%5.0%10.0%15.0%20.0%25.0%30.0%

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Building Materials


around 40% of the market is agriculture (rigid PVC pipes), wherein there is a higher instance of unorganised brands and little product distinction. Market participants indicate more than 200 players manufacturing PVC pipes and around 80-100 players manufacturing CPVC pipes.

Plumbing pipes industry—Relatively less fragmented, witnessing new entrants but a very fast growing and an evolving market

We believe within the plastic pipes industry, the plumbing industry is growing faster than the overall market (key players grew at ~28% over FY05-15) given the rising use of PVC/CPVC pipes in institutional real estate construction, renovation of the older houses and adoption for new applications wherein erstwhile materials/unorganised players were non-existent. Builders and consultants indicate that the plumbing systems are no more just water/sewage transportation and are becoming more “water/sewage management systems” and the intensity of pipe usage is presently 4-8X the intensity earlier; adoption of better sanitation practices in smaller cities further increase usage of plastic pipes in smaller cities.

Whilst new entrants like Precision, HSIL and Skipper are entering the PVC/CPVC pipes manufacturing, note that these players have a long way to go before they can create an impact in the market given the small product portfolio. The impact will be lesser in the future also, as leading Indian players’ portfolios and readings of global pipe majors commentaries suggest that the plastic pipes product portfolio/use is changing. For example, where CPVC is a very fast growing product in India, this product has stagnated in USA and already cross-linked polyethylene (PEX) pipe has replaced CPVC pipes and now account for two-third of the overall hot-cold water applications; further, we hear of new applications such as fire protection, HVAC, compressed air and process fluid handling evolving, which will drive the opportunity size/quality. Moreover, apart from the residential building plumbing applications, we believe that the leading Indian plastic pipes companies will see opportunity emerging from hospitals, industrial application and even government infrastructure (GRE/GRP pipes to replace iron/concrete pipes).

The three leaders are fanatics—Supreme, Ashirvad and Astral; now expanding portfolios and manufacturing architecture

One of the senior employees of the leading pipes manufacturers remarked that the three leading companies are run by “hardworking, focused and fanatic” promoters who are deeply involved in quality control, product innovation and intermediary programmes (unlike many other smaller/larger players). Where clearly Supreme set the stage for the industry with widening product portfolio (especially for fittings/systems), Astral and Ashirvad followed with distinct pipes products, CPVC and column pipes, respectively; later Supreme followed the two in these respective products. During our recent visit to their stalls at an exhibition, we noticed Ashirvad because of its parentage (Aliaxis) having a materially distinct portfolio, followed by Astral and Ashirvad. No doubt Supreme claims that it has a 6500+ product portfolio and 20 systems. Intermediaries and consultants highlight exciting new launches by Astral and Ashirvad; we find Ashirvad to be gaining over the two on innovation and has not only launched products (see exhibit) from Aliaxis’ global portfolio but also opened Ashirvad Technology and Experience Centre in Bengaluru.

Alongside portfolio expansion, we also notice that the three players are expanding manufacturing footprint by adding more manufacturing locations; this will not only increase competition within these three but also in high likelihood push out a lot of smaller and unorganised players. Supreme plans to increase pipe manufacturing from 5 locations to 7-8 locations by adding plants in North India (Rajasthan), North East India (Assam) and gradually South India. Likewise, Astral is also planning to increase manufacturing locations from present three by setting up a plant in Rajasthan and then gradually East India. Similarly, Ashirvad is expanding its manufacturing footprint to North India.

Cross-linked polyethylene (PEX) pipe has replaced CPVC pipes and now account for two-third of the overall hot-cold water applications

Building Materials


Exhibit 47: Astral and Ashirvad have grown revenues faster than Supreme in plastic pipes

Company FY10 FY11 FY12 FY13 FY14 CAGR FY10-14

Supreme 20.0% 21.8% 24.7% 28.6% 21.8% 23.4%

Astral 50.2% 41.6% 41.0% 41.7% 30.7% 40.9%

Ashirvad 63.5% 46.0% 22.7% 51.5% 25.5% 41.0%

Source: Company, Ambit Capital research, AceEquity

Exhibit 48: RoCE of Supreme, Astral and Ashirvad is broadly similar

Source: Company, AceEquity, Ambit Capital research

However leaders are taking different directions! Whilst we note that these three leading pipe companies are further fortifying their plastic piping business, these companies are also taking different long-term directions. Where we see Supreme becoming an engineering plastic company (capital allocation to cross laminated films, composite cylinders), we see Astral emerging into a larger home building (chemical based) material brand; its foray into construction/industrial adhesives and construction chemicals through Resinova and Seal It acquisitions gives it an opportunity to participate in another opportunity which is akin to pipes—increasing application, increasing adoption in construction practices. Ashirvad on the other hand, given its global parentage, will likely remain in piping and related business (pumps) but could expand into industrial and infrastructure applications.

Exhibit 49: The top-3 companies taking divergent paths

FY13 FY14 FY15/16

Astral (becoming a multi-product home building brand)

In the PVC segment: Astral column pipes

In the CPVC segment: Astral Bendable

Special products: FirstPlast channel drains used for indoor and outdoor bathroom fittings

In the PVC segment: Astral Wire Guard and Astral AquaSafe

In the CPVC segment: Astral BlazeMaster Fire Sprinkler systems

Special products: FirstPlast channel drains used for indoor and outdoor bathroom fittings

Adhesives and Sealants: Resinova and Seal IT (acquisitions); entry into construction chemicals

Supreme (growing into newer polymers, raw materials for servicing multi-industry clients; an emerging engineered plastics company)

Introduced a new range of insulation products, including the NBR PVC hose

In Cross Laminated film products: the 35 GSM was launched

Composite LPG cylinder launched Insulation vertical: introduced higher

ID chiller pipe insulation material 4 layers insulated water tanks in 500

ltr and 1000 ltr capacity

In FY15, Supreme introduced Silent Pipe System, Bath fittings, Solvents, several varieties of Pipe fittings, Premium range of furniture, overhead storage tanks and cost effective solutions in the Protective Packaging Division, CPVC Fire Sprinkler system

In Q3FY16, the company will be launching chrome plated bathroom fittings, along with various un-plated varieties

Plans to add more than 100 varieties of Plastics Pipe Fittings for various applications

In Cross Laminated film products: launching six colour printed film on 9 feet width Roll (around Jan/Feb 2016)

Launching new varieties of Special type of Pallets and Crates along with installation of a 3000 ton Injection Moulding Machine during Q4FY16.

Ashirvad (as part of the Aliaxis, Ashirvad will become a pipes supplier to multiple industries and possibly start selling treatment solutions and pumps)

Ashirvad developed a co-moulded ring/seal for soil, waste and rain outlet systems.

In early 2015, a full range of underground drainage pipes and fittings was introduced with the support of REDI (Italy)

Introduced Pan Connectors, Grease and solid interceptors, Air Admittance Valves, Fire Collars, Chambers and Manholes Introduced two acoustic SWR product lines, developed in collaboration with the product development teams in France

Cooperation with Aliaxis Latin America has led to the launch of a range of concealed valves in the hot & cold water supply segment.

Ashirvad collaborated with specialists from FIP in Italy to develop a full range of ball and butterfly valves in uPVC as well as cPVC.


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FY10 FY11 FY12 FY13 FY14

Supreme Astral Ashirvad

Building Materials


Mapping the pipe companies on the IBAS framework

We have used the IBAS framework to rank the organised plastic piping companies. The IBAS framework is based on four key parameters: (a) innovation, (b) brand, (c) architecture, and (d) strategic assets. Supreme is the highest-ranked company amongst organised players, owing to superior architecture, strong brand recall and diversified product portfolio.

Astral and Supreme - Leaders in innovation: Astral was the first company to introduce CPVC pipes in India and they have recently introduced new products such as composite column pipes, blazemaster and bendable pipes. Supreme Industries has more than 5,800 products in pipes and fittings developed through feedback from distributors. Further, Supreme has plans to launch composite cylinders after getting approval from PESO. In addition, the company would launch other composite products such as pipes and pallets and fire resistant pipes.

Brand equity: Supreme has the strongest brand in urban cities for PVC pipes. Astral also has high brand equity for CPVC pipes in urban cities. Finolex Industries has the highest brand equity in rural markets. Ashirvad also a strong retail brand but mainly in South and West India.

Supreme has superior architecture: Supreme has pan-India manufacturing reach through 22 manufacturing plants across India not only for PVC pipes but also for other products such as protective packaging. Finolex’s manufacturing plants are mainly located in west India. Astral is expanding its reach through a new plant at Hosur, Karnataka in south India. Ashirvad has only one plant in South India.

Strategic asset: Astral’s and Ashirvad’s tie-up with Lubrizol is a source of key competitive advantage. In our opinion, Supreme’s unmatched pan-India distribution reach and its patent license for cross laminated film product are its strategic assets.

Exhibit 50: IBAS framework for organised PVC pipe players

Innovation Brand Architecture Strategic asset

Overall rank

Rural Urban Manufacturing reach

Distribution reach

Supreme Industries

Astral PolyTechnik

Finolex Industries

Ashirvad Pipes Prince Jain Irrigation Source: Ambit Capital research; Note : - Strong; - Relatively Strong; - Average; - Relatively weak.

Exhibit 51: Comparison of the top-6 plyers

Company

Capacity (tons)

Revenue ( mn) CAGR

Products Plants (figures in brackets indicate no. of plants in the state) FY15 FY15 FY10-FY15

Supreme 340,000 21,140 20% Plumbing and Agri Maharashtra (3), UP (1), WB (1), MP (2)

Astral 102,371 12,521 34% Plumbing, Agri and Industrials Gujarat (2), HP (1), TN (1)

Ashirvad 70,000 13,601 32% Plumbing, Agri and Industrials Karnataka (2)

Finolex 230,000 16,938 15% Largely Agri, now getting into plumbing Maharashtra (2), Gujarat (1)

Prince 90,000 6,907 14% Largely Agri, now getting into plumbing Dadra (2), Uttarakhand (1), Maharashtra (1), Tamil Nadu (1)

Jain Irrigation 100,000 11,628 2% Agri Maharashtra (2), Gujarat (1), TN (1)


Building Materials


Exhibit 52: Strategic initiatives and channel checks on the top-4 brands Pipes Company’s plans Our channel checks

Supreme

Expanding scale: Set up two units, one at West Bengal and one at Madhya Pradesh. 25 manufacturing units enable the company to reach its products to the market at shortest possible time with least freight cost.

Increased channel partners from 2257 on 30th June 2014 to 2469 on 30th June 2015.

Taken measures to increase product awareness through advertising by way of TV, Radio, Print media, outdoor i.e. bus panel hoarding, wall painting etc.

Leading brand with superior distribution to any other pipe manufacturer in India. Commands a premium in PVC plumbing pipes

Astral

Acquired Seal IT Services (UK) and Resinova Chemie Limited during FY14; with these acquisitions the company now supplies a full range of products in the Adhesives, Sealants and Building Chemicals segment.

Appointed Salman Khan as the brand ambassador Commenced production and sales from its South-based plant (Hosur- Tamil Nadu) which will help expand its Southern market in India.

The leaders of CPVC pipes, command a premium across CPVC price range and have a superior quality product compared to Supreme

More focussed on plumber trainings that its competitors post the launch of its products

Finolex

The company opened a depot at Cuttack and is starting two new depots at Noida and Indore, to improve distribution.

In the non-agri, the company is focusing on leveraging its distribution strength, by targeting the rising demand for pipes and fittings in tier two and tier three cities

Finolex has also added a Column pipes, to its portfolio. Column pipes are suitable for submersible pumps which are used to draw water from bore wells.

Largely perceived as an agri brand and is now trying to build its retail reach

Amongst the top-5 brands, it is the lowest priced product

Ashirvad Tied up with Aliaxis, which gives the company to ability to launch new-age high

quality piping products in India Doubled capacity in Karnataka

Premium player with high quality products. Market leader in South India


Exhibit 53: Consensus expects a sharp uptick in Supreme’s revenue in FY17

Source: Company, Bloomberg, Ambit Capital research

Exhibit 54: Supreme’s margins have historically been higher than Astral’s


Exhibit 55: The gap between Supreme’s and Astral’s RoE is narrowing


Exhibit 56: Supreme is trading at a 30% discount to Astral


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Astral Supreme5-yr average (Astral) 5-yr average (Supreme)

Building Materials


Entry of global players; is it a threat?

Similar to Indian plumbing pipes industry, global pipes industry is also fragmented with multiple local players. However, a few of the global players have become leaders across the developed regions on the back of continuous product innovation; in many cases we note that Indian companies have tied up with these leading pipe companies (Wavin) for new products (new applications). Amongst the global players, only Georg Fischer and Aliaxis are present in India; whilst Georg Fischer has a very nominal presence, Aliaxis acquired Ashirvad to get a strong foothold in the large Indian market. PipeLife (who is part of Weinerberger) could enter into India as Weinerberger has a presence in India for selling clay bricks, clay roof tiles and clay facades.

Amongst the global pipes companies we note that Georg Fischer and Aliaxis are the fastest growing because of acquisitions and continuous product innovations. We do not think any of these global majors will be able to enter India and prove to be a threat to Indian players given the vast geography and importance of wide/deep distribution network. Similar to Aliaxis, any global entrant will have to either acquire a leading player or partner with them; given their own reputation and focus on innovation, we believe it is unlikely that these globals could look beyond the top-4.

Exhibit 57: Large global players who could enter India in the future

Company Piping products Countries of operation FY14 (in USDmn)

3-year CAGR

5-year CAGR

10-year CAGR

Georg Fischer Fittings, valves, pipes, automation and jointing technology and covers all water cycle applications

Germany (29%), Rest of Europe, Asia, Americas, Switzerland, Austria

4,008 11% 14% 7%

Aliaxis PVC water distribution, waste outlets and taps, WC equipement,waste water drainage, raingutters,

North America, Latin America, Europe, Australasia, Asia, Africa

3,456 15% 11% 8%

Wavin (part of a Petrochem/Chemicals major, Mexichem)

Pipes and fittings providing solutions for drinking water, rainwater, sewage, heating & cooling water

UK, Europe, Asia, Middle East, Russia 1,449 -3% 1% 2%

PipeLife (part of a building material solutions major, Weinerberger)

Pipes, fittings, floor drains, traps, roof drainage systems, water heating systems, PVC, PP & PE pipe systems

US, Central Europe, West & North Europe 1,053 3% 0% 2%

Poly pipes Plumbing, heating and drainage products, rainwater and sewer systems, cable protection systems

UK, France, Italy, Middle East 520 15% NA NA


Building Materials


Tiles Not as akin to paints as it seems Five tile manufacturers in India have >`10bn revenue and the laggard brands have a clichéd strategy - scale enhancement, improving retail brand recall and portfolio improvisation. Alongside a strong brand, what sets Kajaria and Somany design/size/finish leadership apart are a healthy balance sheet and a professional mid-level management to implement the stated strategies. Process innovation, talent pool, branding and efficient logistics management are the key competitive advantage which competitors will find difficult to replicate. Whilst demand remains weak (especially from organised real-estate), the levy of anti-dumping duty partially mitigates the growth challenges faced by the domestic players. Whilst we believe that established brands will garner market share over time, we do not think that the supremacy of the top-2 brands will be as profound as the paints industry; no manufacturer in tiles has a major lead in terms of scale and larger players from other categories can establish a decent franchise at low capital intensity if they approach the business in a right manner.

Sharp demand deceleration but larger players maintain superior growth Tiles demand growth has decelerated significantly in the last few quarters; a few channel participants highlighted nearly flat YoY volumes for the last two quarters. Revenue growth of leading brands, Somany and Kajaria dropped to 11% in 2QFY16 vs 19% average for last 14 quarters. EBITDA margin of 14.5% is the highest in the last 16 quarters, led by a sharp reduction in gas prices. Both Somany’s and Kajaria’s JV sales increased, since the cost of manufacturing for JVs is lower than own manufacturing (given spot LNG procurement). Exhibit 58: Deceleration in revenue growth of tile manufacturers


Exhibit 59: Margin improvement driven by savings in raw material costs


Exhibit 60: Kajaria and Somany continue to gain market share


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Building Materials


Anti-dumping duty: A much-needed shot in the arm

Anti-dumping duty is likely to be levied shortly (US$2.5-3/msm) which will wade off competition from the Chinese manufacturers, who are currently aggressively dumping in India. Not only will this support volume growth for domestic players (Chinese garnered 10% market share in India) but also support pricing growth given that the Chinese products were priced much lower than the domestic tiles; reducing input prices plus no pricing competition could keep margins high

Big brands maintain expenditure on branding and distribution

Kajaria and Somany have maintained expenditure on brand building and increased dealer count by ~20-30% in 1HFY16 despite an adverse demand environment. Kajaria’s increased branding expenditure by 69% and Somany by 48% in FY15. The growth in branding expenditure of other smaller brands is much lower than Kajaria/Somany as the former aim to protect their margin in times of weak demand.

Exhibit 61: Kajaria’s branding expenditure increased by 60%...


Exhibit 62: …and Somany’s by 47% in FY15


Scale expansion and rising JV mix

The proportion of sales from JVs for Kajaria and Somany has risen in 1HFY16, as the JVs benefit disproportionately from the gas price reduction, since they procure gas at spot prices. Both the companies continue to add scale either through JVs or organic capacity expansions to sustain the growth rate and gain market share in new markets. Companies are setting up capacities in South India to reduce the lead time and logistics cost to reach the end market and hence strengthen their franchise in the region, which is a large and premium tile market of India.

Exhibit 63: Savings in LNG prices


Exhibit 64: …and rising share of JV production


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Kajaria and Somany have maintained expenditure on brand building and increased dealer count by ~20-30% in 1HFY16 despite an adverse demand environment

Building Materials


RasGas deal should reduce gas procurement costs RasGas prices prevailing at US$12/mmbtu are likely to be reduced to US$7-8/mmbtu as per media reports which will positively impact the tile manufacturers. In addition, this will also remove the take-or-pay overhang, in case of shortfall in procurement from the tile manufacturers. Expansion in Sanitaryware/faucets

Tile majors forayed in sanitaryware in the last few years and have gradually built a `500mn-1,000mn turnover, largely through outsourced manufacturing and JVs with Morbi-based players. The products are largely in affordable mid category and these players are currently selling at a 20% discount to the established brands. We believe this product portfolio can easily sell in the cities outside top-10/15 as the strength of brand recall can help Kajaria/ Somany gain entire share of the IHB bathroom. Tiles - Can it replicate the paints industry? Investors compare tiles to the stellar growth exhibited by the paints industry, since both are large categories and two brands stand out from the rest. Whilst we agree that Kajaria and Somany are indeed doing a credible job of building a strong franchise, we are still not convinced that they will garner as much market share as the paints company did over the last decade and a half, since: #1 - Manufacturing is not that big an entry barrier: Paints had both manufacturing and logistics as an entry barrier, which is not as significant in tiles given that a large and efficient manufacturing cluster can be used by competition to enter this segment. Rising propensity of the unorganised manufacturers to partner with the larger brands, we believe that a key barrier to entry – manufacturing – will cease to exist for unrelated home building brands such as Asian Paints. If a brand like Asian Paints, which has a strong franchise, access to capital and a talented management team, decides to enter into this category, then it can build a credible brand in 3-5 years. #2 - No player has a clear scale lead: Unlike Paints, wherein Asian and Berger had a clear lead; in tiles apart from Kajaria and Somany, other organised manufacturers such as H&R Johnson, Simpolo, Varmora and Asian Granito have a fairly large scale and are expanding capacities. #3 - Product innovation is NOT a key competitive advantage: Our checks in the ecosystem suggests that each company has a wide array of designs/sizes and the scope of design innovation is little and competition replicate new designs. Also, dealers highlight that the quality of Morbi is as good as the branded manufacturers. Whilst Somany and Kajaria have more than two-third of their sales through retail channels, most other brands have a materially higher institutional mix and aim towards improving their retail mix. What differentiates Kajaria and Somany?

The exhibit below highlights that Kajaria and Somany have grown significantly ahead of peers in the last five years.

Exhibit 65: Kajaria and Somany have growth significantly higher than other peers


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Building Materials


In our view, the reason for this is:

#1 - Brand leaders: Kajaria and Somany started investing in brand and distribution much before their peers and they are clearly the brand leaders in India. Both these companies have a significantly higher proportion of retail sales.

Note in the exhibit below that in the last five years Kajaria and Somany have spent the highest on branding, which is clearly manifesting in superior sales growth for these companies.

Exhibit 66: Kajaria and Somany have spent significantly on branding

Source: Company, Ambit Capital research;

#2 - Distribution architecture: Both Kajaria and Somany have a significantly superior distribution architecture, with pan-India presence and better dealer service than the unorganised players. Dealers rate Somany and Kajaria highly for prompt delivery (48 hours in most cases), despite having over 2,000 SKUs.

#3 - Balance sheet bandwidth: Kajaria and Somany have higher RoCE than most of its peers, strong cash flow generation (highest CFO/EBITDA in the industry), and low debt/equity. Barring Kajaria and Somany, none of the branded manufacturers have the financial strength (high leverage, poor cash conversion) and hence they are facing growth challenges, in the current adverse demand environment. Moreover, the unorganised players show aversion to partner with these players given their weak balance sheet.

#4 - Management quality: During our recent trip to Morbi, we met multiple industry participants and we received extremely positive feedback on Mr Ashok Kajaria and Mr Abhishek Somany, as being way ahead of their peers; most of the smaller brands would willingly associate with Kajaria and Somany, given their reputation. The quality of management is also visible in exceptional capital allocation by both the companies, which has led to industry leading RoCEs and unlevered balance sheets.

Also, both these companies have built a strong process ecosystem, with senior vertical heads to implement the sales, marketing and logistic strategies. Not only have these companies managed to retain high-quality talent and helped them grow up the ranks, but have recently been able to attract talent from other companies to strengthen their franchise.

In building materials, ability to attract top-talent and setting strong processes is a significant competitive advantage, which is not easily replicable by the competitors.

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Building Materials


Exhibit 67: Strategy and primary checks on the top-4 companies Tiles Company's plans Our channel checks

Kajaria

Scale expansion: 3 MSM ceramic floor tile capacity at Gailpur is complete; commissioned a 5 MSM polished vitrified tiles facility in June 2015. Setting up a 6.50 MSM polished vitrified tile greenfield facility in Rajasthan by Q4/FY16. To put up a 5.70 MSM polished vitrified tile facility in Andhra Pradesh by 2016-17. Distribution: Increasing shelf space by growing the dealer and sub-dealer network, primarily in Tier II and Tier III cities and towns. Opening exclusive showrooms for all product segments like Kajaria Galaxy, Kajaria World, Kajaria Star, Kajaria Prima and Kajaria Studio etc. Working closer with dealers, subdealers, masons and architects towards skill development, thereby graduating them into Kajaria’s brand ambassadors. Brand Building: Invest in television campaigns on select national and regional channels. Focusing on social and digital media campaigns Lastly, Kajaria is building a strong mid-level management and has recently hired senior personnel across vertical heads

Kajaria undoubtedly is the strongest and the most premium tile brand in India. The company's dealer margins are amongst the lowest and the company also works on strict credit terms. Its early entry in vitrified tiles has helped in establishing the company as the best GVT brand Logistics management of the company is better than most peers given its higher scale The company has designated sales executives for major dealers who help them in inventory management, commissions etc The JV partners highlight that the company ensures 90% offtake and working with Kajaria is more profitable than standalone operations

Somany

Plan to add 4 msm of new capacity in the value-added segment. Commissioned 4msm of PVT capacity in Oct-15, through a JV Aggressive expansion of touch points, majorly into tier II and III cities and investment into brand promotion. Two of the company's nascent but promising business blocks, Exports and sanitary Ware & Bath Fittings, are headed towards 1bn sales Innovative branding: Improving brand recall through social media and innovative advertisement campaigns.

The oldest ceramic tile brand in India and commands premium in ceramic floor tiles Whilst the company has been a late entrant in vitrified tiles, it has managed to build a good brand in the last few years Credit terms are better than Kajaria but stricter than the smaller brands Equally as good as Kajaria in terms of product launches, design inventory Existing JV partners already thinking about next leg of capacity expansions with Somany

H&R Johnson

Entering new segments but no focus on expansions in tiles: H&R Johnson has announced strengthening of its strategic partnership with Germany’s Nobilia, by expanding its operations and opening its first store in Mumbai. H&R Johnson (ill promote Nobilia in the retail and developer space. Hired a prominent Bollywood actress as the brand ambassador.

Losing market share due to quality issues, despite being one of the oldest ceramic brands in India Losing market share in East India, given aggressive marketing by the leading brands Facing production challenges due to which cost of manufacturing is higher Produces lower end of the vitrified tiles

Asian Granito

Increasing dealer incentives: In FY15, the Company broke new ground by unveiling its new products á la photographic and painting exhibitions. It offered lucrative incentives to its dealers to enhance visibility. The Company to enhance the visibility ensures that its dealers are always adequately stocked with Asian Granito products.

Premiumisation strategy: Outsourcing to address the growing demand for tiles addressing the mid-value and institutional segments, leveraging capacity for the Company to focus exclusively on high-end products.

Dealer network: In FY15 the company widened its pan-India distribution footprint, reaching out to more than 4,000 dealers and trade associates. The Company doubled its domestic presence, adding 1,200 dealers and sub-dealers, it established 25 exclusive showrooms across major Indian cities and set up dedicated 2014-15. Hired the COO of Somany Ceramics Mr Tapan Jena as the CEO of the business Expanding capacities in Gujarat

Disruption in brand recall, due to the rebranding exercise in FY12 Largely in an institutional brand with significantly lower penetration than the leading brands Incentive structure is significantly better than Kajaria and Somany, since it is trying to expand dealer base


Kajaria - Limited room for further multiple expansions

Kajaria’s stock price has increased by 54% in the last one year, despite the worst demand growth phase in the last decade, since the company maintained industry leading growth and posted a significant improvement in EBITDA margin. Whilst Kajaria has displayed traits of a champion franchise evident from the strong growth and significant improvement in RoCE in the last decade, we do not think that Kajaria’s multiples have further room to grow (24x FY17E EPS), given the demand uncertainty and no little chances of consensus earnings upgrades (25% EPS CAGR over FY15-17E).

Building Materials


Somany – Improving franchise; trading at a 40% discount to Kajaria Whilst industry growth decelerated in FY15 and 1HFY16, Somany posted nearly 2x the industry volume growth, due to superior design innovation and investments in brand/reach expansion. Alongside continued capacity expansions, the management expects to expand PBT margin by 200bps by FY18, underpinned by higher vitrified mix and operating leverage benefits. The stock is trading at 16x FY17 consensus EPS (40% discount to Kajaria); multiples should be seen in light of the large opportunity but few credible participants.

Somany has underperformed Kajaria by 45% in the last one year, despite higher earnings growth and improving RoEs. It now trades at a 40% discount to Kajaria and consensus expects 33% earnings CAGR and RoEs of 24% over FY15-17.

Mapping the tile majors on the IBAS framework Kajaria and Somany fare much better than other tile companies on the IBAS framework, than its peers, reasons being:

Innovation: Kajaria launched GVT ahead of most of its peers which gave it a lead over peers in terms of profitability and brand perception. Similarly it partnered with Morbi-based players as JVs, thereby reducing capital intensity ahead of most peers in the Industry. Somany was the first Indian tile manufacturer to launch slip-shield tiles and abrasion resistant Veilcraft and Shield (patented) technologies.

Branding: Kajaria is the tile brand leader in India, which is evident from higher realisation than peers and the least exposure to institutional clients. The company recently won the “Super-brand” award for the eighth consecutive time, and it has been awarded Asia’s most-promising brand and it is also the most certified tile company in the world. Somany Tiles is one of the oldest tile brand in India and a premium brand in ceramic tiles. Its vitrified tile brand has improved in the last few years, although the company has been a late entrant in this segment.

Architecture: Here we ascertain the relative positioning of companies based on manufacturing and distribution reach. Kajaria trumps its peers due to highest capacity share and continued expansions alongside pan-India reach through over 6000 dealers and 23 offices. Somany is the third largest tile manufacturer in India but it is also increasing capacities steadily. Somany also has pan-India reach through multiple distribution centers.

Strategic asset: Whilst there is no discernible strategic asset, barring the scale brand, we believe that superior balance sheet and reputation of the promoters positions them a few notches above competition. Both Kajaria and Somany have tax SOPs for their own capacities, which is also a strategic asset for these companies.

Exhibit 68: Kajaria and Somany fare better than other tile manufacturers on the IBAS framework

Company Innovation Brand Architecture Strategic

asset Overall

rank Manufacturing Distribution

Kajaria

Somany

Asian Granito

H&R Johnson

Nitco

Orient Bell

Source: Company, Ambit Capital research.

Note: - Strong; - Relatively Strong; - Average; - Relatively weak.

Building Materials


Exhibit 69: Consensus expects Somany to grow faster than Kajaria


Exhibit 70: Despite a significant gap in EBITDA margin…


Exhibit 71: …the RoE of Kajaria and Somany is likely to converge


Exhibit 72: Somany is trading at a 40% discount to Kajaria


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Building Materials


Wood panel products (ply and laminates) Smaller players stuck in a rut Unlike other building material categories, which are used at the time of construction, timber products (plyboards and laminates) are used after the sale of the residential units. Secondary real estate transactions have declined sharply in the last few quarters, which has led to a sharp deceleration in revenue growth of Century Ply and GreenPly (2-3% revenue growth in 1HFY16 vs 17-21% CAGR over FY10-15). Whilst the demand recovery might take some time, we believe that larger players will be able to gain market share, as the smaller players face issues such as raw material procurement (face timber), regulatory changes (GST) and liquidity constraints (black money squeeze). Century Ply’s focus on scale/reach expansion and long-term security for face veneer position it favourably in the large-but-fragmented plyboards market in India. We also like GreenPly given its strong improvement in the MDF business and given that it is finding its feet in ply again, post the resolution of the channel disruption. Greenlam is the smallest of all the branded wood panel companies but we believe its business has much stronger visibility given the promoter’s focus on innovation, rising application, exports opportunities and very strong customer connect.

Growth rates taper, rising down-trading and margin expansion

Our channel checks suggest that plyboard demand in India has declined by 8-10% in the last one year, whilst the top-2 players managed to maintain revenue growth in high single digits in FY15, revenue was flat in 1HFY16. Despite an adverse demand environment, Century’s plyboard volumes grew by 5% (as against a 2% decline for Greenply) led by market share gains from the unorganised players in the affordable segment. Volume for Century’s mid-end product, “Sainik”, grew by ~10%, whilst its premium product’s volumes dropped by 6% in 1HFY16. Similarly, Greenply’s mid-segment product “Ecotec” volumes grew by 16% in 2QFY16, whereas the premium product’s volumes dropped by 9%. This indicates rising downtrading as consumers are shifting to a lower priced product given the weak demand environment.

Exhibit 73: Sharp deceleration in revenue growth in the last few quarters

Source: Company, Ambit Capital research (we use the sum of Century Ply and Green Ply for our analysis)

Exhibit 74: EBIT margins have remained stable due to lower RM prices

Source: Company, Ambit Capital research (we use the sum of Century Ply and Green Ply for our analysis

Unorganised manufacturers losing steam

The aforementioned decline in plyboard sales and the clamp-down on black money has had a magnified impact on the unorganised manufacturers that have had to scale down owing to the working capital stress. Add to that, regulatory changes and difficulties in evading indirect taxes, the competitiveness of the unorganised players has dropped materially, which leaves room for incumbents to gain market share.

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Building Materials


Lower brand relevance than other categories; low scope for premiumisation Our channel checks suggest that the relevance of branding is much lower in plyboards, since it has no aesthetic value (unlike paints, tiles and sanitaryware) and is covered by laminates. Hence, the company’s initiatives are largely with the intermediaries (carpenters, interior designers), who influence the buying decision of the end-consumers. Whilst premiumisation is rising in most building material categories, the scope for the same is low in plyboards, as furniture penetration increases in tier II/III cities, evident from strong growth in the mid categories of Century Ply and Greenply. Organised competitors much smaller in scale than Century and Greenply Apart from Century Ply and Green Ply, no other plyboard manufacturer has a major scale advantage and the third largest player is only one-fourth their size. The scale advantage has helped the company commit capital in raw material security and adding product lines such as MDF.

Exhibit 75: Century and Green are way ahead of its peers in terms of scale


MDF finding acceptance, but will still not overshadow plyboards

The ban of face timber exports from Myanmar resulted in a sharp increase in prices of low cost plywood, due to which MDF has started finding acceptance in retail markets (albeit in small quantities). This is evident from a sharp increase in MDF volumes of Greenply in FY15 and 1HFY16, with capacity utilisation increasing to 90% vs 70% in FY14.

Exhibit 76: Century and Green are way ahead of its peers in terms of scale


Century continues to perform better than Greenply Century’s 2QFY16 LTM ply revenue growth was 7.5% as against 5% for Greenply, which is a function of Century’s aggressive expansions and Greenply facing challenges such as channel disruption (uneven incentive structure) and quality issues. Moreover, Century’s LTM Ply EBIT margin is 18% as against 8% of Greenply, which is a function of lower cost of face veneer procurement from Myanmar and sales of high margin face veneer in the market.

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Building Materials


Exhibit 77: Century’s revenues have growth higher than Green…

Source: Company, Ambit Capital research (we use the sum of Century Ply and Green Ply for our analysis)

Exhibit 78: …and it has posted higher EBIT margins

Source: Company, Ambit Capital research (we use the sum of Century Ply and Green Ply for our analysis

Exhibit 79: Companies’ strategy and channel checks

Timber Products

Century Ply

Raw material security: Global face veneer linkages to ensure long term RM availability. Targeting smaller untapped centres, launching economic brands MDF The company entered the MDF business through an outsourcing model and is adding its capacity in Punjab (`2.5bn) Distribution: Increased depots, dealer-count to accelerate growth across regions and deliver operational and logistical cost-cutting

The company has been very aggressive in pushing the Sainik brand in the market where its finding difficulty in positioning its premium products Undeniably the best quality and commands a premium over any other ply brand in India The relevance of branding is the least in ply but distribution is important and Century has managed distribution extremely well, with its spread out plants and warehouses

Greenply

Increase pan-India brand visibility through proactive below the line (BTL) and above the line (ATL) activities, achieve better Ramp up MDF capacities: A new plant is being set up in the Chittoor district of Andhra Pradesh, with an installed capacity to produce 1,200 cubic metres of MDF per day for an estimated investment of over `. 6bn. The company has entered into a joint venture with a Singapore based company to control and run the veneer manufacturing facility in Myanmar.

The company was facing channel disruption due to uneven incentive structure. It has now made the incentive structure even and reduced the relevance of big dealers The company was facing quality issues (white spots) and rising counterfeits, which has been adequately addressed by the company The company has focused on growing the Ecotec brand and has started pushing it in tier II//III markets

Greenlam

Plan to increase laminate capacity (million sheets per annum) from 10.02 to 12.02, with a project cost of `. 20 crore. Further to put up a new 1.2 lakh engineered doors capacity in FY16, with a project capital cost of `. 270 mn Advertising its engineered wood flooring brand - Mikasa, in tier i towns, working with intermediaries. Investments in increasing SKUs and quality enhancement for premium product positioning

Greenlam and Merino are the best brand and do good logistics management, given the high number of SKUs in laminates, logistics is a key competitive edge. Greenlam is focusing on the 1mm laminate category, which is a premium product

Source: Company, Ambit Capital research, Channel checks

Mapping the ply and lam manufacturers on the IBAS framework We compare the panel product manufacturers on an IBAS framework and find Century one step ahead of peers due to innovative launches, premium brand positioning, well established production and distribution architecture and raw material linkages Innovation: Century was the first Indian company to launch borer proof plywood in India in 1997. It has also launched new-age products such as wood plastic composites ahead of its peers which could be a large opportunity in the future. Similarly, Greenply was the first Indian company to expand majorly in MDF. Greenlam has a devoted R&D team and it is the first player in India to offer a complete range of anti-bacterial laminations and 10ft veneers. Greenlam has recently launched wooden flooring with patented lock mechanism Branding: Century is the most premium ply brand in India and commands a 5-8% premium to its closest competitor. It has recently launched television commercials for its premium and mid-segment play and also for its laminates to further strengthen its

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Building Materials


brand. Greenply is the second best ply brand in India but has the best MDF franchise. Greenlam and Merino are the most premium laminate brands

Architecture: Century has seven plants across India (presence across regions) and manages distribution through 36 warehouses. Greenply has four plants in India but none in South India. Greenply has two plants (West and North India), 14,000 dealers, distributor presence and 40 sales and marketing offices (India and abroad). Strategic asset: Raw material linkage is the key strategic asset for both Century and Green. Century has leadership in face veneer (Myanmar and Laos), and Greenply has a JV in Myanmar to meet its face veneer needs and is setting up plantations for core timber. Moreover, both the companies have tax-exempt plants in North East India.

Exhibit 80: Century is positioned better than peers on the IBAS framework


asset Overall Rank Manufacturing Distribution

Century Ply Greenply Greenlam Uniply Sarda Ply Source: Company, Ambit Capital research.


Greenply- finding its feet again

Greenply’s channel disruptions and corporate restructuring meant that company’s plyboard growth decelerated in FY15. The company has taken measures to address the channel disruption (even incentive structure and reducing the bargaining power of the big dealers) and its face veneer plant in Myanmar is now operational which is sufficient to meet its requirement for the raw material. Moreover, its MDF division has started performing well (90%+ utilization since 3QFY15 as against 73% in FY14) as the company launched new products (pre-laminated and UV coated boards) and MDF competiveness rose as the cost of low-quality plywood shot up. Greenply’s management is focused on growing the MDF business with a 3x scale expansion in next 4 years– to 0.54mn CBM by FY18-end as against 0.18CBM in FY14. The stock trades at 15x FY17 EPS.

Greenlam- capex phase behind, time to reap free cash flows

Whilst laminates is a relatively small market, the top-4 players (Greenlam, Merino, Royale Touche and Century Ply) have a significantly superior franchise than their competitors, in terms of scale, design innovation and distribution management. In the recent building material exhibition in Mumbai, we were impressed by Greenlam’s approach of building scale across decorative surface products which is run by experienced vertical heads, which means that the company will be able to sustain the stellar performance of the last five years (21% revenue CAGR over FY10-15). The company incurred Rs2bn over the last two years to expand its laminate capacity in Behror and to add new products such as melamine faced chipboards and engineered wood floorings/doors and the capex need for the next 3 years is modest (Rs800-1,000mn).

Rising market share in laminates, improving margin (scale benefits and lower crude prices) and low capex needs for the next three years could lead to significant earnings and free cash flow growth for the company. Whilst near-term multiples look stretched on a low base, we believe that the opportunity is large enough and hence near-term multiples do not depict the potential of sustainable future earnings growth.

Building Materials


Exhibit 81: Consensus expects Century and Green to grow at a similar rate


Exhibit 82: Century’s margin is significantly higher than Green due to RM linkages


Exhibit 83: Century’s RoE is likely to be significantly higher than Green over FY15-17


Exhibit 84: Century trades at a significant premium to its average P/E


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Building Materials


Sanitaryware Pressure all around Sanitaryware is a relatively small building material category (`35bn) and it is facing rising competition from tile manufacturers and renewed aggression from the global brands. The entry of large global brands in the premium category (and mass premium) will curtail premiumisation opportunity for the domestic manufacturers. Moreover, the top-4 brands are equally large and well-established and account for 60% market share, which restricts the scope of further market share gains. Whilst the sanitation programmes administered by the NDA Government will add to industry growth rates, the opportunity there will not be meaningful for branded players, given the low quality product requirement. Whilst low penetration suggests a large opportunity, we believe that for penetration to improve meaningfully, plumbing infrastructure in rural areas needs to improve significantly, which is a time-consuming process. Leading brands such as HSIL do not display the traits of a champion franchise and its capital allocation decisions in the past have not been enthusing.

Recent entrants gaining share amid slowing industry growth rates

Similar to other categories, growth rate of the sanitary ware industry has moderated on account of a sharp reduction in new residential construction. Moreover, entrants from other categories such as tiles have started building a brand in sanitaryware and have garnered market share (albeit marginal at present). Also, our checks suggest that players like Parryware have become aggressive in India (see Link: http://goo.gl/8ayz3K). Hence, we do not think that established brands such as Cera and HSIL will post strong growth of yesteryears in the near term.

Global majors entering the premium spectrum

Incumbents are facing challenges from tile manufacturers and large global players in the premium category, as players such as Kohler have become aggressive in India and are planning to further increase capacities to sell at affordable prices. Mr David Kohler, CEO of Kohler, in his recent interview stated: “India is absolutely one of our top three strategic markets. We are number one in the US and we’re number one in China. We’re not number one in India yet—although we’re the number one international brand here—but India is right up there in our three most strategic markets globally because we think if we can lead in India over time, as well as the US and China, that’s really global leadership because of the importance that this economy and country will play over time.”

(Source: http://goo.gl/8IcpKI )

German major Duravit started its sanitaryware plant in Tarapur and is growing in Indian at 20-25% albeit on a small base.

Receding pricing power limits margin expansion capability

Sanitaryware is the only category amongst building materials wherein EBITDA margin has been declining (see the exhibit below). Moreover, the recent entrants have been fairly aggressive on pricing, which means that realisation growth possibility for the sector is limited and the companies have to increase branding/dealer incentive to maintain market share. Hence, savings in gas prices, would largely be passed on and hence we do not see a scope of margin expansion in this category.

Building Materials


Exhibit 85: Sharp drop in revenue growth


Exhibit 86: Margin has remained stable in recent quarters


Sanitation programmes such as Swachh Bharat Abhiyaan will not have a major impact on organised manufacturers

The sanitation programmes launched by the NDA Government aims to add 120mn toilets in India by 2019 which seems highly ambitious with little progress seen in the last 12 months. We do not think that these welfare programmes will have a major impact on the organised players since the quality of products is far inferior to the products manufactured by them. Moreover, an increase in rural penetration of sanitaryware requires better plumbing infrastructure which is difficult to develop in a 3-5-year time horizon. Moreover, recent news articles suggest that implementation of the Swachh Bharat Abhiyan in rural areas has been a challenge, owing to poor water supply.

Whilst brand is highly relevant, the customer is now spoilt for premium choices

Sanitaryware is the only category in amongst building materials, wherein brand name is visible on the product which increases the relevance of branding. However, there is no major difference in the brand recall of the top 4-5 players and with global brands such as Jaquar and Kohler expanding reach in tier III markets and product portfolio, there is ample options for the customer to choose from. Also, since tiles manufacturers have a strong recall in their category, they are finding acceptance in sanitaryware as well. Even in large residential and commercial projects, the global brands compete with the Indian brands, using their premium brand as bait and are able to offer competitive prices given that they have indigenous manufacturing capacity.

Cera - Premium multiples not justified: Similar to other building materials companies, Cera saw significant multiple expansion in the last few years. Cera currently trades at 23x FY17E EPS and consensus expects 22% earnings CAGR and 22% RoE. We do not think that the premium multiples are justified due to rising competition in a small addressable market alongside receding pricing power.

HSIL - Unbridled aspirations and capital misallocation risks

HSIL’s stock price has declined by 33% since its QIP due to investor apprehensions on the company’s foray in CPVC pipes and counterfeit management caps/closures. Whilst the company has a very strong brand in sanitaryware, it is facing competition and none of the company’s previous expansions in unrelated categories (tiles, bathroom appliances) have been RoCE-accretive. Given that the CPVC market is dominated by innovators such as Ashirvad, Supreme and Astral, with over a 1.5 decade experience, we do not think that it will be easy for HSIL to establish its brand. Moreover, the company plans to expand in other categories such as high-end kitchen fittings, kitchen designing/installation and ‘other’ home building categories concern us. Whilst the stock appears less expensive than other building material names (14x FY17 consensus EPS), it should be seen in light of single-digit RoEs (consensus estimates of 9% in FY17) and high risks of capital misallocation.

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Building Materials


Mapping the sanitaryware majors on the IBAS framework We compare the two Cera and HSIL on the IBAS framework. HSIL and Cera fare similar on innovation, HSIL has a better brand and distribution whereas Cera has access to APM gas for two-third of its gas needs (strategic asset).

Innovation: Both the companies have launched premium designs and added features to reduce water use but we do not note any instances of break-through innovation which has positioned one company ahead of the other. Whilst HSIL tried to enter into the premium and wellness bathing category (through Queo), the company is yet to find meaningful success.

Branding: Our channel checks suggest that HSIL has a stronger brand than Cera and commands a premium across product segments. Both the companies have appointed Bollywood actors as brand ambassadors.

Architecture: HSIL has two plants (one in North India and one in South India), which helps the company better manage distribution, whereas Cera has a plant only in West India. Also, the dealer network of HSIL is more expansive

Strategic asset: Cera receives APM gas (50% cheaper than RLNG gas) which accounts for 60% of its overall production, resulting in sustainable cos the company cost advantages.

Exhibit 87: HSIL and Cera fare similar than on the IBAS framework


asset Overall Rank Manufacturing Distribution

HSIL Cera Source: Company, Ambit Capital research.


Exhibit 88: Top-4 players’ strategy and primary checks Company Company’s strategy Primary checks

HSIL

Commissioned Greenfield faucet plant with an annual capacity of 2.5 million pieces at Kaharani, Rajasthan. HSIL forayed into heating systems and home comfort appliances. Introduce a new product category; domestic water heaters in the market. The products will be sold under a joint brand name of ‘hindware atlantic’. Building a higher profile for HSIL's brands with Shah Rukh Khan and Jacqueline Fernandez to create higher visibility across all media platforms. Expanding in CPVC pipes and counterfeit management caps

Amongst the top-2 sanitaryware brands in India. Presence across the price points and a wide range of product offering. Facing rising competition from Jaquar and Kohler in the premium category

Cera

Cera is making aggressive efforts to leverage the high brand value and for product optimisation, besides deeper penetration in tier 2 markets. The company has appointed Sonam Kapoor, as the brand ambassador in an attempt to increase the brands visibility. Television campaigns on national and regional channels showcasing sanitaryware, faucets and tiles. The television campaign was supplemented by print advertisements in magazines. The company is also strengthening CERA Care, its after-sales division with induction of technicians for taking care of its services in all key cities of the country. Increasing capacities in faucets

Considered as a mid-level brand, the top-end products sell at a discount to HSIL and Jaquar Excellent dealer service, quick deliveries and rising focus on brand building

Parryware (Roca)

Re-launch: unveiled new range of bathroom products to re-launch aims market position in the bathroom products space. Expand retail presence by increasing its dealership network in tier II & III cities, maintaining high focus on quality, launch new businesses & new channels by end of FY 2015 across India. Ramping up production capacity with a planned investment of INR 150 crore in the coming years for ramping up production capacity, R&D and new product launches

The company has revamped top management and become aggressive again in India Whilst the company's brand recall had waned in the last few years, it has started brand building and promotion activities to reinvigorate its brand

Jaquar Launched entry level products with the brand ESSCO and expanding capacities Plans to invest `150mn annually for brand building

Premium brand recall and now has products priced close to the domestic players Improved reach significantly and now available in tier III/IV towns as well


Building Materials


Exhibit 89: Consensus expects Cera to grow faster than HSIL


Exhibit 90: Despite slightly higher EBITDA margin…


Exhibit 91: HSIL’s RoE will remain half of Cera


Exhibit 92: Sanitaryware stocks trade at rich valuations


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Building Materials


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Key Financials (consolidated) Y/E March ( mn) FY14 FY15 FY16E FY17E FY18E

Operating Income 39,622 42,552 32,833 55,215 65,768

EBITDA 5,888 6,662 5,009 8,058 9,677

EBITDA % 14.9% 15.7% 15.3% 14.6% 14.7%

Adjusted EPS (`) 20.3 20.1 17.4 32.7 40.7

ROE (%) 26.8% 22.7% 17.1% 28.4% 31.1%

RoCE (%) 21.6% 17.8% 13.8% 23.8% 27.3%

P/E(x) 31.6 31.9 36.7 19.6 15.7

Source: Company, Ambit Capital research. FY16 is a 9 month period

True to its name

Sustainability of plumbing pipes industry and management’s focus on engineered plastics suggests that Supreme’s revenue will grow in mid-teens for another decade as plastics penetration across applications increases. No doubt Ashirvad and Astral are closing on Supreme in plumbing pipes, but Supreme has enough brand recall amongst channel/intermediaries, product innovation capabilities and capital for sustaining growth. Management behavior remains top-notch in the face of the rising credible competition. Recent volume growth/guidance upgrade provides near-term comfort; composite cylinder is an inevitable and large opportunity with little initial competition. RoCEs might plateau (28-30%), but earnings trajectory will be higher (27% in FY15-18 vs 7% in FY12-15). Key risks: succession, delayed utilisation of composite cylinders and prolonged slowdown.

Competitive position: STRONG Changes to this position: STABLE Pipes – a franchise facing competition not threat Emergence of challengers such as Astral and Ashirvad has increased the competitive intensity in plumbing pipes. However, this will not impact the long term growth trajectory for Supreme’s pipe franchise, since: (a) plastic pipe penetration will continue to increase from price deflation, rising applications; (b) product innovation through technology tie-ups with global leaders and (c) expanding manufacturing/distribution reach along with intermediary education. Engineered plastics – little steps, inevitable large opportunity Whilst Supreme’s composite cylinder capacity (0.5mn) is small and underutilized, the cylinder market in India (20mn cylinder) is large enough to accommodate Supreme’s capacity, once the bureaucratic hurdles are cleared. It is investing `15bn over FY15-20 to evolve as an engineered plastics player (like Berry plastics, Georg Fischer); its wide portfolio of raw materials handled, products manufactured and industries serviced alongside recent investments in composites indicate the direction the company is taking. The end of the downgrade cycle Supreme’s management recently raised volume growth guidance for FY16 after five quarters of downgrades. Capacity expansions, higher VAP mix and improving acceptance of new launches (silent piping systems and solvents) mitigates risks of the building materials slow-down. We estimate 16% volume/revenue and 26% EPS CAGR along with 28-30% RoEs over FY15-18.

Multiples will expand as opportunity transpires to reality Composites and engineered plastics is a large opportunity for innovators; rising acceptance of plastics in India will support Supreme’s revenue/earnings longevity. We expect 15% revenue CAGR over FY18-27 but expect the composite business to grow multi-fold and build related capex. Our TP implies 24x FY17 EPS (20x earlier) for a company with a decade long track record of positive free cash flow and just needing 50% of CFO to double capacities.

CHANGE IN STANCE SI IN EQUITY December 01, 2015

Supreme IndustriesBUY

Building Materials

Recommendation Mcap (bn): `83/US$1.2 6M ADV (mn): `46.6/US$0.7 CMP: `653 TP (12 mths): `785 Upside (%): 20

Flags Accounting: GREEN Predictability: GREEN Earnings Momentum: AMBER

Catalysts

Recovery in volumes in FY16 to 16%

EBITDA margin expansion in FY16 by 40bps, led by stable resin prices

Improving CE turnover from composite cylinder sales

Performance (%)

Source: Bloomberg, Ambit Capital research

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Analyst Details

Nitin Bhasin +91 22 3043 3241 [email protected]

Achint Bhagat, CFA +91 22 3043 3178 [email protected]

mailto:[email protected]


Supreme Industries


Change in assumptions Exhibit 1: Changes to our assumptions

Key assumptions Old estimates New estimates Change in estimates

Comments FY16E FY17E FY18E FY16E FY17E FY18E FY16E FY17E FY18E

Revenues 32,833 55,215 65,768 32,833 55,215 65,768 0.0% 0.0% 0.0%

What are we building in? We are building in ~16% volume CAGR in the plastics business over FY15-18 and revenue contribution of `600mn and `1,200mn from composite cylinder in FY17 and FY18 Changes to our estimates We keep our estimates unchanged from our previously published estimates

YoY growth (%) -22% 71% 19% -22% 71% 19% Plastic Piping Segment 26,186 31,553 37,902 26,186 31,553 37,902 0.0% 0.0% 0.0%

YoY growth (%) 24% 20% 20% 24% 20% 20% Packaging Products 9,712 11,069 12,632 9,712 11,069 12,632 0.0% 0.0% 0.0%

YoY growth (%) 6% 14% 14% 6% 14% 14% Industrial products 6,967 8,413 10,062 6,967 8,413 10,062 0.0% 0.0% 0.0%

YoY growth (%) 8% 21% 20% 8% 21% 20% Consumer products 2,862 3,183 3,507 2,862 3,183 3,507 0.0% 0.0% 0.0%

YoY growth (%) 4% 11% 10% 4% 11% 10% Plastics EBIT 3,654 6,300 7,700 3,522 6,386 7,757 -3.6% 1.4% 0.7% What are we building in?

We build in 30-40bps margin expansion in Fy16 and FY17, since RM volatility should recede incrementaly and as utilisation of recently added capacities increases Changes to our estimates: We keep our estimates unchanged from our previously published estimates

Plastics EBIT margin 11.0% 11.4% 11.7% 11.0% 11.6% 11.8% -3bps 23bps bps Plastic Piping Segment 13.9% 13.6% 13.7% 13.9% 13.6% 13.7% 0bps 0bps bps

Packaging Products 17.2% 17.3% 17.4% 17.2% 17.3% 17.4% 0bps 0bps bps

Industrial products 11.2% 11.3% 11.4% 11.2% 11.3% 11.4% 0bps 0bps bps

Consumer products 11.7% 11.8% 11.9% 11.7% 11.8% 11.9% 0bps 0bps bps

Net depreciation 1,006 1,494 1,663 1,006 1,511 1,720 0.0% 1.2% 3.4% Marginal increase due to factoring in a slightly higher rate

Net Interest Expense 414 445 309 407 415 288 -1.7% -6.7% -6.9% PBT before EO 3,259 6,165 7,633 3,616 6,152 7,691 10.9% -0.2% 0.8% Reported PAT (excl associate income) 2,200 4,162 5,152 2,441 4,152 5,191 10.9% -0.2% 0.8%

Marginal changes in PAT due to higher depreciation

Adjusted PAT (excl real estate sales, associate income)

2,200 4,053 5,152 2,116 4,044 5,056 -3.8% -0.2% -1.9%

Adjusted PAT margin 6.6% 7.2% 7.6% 6.6% 7.4% 7.7% -4bps 18bps bps

EPS (`.) (plastics business) 17.3 31.9 40.6 16.7 31.8 39.8 -3.8% -0.2% -1.9%

Avg working capital days excl. cash & real estate

48 47 46 48 39 38 0.0% -15.6% -15.9% Building in lower working capital days since

the company’s bargaining power with dealers/creditors has not deteriorated Avg. capital

employed turnover excl. real estate

1.9 3.1 3.4 1.9 3.0 3.4

CFO 3,958 3,378 5,951 4,333 4,360 6,312 9.5% 29.1% 6.1%

Increase in CFO and FCF is due to lower working capital investment

Capex (2,000) (2,400) (2,500) (2,000) (2,900) (3,150) Free Cash Flow 1,958 978 3,451 2,333 1,460 3,162 19.1% 49.3% -8.4%

Net debt/equity 0.2 0.2 0.1 0.2 0.1 0.1 Source: Company, Ambit Capital research

Supreme Industries


Near term operational estimates The table below summarizes our near-term volume and realisation growth estimate. We build in 16% volume growth for piping business, 12% for packaging business, 15% and 8% for industrial products and consumer durables, respectively. We build in a moderate realisation growth of 2-3%.

Exhibit 2: Operational assumptions

Volume ` mn Growth


Plastic Piping Systems 264,763 306,970 355,548 15.9% 15.8%

Of which : PVC pipes 249,202 289,074 335,326 16.0% 16.0%

CPVC 15,561 17,895 20,221 15.0% 13.0%

Packaging products 45,279 50,774 56,964 12.1% 12.2%

Of which : Silpaulin 19,346 22,248 25,585 15.0% 15.0%

Others 25,933 28,526 31,378 10.0% 10.0%

Industrial products 41,966 48,261 55,501 15.0% 15.0%

Consumer durables 17,234 18,612 20,101 8.0% 8.0%

Realisation/Kg FY16 FY17 FY18 FY17 FY18

Plastic Piping Systems 99 103 107 3.9% 3.7%

Of which : PVC pipes 90 94 98 4.0% 4.0%

CPVC 238 247 256 4.0% 3.5%

Packaging products 214 218 222 1.6% 1.7%

Of which : Silpaulin 236 243 250 3.0% 3.0%

Others 199 199 199 0.0% 0.0%

Industrial products 166 174 181 5.0% 4.0%

Consumer durables 166 171 174 3.0% 2.0%


The company highlights that it will incur `15bn capex over FY16-20, to significantly increase its capacities. We believe that the company will have sufficient internal accruals to meet the capex needs. We estimate that the company will generate CFO of `31bn over FY16-20, which implies that it will re-invest only 46% of its CFO to meet its capex. Moreover, increasing capacity utilization of the composites business alongside stable margins should lead an improvement in RoEs over FY16-20.

Exhibit 3: CFO will fund capex needs comfortably


Exhibit 4: RoE will improve with increase in CE turnover

Source: Company, Bloomberg, Ambit Capital research; Note FY16 is a nine-month period

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Supreme Industries


Multiples will expand as opportunity transpires to reality

Post discussion with industry veterans in composites and engineered plastics, we understand the plastics market globally is large and much more advanced than India. Large global players such as Wavin (acquired by Mexichem), Aliaxis (recently entered into a JV with Ashirvad), Georg Fischer (a US based plastics processing company) and Berry Plastics, have a large inventory of innovative products that are yet to be launched in India. These companies have been entering into technology collaborations to launch their products in India, and could at a later date forge JVs to bring new technologies in India. We believe that the opportunity to benefit from expertize of global leaders is limited to only a few Indian companies, who have the scale, reach and reputation; Supreme clearly qualifies as one such franchise. On its own also, Supreme has been absorbing technologies for newer applications

Hence, we change our long term revenue, EBIT and PAT estimates for Supreme (see table below), due to which our implied FY17 P/E multiple has increased to 24x as against 20x previously.

Exhibit 5: Changes to our long-term DCF estimates

Particulars Old New Old New

FY18-22 FY18-22 FY22-27 FY22-27

Revenue 13.5% 17% 10.5% 12%

EBIT 14% 17% 10% 13%

PAT 15% 18% 11% 14%


Exhibit 6: Direction that the company could take

Company Films & Packaging Piping systems Automotive/industrial Machining solutions Others

Georg Fischer

Fittings, valves, pipes, automation and jointing technology and covers all water cycle applications

Lightweight cast components for Cars, Commercial Vehicles and Industrial Application

Machines, system solutions, and customer services for manufacturing moulds, tools and parts

Berry Plastics

Flexible, hybrid & rigid packaging, tapes & adhesives, protection solutions

Packaging and adhesives for multiple functions such as household, healthcare and industrial applications


Exhibit 7: Astral is trading at a premium to Supreme on one-year forward P/E


Exhibit 8: Do not expect further EPS downgrades


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Supreme Industries


Risks to our BUY stance Increase in competitive intensity from national-level peers: Supreme’s

competitors (Astral, Finolex Industries and Ashirvad Pipes) have learnt from Supreme and have thereby become highly competitive through higher focus on innovative products, higher brand promotion, widening reach and increase in manufacturing capacities. We are already witnessing Astral and Ashirvad (Aliaxis) gaining market share and many smaller/regional players emerging with focus on building distribution and brand.

Inefficient capital allocation could potentially deteriorate RoCE: In our opinion, Supreme’s strength over the last decade has been its efficient capital allocation in the expansion of fast-growing products like PVC pipes and cross-laminated films. In the future, if the company was to allocate its surplus cash generated from operations into commodity plastics then Supreme’s RoCE would deteriorate eventually, reducing the momentum of its snowball effect. Moreover, Supreme in its transition to an engineered plastics will have to commit to capital to new businesses which may have long gestation period impacting RoCE.

Launch of a disruptive product by competitor: Launch of a disruptive product which is easier to install and with better features than PVC and CPVC pipes by a large competitor remains a risk, since it could eat into the addressable market of Supreme. In USA we have already witnessed launch of PEX pipes and these are substitutes to CPVC pipes

Launch of HDPE pipes in India: HDPE pipes are technologically superior to PVC pipes because PVC joints are brittle as compared to HDPE joints. Currently, HDPE pipes are 25% more expensive than PVC pipes, thereby limiting their use in India. However, if the price advantage of PVC over HDPE were to reduce then HDPE pipes could be used as a substitute for PVC pipes. Whilst this is a risk, we believe Supreme, given its portfolio and technological reach, can also shift its portfolio.

Catalysts to our BUY stance Higher-than-industry-average volume growth due to capacity expansion

in east India: Supreme has recently added capacities in PVC pipes and protective packaging in central and east India. The increase in capacity in these two high-demand products can lead to higher-than-industry volume growth for Supreme Industries once these plants reach optimum utilisation levels.

Strong balance sheet to launch new products with the help of technology tie-ups with international players: We expect Supreme Industries to generate strong cash flow from PVC pipes and cross laminated films in at least the next five years. In sync with the company’s strategy, Supreme could potentially tie-up with an international player to launch a new product in the Indian market such as Flame guard, bathroom fittings and composite cylinders.

Acceptance of composite cylinders: Whilst Supreme’s composite cylinder capacity (0.5mn) is underutilized, the cylinder market in India (20mn cylinder) is large enough to accommodate Supreme’s capacity, once the bureaucratic hurdles are cleared. We have built in improving capacity utilization from FY17 onwards.

Future product modifications could increase turnover and margins: Supreme has a strong track record of introducing product modification of the existing product-line to meet consumer needs. For example, Supreme launched ‘no noise’ high-rise pipes in FY14 in the VAP range. The company could consistently launch such product modifications to increase turnover and margins.

Supreme Industries


Exhibit 9: Ambit vs consensus (FY16 is a 9 month period and the consensus data may not be comparable)

Consensus Ambit Divergence Comments

Revenue ( mn) Our revenue estimates are above consensus as we expect strong plastic pipes volume growth alongside growth in Silpaulin and PVC pipes segments. We also considered sales of commercial real estate asset in our revenues.

FY2016 (9M) 30,479 32,833 7.7%

FY2017 54,533 55,215 1.2%

EBIT ( mn) Our EBIT margins forecasts are higher than consensus in FY16 because we assume increase in percentage of high margin Silpaulin and CPVC pipes to overall EBITDA; our estimates are marginally lower in FY17

FY2016 (9M) 4,487 5,009 11.7%

FY2017 8,214 8,058 -1.9%

EPS (adjusted) ( )

Divergence in PAT is in line with EBITDA FY2016 (9M) 18.0 20.0 11.1%

FY2017 33.6 33.5 -0.3%


Exhibit 10: Supreme Industries on our forensic accounting score

Field Score Comments

Accounting GREEN

In our accounting analysis of BSE-500 companies, we have classified Supreme Industries as an ’industrial company‘. Supreme Industries emerges as the best industrial company (amongst 14 industrial companies) on account of its higher ranking on most parameters (such as miscellaneous expenses as a percentage of revenues, other loans & advances /net worth, asset turnover, and audit fee CAGR/revenue CAGR).

Predictability GREEN The company has always given a detailed description and has made timely disclosures regarding its future strategy, expansion plans, expected business momentum and expected earnings performance in their annual reports and during their conference calls.

Earnings momentum AMBER Over the last six months, consensus EPS estimates for FY15 and FY16 have been revised downward by 15%.


Supreme Industries


Income statement

Particulars ( mn) FY14 FY15 FY16E FY17E FY18E


% growth 16.4% 7.4% -22.8% 68.2% 19.1%

Plastics EBITDA 5,494 5,642 4,528 7,897 9,476

Plastics EBITDA margin 14.1% 13.7% 14.1% 14.4% 14.5%

Net depreciation / amortisation 1,015 1,390 1,006 1,511 1,720

EBIT 4,873 5,272 4,003 6,547 7,958

Interest Expense/(income) 761 580 407 415 288

Other income 32 24 19 20 21

PBT 4,143 4,717 3,616 6,152 7,691

Provision for taxation 1,400 1,600 1,175 1,999 2,500

PAT 2,483 2,443 2,116 4,044 5,056

Share of associates 91 106 100 105 108

Plastics PAT 2,483 2,443 2,116 4,044 5,056

Consolidated PAT 2,573 2,549 2,216 4,149 5,164

Consolidated EPS (`) 20.3 20.1 17.4 32.7 40.7


Balance sheet

Particulars ( mn) FY14 FY15 FY16E FY17E FY18E

Total Networth 10,392 12,115 13,746 15,513 17,712

Loans 3,846 3,929 2,929 2,179 1,179

Sources of funds 15,405 16,939 17,570 18,587 19,787

Net block 10,804 10,325 11,319 12,708 14,138

Investments 1,074 1,207 1,207 1,207 1,207

Cash and bank balances 246 1,818 1,185 590 (5)

Sundry debtors 2,348 2,380 1,857 3,028 3,606

Inventories 4,976 4,647 4,193 6,040 7,031

Loans and advances 2,045 2,196 1,713 2,782 3,313

Total Current Assets 9,633 11,058 8,966 12,459 13,963

Current liabilities and provisions 6,362 6,649 4,919 8,784 10,520

Application of funds 15,405 16,939 17,570 18,587 19,787


Cash Flow statement Particulars ( mn) FY14 FY15 FY16E FY17E FY18E

PBT 4,143 4,717 3,616 6,152 7,691

Depreciation 1,015 1,390 1,006 1,511 1,720

Interest expense/ (income) 761 580 407 415 288

Other income (30) (21) 81 85 87

Direct taxes paid (1,237) (1,422) (1,175) (1,999) (2,500)

Change in working capital (1,401) 765 399 (1,803) (974)

CFO 3,252 6,009 4,333 4,360 6,312

Purchase of fixed assets (1,445) (1,936) (2,000) (2,900) (3,150)

CFI (1,338) (1,859) (1,981) (2,880) (3,129)

Net borrowings 28 (797) (1,200) (750) (1,000)

CFF (1,875) (2,598) (3,281) (2,075) (3,778)

Free cash flow 1,807 4,073 2,333 1,460 3,162


Supreme Industries


Key ratios

Particulars FY14 FY15 FY16E FY17E FY18E

Net debt/Equity 0.3 0.2 0.1 0.1 0.1

Working capital turnover (x) 17.2 13.2 10.1 16.5 18.1

Gross block turnover (x) 2.8 2.6 1.9 3.0 3.4

ROCE 21.6% 17.8% 13.8% 23.8% 27.3%

ROE 26.8% 22.7% 17.1% 28.4% 31.1%

P/E (x) 31.6 31.9 36.7 19.6 15.7

P/B (x) 7.8 6.7 5.9 5.2 4.6

EV/EBITDA (x) 14.4 12.5 16.6 10.3 8.5



Warming up for the marathon

Whilst the plyboard industry’s revenues declined by ~8-10% in 1HFY16, Century posted 6% revenue growth, 340bps margin expansion (aided by raw material linkages) and improvement in cash conversion. Alongside scale expansion and brand building initiatives, its focus on cost leadership, when smaller players are losing ground, bodes well for long-term profitability. With MDF gradually finding acceptance over low-quality plywood, Century’s expansion (at low capital intensity - `2.5bn for 600 CBM) is required even if it disrupts its own ply market. Demand slowdown will not suppress Century’s valuations (17x FY17E EPS), as long as the company is able to use its brand, scale and cost architecture to gain market share, launch effective products and reinvest surplus cash to sustain/improve RoEs (~35% over FY15-18E).

Competitive position: STRONG Changes to this position: POSITIVE Credible performance in difficult times Significant slowdown in secondary real estate transaction led to a sharp decline in plyboard sales for the last 18 months. Century sustained industry-leading growth through scale/product expansion and penetration in smaller markets. Strong margin expansion (340bps), owing to raw material linkages in Myanmar and Laos, drove 48% PAT growth in 1H. Moreover, its cash conversion cycle improved in 1HFY16, led by lower inventory and debtor days. Strengthening its back-end to lead from the front Century doubled its ply/lam capacities, invested in branding (`2.2bn; 3% of sales over FY10-15) and hired senior mid-level managers for business verticals in the last five years. Now, it is doubling its face veneer capacities to gain cost leadership, whilst its smaller competitors continue to face challenges to procure the raw material. Moreover, the company has forayed in MDF, with the product finding acceptance and with the costs of equipment reducing. Well positioned to benefit from the demand recovery Whilst demand recovery will take some time, Century will continue to gain market share in the interim, as regulatory changes and liquidity challenges wipe out the low cost advantage of unorganised players. We expect the company to post 17%/23%/33% revenue/EBITDA/PAT CAGR and 34% RoEs over FY15-18. Unhedged forex exposure (`1.5bn) is the risk to our estimates. Multiples have room for further expansion A large addressable market with shrinking unorganised share bodes well for Century. Century trades at 17x FY17E EPS, a 15-35% discount to other building materials; its multiples will expand as the opportunity translates into sustained earnings growth/profitability; our target price implies 21x FY17E EPS. Whilst competition may be less of a risk, product disruption and capex needs for MDF should keep multiples under check.

COMPANY INSIGHT CPBI IN EQUITY December 01, 2015

Century PlyboardsBUY

Building materials

Recommendation Mcap (bn): `145/US$2.7 6M ADV (mn): `177/US$3.3 CMP: `192 TP (12 mths): `230 Upside (%): 20

Flags Accounting: AMBER Predictability: AMBER Earnings Momentum: GREEN

Catalysts

Uptick in volume growth from 2HFY17 onwards as demand recovers

Market share gain from unorganised in FY16 and FY17 led by regulatory re-sets

Better pricing power, with lower industry fragmentation driving margin expansion

Performance (%)

Source: Bloomberg, Ambit Capital Research

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Analyst Details

Achint Bhagat, CFA Tel: +91 22 3043 3178

[email protected]

Nitin Bhasin

Tel: +91 22 3043 3241

[email protected]

Key financials Year to March FY14 FY15 FY16E FY17E FY18E

Net Revenues (` mn) 13,477 15,648 17,495 20,601 27,090

EBITDA (` mn) 1,766 2,488 3,018 3,493 4,720

EBITDA margin (` mn) 13.1% 15.9% 17.3% 17.0% 17.4%

Net Profits (`) 786 1,365 1,833 2,155 3,054

EPS (`) 3.5 6.1 8.2 9.7 13.7

RoE (%) 36.1% 39.8% 40.2% 34.7% 36.5%

P/E (x) 50.7 29.2 21.7 18.5 13.0




Century Plyboards


Exhibit 1: Assumptions summary

Particulars ( mn unless mentioned) FY16 FY17

FY18

Change (%) Comments

FY16 FY17 FY18

Volumes

Plyboard (CBM) 201,057 213,997 239,676 2% 6% 12% Volume growth in in FY16 and FY17 largely driven by Sainik. We expect strong recovery in FY18, led by recovery in construction

Laminate (Sheets) 4,320,818 4,752,900 5,608,422 20% 10% 18% Volume growth in FY18 to be driven by capacity expansion

MDF (CBM) - - 108,000 MDF capacity will start contribution to sales from FY18, we build in 60% capacity utilisation in the first year

Realisation

Plyboard (`/CBM) 64 68 73 5% 6% 7% Realisation improvement to be driven by price hikes

Laminate (`/sheet) 983 1,042 1,115 5% 6% 7% Realisation growth to be driven by improving product mix

MDF (Rs/CBM) - 24 We estimate 10% lower realisation to Greenply

Financials

Net Sales 17,495 20,601 27,090 12% 18% 31%

Significant volume growth in ply and lam will drive strong revenue growth in FY18. We include revenue for the particle board unit of `840mn and `960mn in FY16 and FY17 assuming 70% and 80% capacity utilisation and `2.6bn revenue from MDF in FY18 (Assuming 60% utilisation)

Adjusted EBITDA 3,018 3,493 4,720 21% 16% 35% Margin expansion is largely a function of lower raw material prices Adjusted EBITDA

margin (%) 17.3% 17.0% 17.4% 135 bps -30 bps 47 bps

Depreciation 450 554 659 0% 23% 19% Increase as capacities get capitalised

Interest 314 305 306 -27% -3% 0%

PAT 1,833 2,155 3,054 34% 18% 42% Sharp increase with higher EBITDA and lower interest costs PAT margin (%) 10.5% 10.5% 11.3% 176 bps -2 bps 81 bps

Cash flow parameters

CFO 2,539 2,847 2,393 77% 12% -16% High working capital investment will restrict CFO growth in FY16

Capex (1,468) (1,484) (2,231) 267% 1% 50% Capex to fund office building, maintenance and addition of new plyboard/laminate and MDF

FCF 1,071 1,363 162 4% 27% -88% FCF to remain positive leading to debt repayment

Turnover ratios Working capital (ex-cash) 3.0 3.1 3.6 0.0 0.2 0.5 Improving WC cycle with lower inventory days and mostly

towards FY18 Gross Block 3.0 2.7 2.9 (0.1) (0.3) 0.1 GB turnover to improve as utilisation rates increase

Capital employed 1.9 1.8 2.0 0.0 (0.0) 0.2 Higher GB and WC turnover to drive capital employed turnover

Profitability Ratios

RoCE 22.7% 22.6% 25.8% 82 bps -18 bps 329 bps Improvement in EBIT margins and higher capital employed turnover to drive profitability for the company RoE 40.2% 34.7% 36.5% 34 bps -547 bps 183 bps

ROIC 24.0% 24.5% 27.7% 94 bps 50 bps 327 bps


Exhibit 2: Ambit vs consensus

Particulars Consensus Ambit Divergence Comments

Revenue ( mn) FY16 17,476 17,368 -0.6% Our revenue estimates are lower than

consensus as we build in tepid demand growth for ply until FY17 FY17 21,145 19,630 -7.2%

EBITDA ( mn) FY16 2,974 3,018 1.5% Our EBITDA estimates are lower than

consensus despite similar margins in FY17 due to lower revenues FY17 3,757 3,493 -7.0%

PAT ( mn) FY16 1776 1,833 3.2% Our PAT is higher than consensus despite

lower EBITDA, since we do not build forex loss FY17 1819 2,216 21.8%


Century Plyboards


Valuation: Stretched multiples but large opportunity Ply is a large category, wherein 50% market share is held by unorganised players, which is facing rising liquidity and regulatory challenges. The organised market is largely oligopolistic, and over the last four years, Century has done the right things in terms of building scale and brand, ramping up distribution and assuring long-term raw material supply. In a category which is undergoing a structural shift, near-term earnings multiples often look stretched. However, this should be seen in light of the long-term earnings growth potential, which is higher than most other categories, provided incumbents are able to re-invest efficiently, launch new products which will replace wood products (polymers/wood plus paper composites) and sustainably improve asset turnover and RoEs. The stock is trading at 16x FY17E EPS; our estimates imply 33% EPS CAGR and 34% average RoEs over FY15-18E; our target price implies 21x FY17E EPS.

Exhibit 3: CPBI re-rated significantly…


Exhibit 4: …but premium profitability justifies premium multiples


Exhibit 5: Explanation for the accounting Flags

Segment Score Comments

Accounting AMBER

Century’s cash conversion cycle is materially longer than Greenply (110-130 days in FY13-14 as against 70-76 days for Greenply), mainly due to significantly lower creditor days (16-20 days in FY13-14 against 53-60 days for Greenply. Century’s CFO/EBITDA has been low at <50% for the two years, as revenue growth required investment in working capital.

Predictability AMBER Management has made time announcements of capacity expansion and volume growth guidance has been fair. The only concern is unpredictable forex losses.

Earnings momentum GREEN Consensus estimates have remained flat in the last month.


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FY13 FY14 FY15 FY16E FY17E FY18E

RoCE RoE

Century Plyboards


Key catalysts Further margin improvement: We have built in 50bps margin expansion both in FY16 and FY17, led by lower input prices. Improvement in margin alongside improving revenue growth will be a key catalyst for the stock.

Market share gains: Century has continuously gained market share over peers for the last 2-3 years. We have built in higher than industry volume growth for the company on the premise that its established scale and RM security will accelerate market share gains. Higher than industry volume growth could be a key positive catalyst

Success in particle boards and MDF: Whilst we have built in 50% utilisation rates in initial years, which could need upgrades if the company is able to launch these products successfully.

Price hikes and further decline in input costs: If unorganised players lose competitiveness, the organised players’ pricing power will improve which means that even in a deflationary input cost environment, incumbents will be able to push through price hikes. We have built in 4% price hikes in FY17.

Risks Product disruption: Given that timber reserves globally are shrinking, there is a major risk that innovative product launches (specifically plastic composites - already eating into the wood market in the US), would displace plyboards. Century needs to actively think through long-term disruptions or it risks losing the opportunity to a global innovator.

INR depreciation: The company has `1.4bn of buyers credit outstanding in USD and if the INR depreciates before the payments, the company will suffer forex losses.

Face veneer export ban in Myanmar: Myanmar has banned the export of raw timber but face veneer export is allowed. If Myanmar were to ban exports of face veneer as well, a key raw material source would be eradicated.

Capital misallocation: Century is incurring `500mn to build a corporate headquarters in Kolkata. The management’s argument is that, given the increasing scale of the business and high-profile talent acquisition, the company needs a corporate office. We believe that Century’s CFO generation will be much higher than it capex needs and if the company misallocates or digresses in unrelated businesses, it will erode shareholder value. In the past, the Group has expanded into multiple businesses from one listed entity; in the last year, the company has demerged its cement business into a separate ferro chrome and cement subsidiary (Star Ferro and Cement).

Century Plyboards


Balance Sheet ` mn unless mentioned FY14 FY15 FY16E FY17E FY18E

Share capital 223 223 223 223 223

Reserves and surplus 2,708 3,526 5,040 6,820 9,343

Total Networth 2,931 3,749 5,262 7,042 9,565

Loans 5,276 4,677 4,527 4,327 4,477

Of which Buyers credit 2,002 1,500 1,100 800 800

Deferred tax liability (net) (7) (63) (63) (63) (63)

Sources of funds 8,314 8,418 9,782 11,362 14,035

Net block 3,164 2,781 3,800 4,730 6,301

Capital work-in-progress - - - - -

Investments 31 4 31 31 31

Cash and bank balances 387 374 526 1,069 607

Sundry debtors 2,089 2,683 2,855 2,958 3,775

Inventories 3,029 3,322 3,093 3,227 4,202

Loans and advances 1,100 1,323 1,475 1,613 2,137


Current liabilities and provisions 1,914 2,041 2,114 2,382 3,134

Net current assets 4,879 5,778 5,951 6,601 7,702

Application of funds 8,314 8,418 9,782 11,362 14,035


Income statement

mn unless mentioned FY14 FY15 FY16E FY17E FY18E

Revenue 13,477 15,525 17,368 19,630 25,995

Plyboards 10,480 12,126 12,961 14,655 17,562

Laminates 2,587 3,372 4,249 4,954 6,255

yoy growth 15% 15% 12% 13% 32%

Total expenses 11,961 13,015 14,350 16,289 21,467

EBITDA 1,766 2,488 3,018 3,493 4,720

yoy growth 52% 41% 21% 16% 35%

Depreciation 387 448 450 554 659

EBIT 1,416 2,231 2,605 2,999 4,123

Interest and financial charges 603 432 314 305 306


Adj PBT 629 1,654 2,291 2,693 3,818

Provision for taxation 124 290 458 539 764

Adjusted PAT 786 1,365 1,833 2,155 3,054

yoy growth 63% 74% 34% 18% 42%

Reported PAT 633 1,509 1,833 2,155 3,054

EPS basic (`) 4 6 8 10 14


Century Plyboards


Cash Flow statement Rs mn unless mentioned FY14 FY15 FY16E FY17E FY18E

PBT 629 1,799 2,291 2,693 3,818

Depreciation 387 448 450 554 659

Interest paid 603 432 314 305 306

CFO before change in WC 1,623 2,633 3,018 3,493 4,720

Change in working capital (1,168) (911) (21) (107) (1,564)

Direct taxes paid (117) (290) (458) (539) (764)

CFO 338 1,432 2,539 2,847 2,393

Net capex 643 400 1,468 1,484 2,231

CFI (706) (327) (1,459) (1,424) (2,168)

Proceeds from borrowings 372 364 (150) (200) 150

Change in share capital - - - - -

Interest & finance charges paid (287) (432) (314) (305) (306)

Dividends paid (60) (516) (319) (375) (531)

CFF (281) (1,263) (783) (880) (687)

Net increase in cash (649) (158) 298 543 (462)

FCF (305) 1,032 1,071 1,363 162

Opening cash balance 983 387 229 526 1,069

Closing cash balance 334 229 526 1,069 607

Source: Company, Ambit Capital research,

Ratio Analysis

FY14 FY15 FY16E FY17E FY18E

Revenue growth 14.7 15.2 11.9 13.0 32.4

EBITDA growth 52 41 21 16 35

PAT growth 25 138 21 18 42

EPS norm (dil) growth 63 74 34 18 42

EBITDA margin 13 16 17 18 18

EBIT margin 11 14 15 15 16

Net margin 6 9 11 11 12

RoCE 19 22 23 23 26

RoIC 23 24 24 28 30

RoE 36 40 40 35 37


Valuation Parameter

FY14 FY15 FY16E FY17E FY18E

Working capital turnover 2.5 2.9 3.0 3.1 3.6

Debt/Equity(x) 1.7 1.2 0.9 0.6 0.5

Net debt/Equity(x) 1.6 1.1 0.7 0.5 0.4

P/E (x) 50.7 29.2 21.7 18.5 13.0

P/B(x) 13.1 10.5 7.5 5.6 4.1

EV/EBITDA(x) 25.3 17.7 14.5 12.3 9.3



Good quality but expensive Kajaria, undeniably, is the scale, brand and cost leader of the Indian tile industry. It is displaying the traits of a champion franchise, evident from its industry-leading margins (18% in 1HFY16) and RoEs (28%) and strong bargaining power with the channel (stable working capital cycle in 1HFY16 unlike peers). Moreover, its reputation helps attract JV partners (thereby reducing its capital intensity) and build/retain its talent pool. Receding Chinese competition and lower gas prices also bode well for leading brands. Whilst we acknowledge the franchise of Kajaria, we believe that the current valuations adequately factor this in. The stock has rallied by 54% in the last one year and it now trading at 26x FY17 consensus EPS. Current valuations leave little room for re-rating and could be ignoring rising competitive intensity, limited options to expand margins/ RoCEs and potential entry of larger home building brands.

Competitive position: STRONG Changes to this position: POSITIVE

A leader in every sense Over FY10-15, Kajaria’s sales/EBITDA tripled, earnings jumped six-fold and RoE tripled to 30% (from 10%), as it built the best tile franchise in India. Despite a sharp deceleration in the tile industry’s growth in 1HFY16, its volumes grew 10%. EBITDA margin expanded by 440bps in 1H, led by deflation in gas prices especially for the Morbi capacities. Stable pricing and working capital cycle (unlike peers) are a testament of the strength of its franchise.

Leveraging its brand and cost leadership Kajaria is increasing its capacity by ~40% (20.2msm) over FY15-17, including large cost efficient capacities in Rajasthan and AP (6.5msm and 5.7 msm, respectively). Its brand and cost leadership transpires into industry-leading EBITDA margin; scale benefits and lower gas cost are further levers to margin expansion. Alongside, the company is investing in building its talent pool and professionalising management across key business functions. It continues to invest 2.5-3% of sales on branding alongside increasing sales touch points.

Well positioned for the demand recovery Kajaria is strengthening its franchise, whilst most other peers worry about tepid demand, low profitability and weak balance sheets. Whilst demand recovery might take some time, levy of anti-dumping duty on Chinese imports and working capital stress of smaller players should support volume growth for Kajaria. Consensus estimates 16%/23%/25% revenue/EBITDA/PAT CAGR for Kajaria and RoEs of 27% in FY15-17.

Expensive valuations leave no margin of safety Kajaria is displaying the traits of a champion franchise and hence its profitability and earnings could grow sustainably. However, the stock has become expensive (26x FY17 consensus EPS) post the recent re-rating, which leaves no margin of safety and its rich multiples could shrink if the demand slowdown persists. The rich multiples build in an underlying assumption that no large building material company will enter the tile industry and disrupt the growth momentum of the incumbents.

Kajaria Ceramics NOT RATED

COMPANY INSIGHT KJC IN EQUITY December 01, 2015

Building materials

Recommendation Mcap (bn): `75/US$1.1 6M ADV (mn): `95.4/US$1.4 CMP: ` 945

Flags Accounting: AMBER Predictability: GREEN Earnings Momentum: GREEN

Potential catalysts

Strong volume growth post commissioning of capacities in FY17

Margin expansion with further reduction gas prices from 3QFY16

RoE expansion with improving margins and reducing capital intensity

Performance


Analyst Details

Achint Bhagat Tel: +91 22 3043 3178 achintbhagat @ambitcapital.com

Nitin Bhasin Tel: +91 22 3043 3241 [email protected]

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Key financials (` mn) Profit and Loss account FY11 FY12 FY13 FY14 FY15

Revenue 9,533 13,130 16,120 18,388 30,518

EBITDA 1,489 2,064 2,455 2,808 3,081

Adj PAT 618 829 1,091 1,314 1,464

RoE (%) 30 33 34 30 17

P/E 92.3 68.8 52.3 44.6 42.1


mailto:@ambitcapital.com


Kajaria Ceramics


Consolidated financials Balance sheet

` mn unless mentioned FY12 FY13 FY14 FY15

Share capital 147 147 151 159

Reserves and surplus 2,674 3,462 5,144 7,251

Total Networth 2,821 3,609 5,295 7,409

Loans 2,782 3,202 1,938 2,220

Deferred tax liability (net) 644 656 713 791

Sources of funds 6,319 7,742 8,355 11,045

Net block 5,209 6,200 6,916 8,601

Capital work-in-progress 24 78 405 778

Investments 1 1 1 1

Cash and bank balances 72 55 61 112

Sundry debtors 1,190 1,436 1,649 2,071

Inventories 1,865 2,197 1,931 3,033

Loans and advances 549 508 794 997

Total Current Assets 3,675 4,196 4,434 6,213

Current liabilities and provisions 2,590 2,732 3,401 4,547

Net current assets 1,085 1,464 1,033 1,666

Application of funds 6,319 7,742 8,355 11,045


Income statement


Revenue 13,130 16,120 18,388 21,778

yoy growth 38 23 14 18

Total expenses 11,066 13,664 15,593 18,350

EBITDA 2,064 2,455 2,808 3,520


Net depreciation 393 446 470 559

EBIT 1,671 2,009 2,338 2,962

Interest and financial charges 487 462 408 294

Other income 15 30 63 94

Adj PBT 1,199 1,577 1,993 2,761

Provision for taxation 381 499 678 854

Adj PAT 829 1,091 1,314 1,850


EPS basic (`) 11 15 17 23


Kajaria Ceramics


Cash flow statement


PBT 1,199 1,577 1,993 2,761

Depreciation 393 446 470 559

Others 15 18 - -

Interest paid 379 399 408 294

CFO before change in WC 1,985 2,440 2,871 3,614

Change in working capital (356) (599) 437 (583)

Direct taxes paid (337) (483) (678) (854)

CFO 1,292 1,358 2,629 2,177

Net capex (725) (1,509) (1,648) (1,782)

Net investments 38 8 - -

CFI (687) (1,501) (1,648) (1,782)

Proceeds from borrowings (23) 568 (1,264) 282

Change in share capital - - 4 997

Interest & finance charges paid (384) (407) (408) (294)

Dividends paid (171) (214) (264) (369)

CFF (578) 117 (975) (343)

Net increase in cash 28 (27) 6 51

FCF 568 (152) 981 395


Ratio analysis

FY12 FY13 FY14 FY15

RoCE 20 20 20 20.0

RoIC 19 19 20 20.8

RoE 33 34 30 29.1

Debt/Equity(x) 1.0 0.9 0.4 0.3

Net debt/Equity(x) 1.0 0.9 0.4 0.3

Gross Block Turnover (X) 2 2 2 1.7

Working capital Turnover (X) 13 11 19 14.1

P/E (x) 69 52 45 33.3

P/B(x) 20 16 11 8.3

EV/Sales(x) 5 4 3 2.9

EV/EBITDA(x) 29 25 22 18.1


Kajaria Ceramics


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Key Financials (consolidated)

Y/E March ( mn) FY11 FY12 FY13 FY14 FY15


EBITDA 1,556 1,505 1,992 2,427 3,029

EBITDA % 14.5% 12.0% 13.3% 13.6% 13.6%

Net Profit (Adj) 976 755 1,141 1,445 1,869

Adjusted EPS (`) 8.7 6.4 9.6 12.2 15.8

ROE (%) 35.1% 16.3% 17.1% 18.4% 20.0%

Source: Company, Ambit Capital research.

“Flow” and “Fix” guardFocus on innovation (products, pricing, branding) has helped Astral become a leading name in the evolving/fast growing polymer-based plumbing piping industry. Its recent foray into adhesives market and emerging signs of replication of similar approach w.r.t new products/branding/distribution suggests compounding of growth and moat. Adhesives/construction chemicals industry is in its infancy wherein applications are evolving akin to pipes 5-10 years back and Astral’s acquisitions along with pipes make it one of the few ‘A’ segment-specific companies to transition into a larger home-building brand. Current premium multiples can become even richer from an effective capture of these two large-potential high-growth categories.

Competitive position: STRONG Changes to this position: STABLE

A franchise built around innovation in products, branding, processes Astral is one of the fastest growing pipe franchises in the country (41% CAGR over FY10-15). Alongside continuous capacity expansions and rising acceptance of plastic pipes, the key drivers for Astral’s market leading growth were (a) innovation not only in products but also in branding (first pipe company with TVC) and processes (pricing and automation), (b) business architecture built around strong reach and expanding manufacturing footprint and (c) strategic assets—relationships with Lubrizol and thousands of plumbers.

Sub-category leader to now a “national building materials” brand Over the last decade, Astral effectively moved from a CPVC pipes manufacturer to now a national plastic pipes brand. Its recent acquisition of Resinova, one of the fastest growing and high RoE generating adhesives company with a strong brand BONDTiTE, puts Astral in a unique position to grow materially ahead of respective sector peers. We are already witnessing increased awareness of product in channel/institutional clients from change in packaging/new launches

Superlative revenue growth, synergies to keep earnings growth high Over the next five years Astral’s pipe revenues could grow~20% from new launches (Blazemaster, column pipes, electrical conduits, agriculture) and capacity expansions in South/North/East. Alongside, we believe India adhesives business could grow material ahead of pipes given small base and Astral’s aggression on branding, capacity expansion, channel connect and more importantly intermediary connect; Seal IT’s silicon portfolio also holds potential.

Unlikely single digit growth rates could give misleading multiples Astral’s management has displayed efficient capital allocation plus swiftness and uniqueness. The next 6-12 months can be a low-growth phase, but management continues to further strengthen its competitive advantages. RoCE should remain high as margins increase with innovation and cash flows get re-invested in large opportunities; assuming low terminal growth rate ten year out could provide misleading exit multiples (eg: Asian Paints in last 10-15 years). Astral trades at 26x consensus FY17 EPS, closer to adhesives/paints companies.

COMPANY UPDATE ASTRA IN EQUITY December 01, 2015

Astral Poly TechnikNOT RATED

Industrials

Recommendation Mcap (bn): `50/US$0.7

6M ADV (mn): `43.4/US$0.7 CMP: `414

Flags Accounting: GREEN

Predictability: GREEN

Earnings Momentum: AMBER

Potential catalysts

EBITDA margin expansion in pipesand adhesives business in 2HFY16

Market share gains in adhesivesbusiness post re-launch of productswith new packaging, campaigns in2HFY16

Increased contribution from new pipe products improving CE turnover

Performance (%)


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Analyst Details

Nitin Bhasin +91 22 3043 3241

[email protected]

Achint Bhagat, CFA +91 22 3043 3178 [email protected]



Astral Poly Technik


The following section is from our recent Coffee Can Portfolio wherein we had discussed Astral as one of the companies as part of the portfolio

Astral on the IBAS framework “As I planned to enter into plastics, I decided against entering PVC given multiple players and instead I chose CPVC for which I travelled to USA and stayed there for a few months to learn the product and then launched an industrial CPVC product”

“We grew at 40% plus CAGR for more 7-8 years up to 2014 whilst economy wasn’t that strong; where was the slowdown? Slowdown is in the mind! If you create new product segments, if you create leadership, if you create brand, growth will be strong and ahead of industry”

“When we were a small company (`250mn revenues) we started branding to effectively compete with the stalwarts, for building awareness with not only intermediaries but also end consumers. Alongside we started plumber meets for training them how to use CPVC product.”

– Sandeep Engineer, Promoter, Astral PolyTechnik

Astral Poly Technik is one of India’s leading plastic pipe companies with leadership in CPVC pipes. Astral was incorporated by Mr Sandeep Engineer (a chemical engineer) in 1996, wherein he first entered into relationship with BF Goodrich (which later became Lubrizol), a leading CPVC player and a patent holder in CPVC resin technology. Later, it entered into a JV relationship (for manufacturing know-how) with US-based Specialty Processes LLC which remains a shareholder till today. With its recent acquisition of Resinova and BondIt in UK, Astral has now become a pipes, adhesives and construction chemical company, with a larger home building materials brand.

Our primary data checks and a reading of its history reveals that the company’s high ROCE generating fast face growth in the last decade has been driven by (a) innovation not only in products but also in branding and processes, (b) business architecture built around strong reach and (c) connect and strategic relationships which have helped in innovation.

1. Focus and determination of the promoter

Mr Engineer’s journey before start of Astral was full of half successful/ unsuccessful ventures and even in the early years (98-02) of Astral’s pipe business, he didn’t taste success and came close to bankruptcy. His associates indicate that despite near-bankruptcy in 2001, Mr Engineer never lost determination to make this novel product a success and would travel back and forth to customers and international partners to bring down the cost, launch new products and sign up new customers. Mr Engineer mentioned recently that “we continue to remain focused on the product and not the sales; but focus on pipes does not mean we will let go of certain opportunities whilst we simultaneously focus on our client and hence have diversified into adhesives/construction chemicals having established leadership in pipes.”

“Promoters of Astral, Ashirvad and Supreme are equally fanatic about not only growing their brands and products but also maintaining/upgrading quality of their products” said a senior person working with a leading pipes company

2. Innovation in products, branding and now processes:

(a) Innovation focus for launching novel products: Since its inception, Astral, led by Mr Engineer, has continuously launched new products at very regular intervals (see exhibit) not only in the CPVC but also in the otherwise very established PVC plumbing systems. Today, Astral is the only licensee of Lubrizol to manufacture and sell all Lubrizol’s four brands (Corzan, FlowGuard, Blazemaster and Bendable) and in some cases the only one to sell in the world (Bendable). Apart from its relationship with Lubrizol, it has entered into relationships with multiple players (Wavin, Spears, IPSC, Hunter and Harvell), from across the developed world for various products and then

Astral Poly Technik


later commenced manufacturing of the same. Whilst its key competitor Supreme has a wide portfolio of fittings, we have seen that over the last few of years, Supreme has entered into products once Astral announced its entry (CPVC, CPVC-based fire sprinkler, noise-free pipes).

Mr. Kajaria, who is also a dealer for other companies such as Supreme and Prince, attributes the success of CPVC in India to Astral. Mr. Kajaria said, “Astral's branding is the most aggressive. Astral knows how to catch hold of the right intermediaries. They have good-quality products and have created a great brand by doing frequent meetings with dealer and plumber meets. Astral has a lot of buzz in the industry. People look forward to new launches from them.”

Mr M P Taparia, promoter of Supreme “Amongst all the pipe manufacturers, we consider Astral to be one of the key competitors given its focus on quality”

Exhibit 1: Astral has consistently launched new products through partnerships with global majors

Year Product Strategic Partners

1999 Flowguard CPVC Piping and plumbing systems Lubrizol

2001 CPVC pipes and fittings Specialty Products LLC (USA)

2003 PVC pressure pipes Lubrizol

2004 CPVC and PVC fittings, flanges and valves Spears (USA)

2004 Solvent Chemicals IPSC (USA)

2005 Underground speciality fittings Hunter (U.K.)

2006 Large Diameter PVC pipes Harvell (USA)

2008 Sound Proof piping Wavin

2012 Lead free column pipes Lubrizol

2013 Bendable Pipes Lubrizol

2014 Blazemaster* Lubrizol

2015 Silicon Sealants / adhesives Seal It (Acquired Bond It (UK based Adhesives manufacturer))

2015 Expoy based adhesives and construction chemical Resinova (Acquired Resinova (Bondtite, Resibond etc) Indian based adhesives manufacturer)

2016 Construction Chemicals (Thormet) Through its subsidiary Resinova

Source: Company, Ambit Capital research. * In Blazemaster, the company entered into the partnership in 2006, but the government approval in 2013

(b) Branding—first one with a unique and a big budget: Prompted by a dealer’s comment “unless someone asks for your product (CPVC) or your brand (Astral), I will not market/store your product” Mr Engineer started investing in branding in smaller scale in this ‘raw category’ unlike its peers. Later, in FY05, Astral took its brand nationwide to attract more distributors. It hired Mudra, a leading Indian ad agency, for an aggressive ad campaign. Recalling the move, Mr. Engineer had this to say in a press article: “That year, we ploughed our profit of `25mn into branding. I was certain there was a huge replacement market in galvanised iron and we needed a pan-India brand if we had to matter.” Later, Astral used aggressive promotional activities such as co-branding with Dabangg-2, stadium sponsorships for Sachin Tendulkar’s last test match series and heavy outdoor campaigning nationwide to increase visibility with retail customers. Astral presently has one of the highest expenditure on publicity amongst peers (2.2% of sales); now it is about to commence one of the biggest campaigns for its recently acquired and re-branded adhesives and construction chemicals business as it sets to compete with industry stalwart like Pidilite built around innovative packaging/branding. In the process, it has re-branded/re-packaged Resinova products to Astral branded products.

Astral Poly Technik


Exhibit 2: Astral’s EBIT margin has been stable and CE turnover has improved consistently (the drop in FY15 is on account of capacity additions) driving its RoCE


Exhibit 3: Branding expenditure expanded at a 48% CAGR over FY07-12; a higher 2.2% of materially higher sales in FY15 against 1.2% in FY07 (small base)


(c) Processes—of pricing and now automation: In order to effectively compete against the traditional GI/CI pipes, Astral followed pricing processes to gain customer entry and then demonstrate value before seeking price hikes. For the builders, the CPVC or noise-free pipes were sometimes priced lower than the traditional product. Builders and distributors mention that pricing was one of the biggest factors of increasing adoption; “in India you not only have to give a lower price for a new product, but also demonstrate more value, which Astral did.” Astral’s innovation in processes continues with increased adoption of automation; very recently without considering payback duration, company installed robotic truck filling machines to reduce truck loading times by more than half but more importantly reducing the probability of work disruption. Astral is set to adopt more automation (more so in packaging) in its recently acquired Resinova facilities using experience of its UK-based subsidiary BondIt.

Architecture—channel and relationships continue to expand

Astral has built a strong network of not only distributors/ dealers but also plumbers and institutional customers. Training of thousands of plumbers across multiple events every year, engagement with consultants/architects and strong branding has helped company expand this architecture. Over the years, company has simultaneously increased its manufacturing capacities and warehouses to enter into newer markets.

“Quality and branding have strengthened Astral’s recall with builders/ plumbers, which leads to relatively higher sales of Astral’s pipes compared to Supreme or Ashrivad’s” says a Mumbai based hardware retailer.

We note that Astral is set to leverage on its pipe reach/connect and Resinova’s reach (700+ distributors and 20,000+ dealer points) to become an even larger home building material brand, a feat not yet displayed by many (note that the company’s distribution reach has doubled over FY12-15). Risks of diversifying into a new segment are mitigated given Resinova’s quality product, limited overlap with Astral’s customers and effective use of its Astral’s strong brand equity with channel.

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Branding exp/sales (RHS)

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Distributors Dealers

FY12 350 11,000

FY13 400 13,000

FY14 400 18,000

FY15 700 20,000


Astral Poly Technik


Income statement Particulars ( mn) FY11 FY12 FY13 FY14 FY15


% YoY revenue growth 41.6% 41.0% 41.7% 30.7% 16.7%

Total expenses 3,548 4,975 7,095 9,176 11,021

EBITDA 560 818 1,116 1,556 1,505

EBITDA margin 13.6% 14.1% 13.6% 14.5% 12.0%

Net depreciation / amortisation 107 134 177 213 330

EBIT 465 723 960 1,364 1,188

Interest Expense/(income) 44 228 181 82 129


Adjusted PBT 422 496 779 1,013 966

Provision for taxation 86 106 184 242 278

Adjusted PAT 334 512 679 976 755

EPS (Adjusted) (`.) 3.0 4.6 6.0 8.7 6.4


Balance sheet Particulars ( mn) FY11 FY12 FY13 FY14 FY15

Share capital 112 112 112 112 118

Reserves and surplus 1,376 1,744 2,306 3,035 6,012

Total Networth 1,488 1,856 2,418 3,148 6,130

Loans 448 887 895 941 1,118

Sources of funds 1,953 2,760 3,401 4,219 7,427

Net block 1,040 1,551 2,055 2,745 3,000

Cash and bank balances 102 350 114 11 71

Sundry debtors 1,133 1,692 1,700 1,805 2,325

Inventories 862 1,255 1,481 1,892 2,046

Loans and advances 395 427 575 587 720


Current Liabilities 1,280 1,943 1,928 2,548 3,017

Provisions 32 48 75 65 73

Net current assets 831 1,067 1,214 1,303 1,635


Astral Poly Technik


Cash Flow statement

Particulars ( mn) FY11 FY12 FY13 FY14 FY15

PBT 422 504 779 1,013 966

Depreciation 107 134 177 213 330

Interest expense/ (income) 43 160 137 82 129

Other income (21) 69 53 (21) (13)

Direct taxes paid (87) (92) (84) (242) (278)

Change in working capital (3) 66 (373) (149) (281)

CFO (post -exceptions) 461 841 688 896 854

Purchase of fixed assets (335) (687) (681) (940) (549)

CFI (328) (668) (717) (919) (535)

Share capital - - - - 2,409

Net borrowings 2 274 (41) 46 177

Dividends paid (26) (29) (29) (52) (51)

Interest paid (46) (169) (137) (82) (129)

CFF (70) 75 (207) (88) 2,405

Net Cash 64 249 (236) (111) 2,723

Cash at the beg 38 101 350 114 3

Cash at the end 101 350 114 3 2,726

Free cash flow 126 154 7 (44) 305


Key ratios Particulars FY11 FY12 FY13 FY14 FY15

Net debt/Equity 0.2 0.3 0.3 0.3 0.2

Working capital turnover (x) 6.1 8.0 9.0 9.0 8.8

Gross block turnover (x) 3.3 3.4 3.5 3.4 3.2

ROCE 21.4% 25.4% 23.6% 27.7% 14.7%

ROE 25.0% 30.6% 31.8% 35.1% 16.3%

P/E (x) 131.9 86.1 64.9 45.2 61.5

P/B (x) 29.6 23.7 18.2 14.0 7.6

EV/EBITDA (x) 79.3 54.5 40.2 28.9 30.0


`````


Sailing through tough times In the worst tile industry slowdown of the last decade, Somany posted 10% volume growth in 1HFY16 (~2x industry growth), led by premium product launches and brand/reach expansion. PBT margin expansion of 50bps in 1HFY16 was in line with the management’s guidance, led by higher vitrified mix, savings in gas procurement costs and operating leverage benefits. Somany strengthened it franchise through continued capacity expansions during times of a paradigm industry shift due to: (a) rising affinity for 2-3 brands, (b) unorganised manufacturers (50% market share) facing financing pressures, and (c) anti-dumping duty on Chinese imports. The stock is trading at 17x FY17 consensus EPS (40% discount to Kajaria); multiples should be seen in light of the large opportunity but few credible participants (as other organised players have significantly smaller scale and weaker balance sheets).

Competitive position: STRONG Changes to this position: POSITIVE

Industry-leading growth in tough times vindicates franchise strength The tile industry’s volume growth decelerated to 3-4% in 1HFY16 (vs past ten-year CAGR of 12%), accentuated by rising liquidity constraints and housing slowdown. Somany posted 10% volume growth, gaining market share both from unorganised and struggling organised manufacturers. Strengthening brand, higher vitrified share, expanding scale/distribution facilitated the strong growth; PBT margin expanded by 50bps in 1HFY16, in line with management’s guidance.

A large pie but few contenders Tiles is the third-largest home building category (`230bn), wherein the unorganised segment is facing regulatory issues (GST) and challenges in working capital financing (black money clamp-down). We expect organised manufacturers, barring Kajaria and Somany, with weak balance sheets to pose lower competition and Chinese imports will lose competitiveness with the levy of the anti-dumping duty. Kajaria and Somany can break away from competition, given their extensive reach and ability to grow with low capital intensity through JV partnerships with smaller players.

Somany’s three-pronged game plan to grow scale and profitability After doubling its capacities in FY10-14, Somany expects to increase capacities by 27% over FY14-16. Alongside, it endeavours to improve the product portfolio (higher share of value-added vitrified tiles) and grow the sanitaryware/bath fittings business to ~8-10% of sales by FY17 (vs ~4% in FY15). The management expects 200bps PBT margin expansion over FY14-18, led by lower gas prices, higher vitrified mix and operating leverage benefits.

40% discount to Kajaria is excessive Somany trades at 17x one-year forward P/E (a 40% discount to Kajaria); however, consensus expects higher earnings CAGR in FY15-17 (33% vs 24% for Kajaria) and gradual RoE convergence. The multiples should be seen in light of the large opportunity and few competitors with established scale and brand. Somany’s scale and low RoE deserve a discount albeit not so much.

Somany Ceramics NOT RATED

COMPANY INSIGHT SOMC IN EQUITY December 01, 2015

Building materials

Recommendation Mcap (bn): `15/US$0.2 6M ADV (mn): `6.9/US$0.1 CMP: ` 386

Flags Accounting: GREEN Predictability: GREEN Earnings Momentum: AMBER

Potential catalysts

Sustaining industry-leading growth, after 4msm JV capacity addition in FY16

PBT margin expansion due to increase in vitrified mix and operating leverage

RoE expansion given low-cost capacity addition and PBT margin improvement

Performance


Analyst Details

Achint Bhagat Tel: +91 22 3043 3178 achintbhagat @ambitcapital.com

Nitin Bhasin Tel: +91 22 3043 3241 [email protected]

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Key financials (` mn) Profit and Loss account FY11 FY12 FY13 FY14 FY15

Revenue 7,199 8,790 10,539 12,648 15,431

EBITDA 677 741 857 815 1,076

Adj PAT 243 254 321 289 453

RoE (%) 26.0 22.1 23.0 12.7 17.2

P/E 48.3 46.2 36.6 45.7 29.1


mailto:@ambitcapital.com


Somany Ceramics


Consolidated financials Balance sheet

( mn) FY12 FY13 FY14 FY15

Share capital 69 69 78 78

Reserves and surplus 1,190 1,462 2,157 2,502

Total Networth 1,259 1,531 2,235 2,580

Loans 1,666 1,624 1,707 1,913

Deferred tax liability (net) 254 262 284 287

Sources of funds 3,178 3,417 4,270 4,833

Net block 1,911 1,999 2,405 2,638

Capital work-in-progress 33 94 29 8

Investments 61 88 548 466

Cash and bank balances 222 258 346 154

Sundry debtors 1,400 1,748 2,149 2,591

Inventories 1,006 1,205 906 1,365

Loans and advances 670 821 1,087 1,434

Total Current Assets 3,298 4,032 4,489 5,543

Current liabilities and provisions 2,124 2,796 3,201 3,822

Net current assets 1,173 1,236 1,288 1,721

Application of funds 3,178 3,417 4,270 4,833


Income statement


Revenue 8,790 10,539 12,648 15,431

Total expenses 8,050 9,682 11,832 14,355

EBITDA 741 857 815 1,076

yoy growth 9.3 15.7 (4.9) 32.0

Net depreciation 183 205 224 266

EBIT 557 652 591 810

Interest and financial charges 207 200 185 205

Other income 12 26 31 77

Adj PBT 362 478 437 682

Provision for taxation 111 153 170 222

Adj PAT 254 321 289 453

yoy growth 4.4 26.4 (10.0) 56.9

EPS basic (`) 7.4 9.3 7.4 11.7

EPS diluted (`) 7.4 9.3 7.4 11.7

DPS (`) 0.8 1.2 1.5 2.0


Somany Ceramics


Cash flow statement


PBT 364 478 435 681

Depreciation 183 205 224 266

Others 9 (6) 16 6

Interest paid 199 184 164 159

CFO before change in WC 755 861 839 1,112

Change in working capital 141 1 34 (648)

Direct taxes paid (110) (155) (134) (213)

CFO 786 707 739 251

Net capex (311) (377) (590) (508)

Net investments (43) (19) (449) 129

CFI (353) (396) (1,039) (379)

Proceeds from borrowings (136) (42) 84 209

Change in share capital - - 536 -

Interest & finance charges paid (205) (202) (184) (205)

Dividends paid (28) (32) (48) (68)

CFF (369) (276) 388 (64)

Net increase in cash 64 36 88 (192)

FCF 476 330 149 (257)


Ratio analysis

FY12 FY13 FY14 FY15

RoCE 12.5 14.4 9.6 12.7

RoIC 13.6 15.9 11.7 14.0

RoE 22.1 23.0 12.7 17.2

P/E (x) 46.2 36.6 45.7 29.1

Debt/Equity(x) 1.3 1.1 0.7 0.7

Net debt/Equity(x) 1.1 0.8 0.4 0.5

EV/Sales(x) 1.7 1.4 1.2 1.0

EV/EBITDA(x) 19.8 17.0 17.9 13.9


Somany Ceramics


Institutional Equities Team Saurabh Mukherjea, CFA CEO, Institutional Equities (022) 30433174 [email protected]

Research

Analysts Industry Sectors Desk-Phone E-mail

Nitin Bhasin - Head of Research E&C / Infra / Cement / Industrials (022) 30433241 [email protected]

Aadesh Mehta, CFA Banking / Financial Services (022) 30433239 [email protected]

Abhishek Ranganathan, CFA Retail / Mid-caps (022) 30433085 [email protected]

Achint Bhagat, CFA Cement / Roads / Home Building (022) 30433178 [email protected]

Ashvin Shetty, CFA Automobile (022) 30433285 [email protected]

Bhargav Buddhadev Power Utilities / Capital Goods (022) 30433252 [email protected]

Deepesh Agarwal Power Utilities / Capital Goods (022) 30433275 [email protected] Gaurav Khandelwal Automobile (022) 30433132 [email protected] Gaurav Mehta, CFA Strategy / Derivatives Research (022) 30433255 [email protected]

Girisha Saraf Mid-caps / Small-caps (022) 30433211 [email protected]

Karan Khanna Strategy (022) 30433251 [email protected]

Kushank Poddar Technology (022) 30433203 [email protected] Pankaj Agarwal, CFA Banking / Financial Services (022) 30433206 [email protected]

Paresh Dave, CFA Healthcare (022) 30433212 [email protected]

Parita Ashar, CFA Metals & Mining (022) 30433223 [email protected]

Prashant Mittal, CFA Derivatives (022) 30433218 [email protected]

Rakshit Ranjan, CFA Consumer (022) 30433201 [email protected]

Ravi Singh Banking / Financial Services (022) 30433181 [email protected]

Ritesh Gupta, CFA Oil & Gas / Chemicals / Agri Inputs (022) 30433242 [email protected]

Ritesh Vaidya, CFA Consumer (022) 30433246 [email protected] Ritika Mankar Mukherjee, CFA Economy / Strategy (022) 30433175 [email protected]

Ritu Modi Automobile (022) 30433292 [email protected]

Sagar Rastogi Technology (022) 30433291 [email protected]

Sumit Shekhar Economy / Strategy (022) 30433229 [email protected]

Utsav Mehta, CFA E&C / Industrials (022) 30433209 [email protected]

Vivekanand Subbaraman, CFA Media (022) 30433261 [email protected]

Sales

Name Regions Desk-Phone E-mail

Sarojini Ramachandran - Head of Sales UK +44 (0) 20 7614 8374 [email protected]

Dharmen Shah India / Asia (022) 30433289 [email protected]

Dipti Mehta India / USA (022) 30433053 [email protected]

Hitakshi Mehra India (022) 30433204 [email protected]

Krishnan V India / Asia (022) 30433295 [email protected]

Nityam Shah, CFA USA / Europe (022) 30433259 [email protected]

Parees Purohit, CFA UK / USA (022) 30433169 [email protected]

Praveena Pattabiraman India / Asia (022) 30433268 [email protected]

Shaleen Silori India (022) 30433256 [email protected]

Singapore

Pramod Gubbi, CFA – Director Singapore +65 8606 6476 [email protected]

Shashank Abhisheik Singapore +65 6536 1935 [email protected]

USA / Canada

Ravilochan Pola - CEO Americas +1(646) 361 3107 [email protected]

Production

Sajid Merchant Production (022) 30433247 [email protected]

Sharoz G Hussain Production (022) 30433183 [email protected]

Joel Pereira Editor (022) 30433284 [email protected]

Nikhil Pillai Database (022) 30433265 [email protected]

E&C = Engineering & Construction











































Somany Ceramics


Supreme Industries Ltd (SI IN, BUY)


Century Plyboards India Ltd (CPBI IN, BUY)


Kajaria Ceramics Ltd (KJC IN, NOT RATED)


0100200300400500600700800

Nov

-12

Jan-

13

Mar

-13

May

-13

Jul-

13

Sep-

13

Nov

-13

Jan-

14

Mar

-14

May

-14

Jul-

14

Sep-

14

Nov

-14

Jan-

15

Mar

-15

May

-15

Jul-

15

Sep-

15

Nov

-15

SUPREME INDUSTRIES LTD

0

50

100

150

200

250

300

Nov

-12

Jan-

13

Mar

-13

May

-13

Jul-

13

Sep-

13

Nov

-13

Jan-

14

Mar

-14

May

-14

Jul-

14

Sep-

14

Nov

-14

Jan-

15

Mar

-15

May

-15

Jul-

15

Sep-

15

Nov

-15

CENTURY PLYBOARDS INDIA LTD

0

200

400

600

800

1,000

Nov

-12

Jan-

13

Mar

-13

May

-13

Jul-

13

Sep-

13

Nov

-13

Jan-

14

Mar

-14

May

-14

Jul-

14

Sep-

14

Nov

-14

Jan-

15

Mar

-15

May

-15

Jul-

15

Sep-

15

Nov

-15

KAJARIA CERAMICS LTD

Somany Ceramics


Astral Poly Technik Ltd (ASTRA IN, NOT RATED)


Somany Ceramics Ltd (SOMC IN, NOT RATED)


0

100

200

300

400

500

600

Nov

-12

Jan-

13

Mar

-13

May

-13

Jul-

13

Sep-

13

Nov

-13

Jan-

14

Mar

-14

May

-14

Jul-

14

Sep-

14

Nov

-14

Jan-

15

Mar

-15

May

-15

Jul-

15

Sep-

15

Nov

-15

ASTRAL POLY TECHNIK LTD

0

100

200

300

400

500

Nov

-12

Jan-

13

Mar

-13

May

-13

Jul-

13

Sep-

13

Nov

-13

Jan-

14

Mar

-14

May

-14

Jul-

14

Sep-

14

Nov

-14

Jan-

15

Mar

-15

May

-15

Jul-

15

Sep-

15

Nov

-15

SOMANY CERAMICS LTD

Somany Ceramics


Explanation of Investment Rating

Investment Rating Expected return (over 12-month)

BUY >10%

SELL <10%

NO STANCE We have forward looking estimates for the stock but we refrain from assigning valuation and recommendation

UNDER REVIEW We will revisit our recommendation, valuation and estimates on the stock following recent events

NOT RATED We do not have any forward looking estimates, valuation or recommendation for the stock

Disclaimer This report or any portion hereof may not be reprinted, sold or redistributed without the written consent of Ambit Capital. AMBIT Capital Research is disseminated and available primarily electronically, and, in some cases, in printed form. Additional information on recommended securities is available on request. Disclaimer 1. AMBIT Capital Private Limited (“AMBIT Capital”) and its affiliates are a full service, integrated investment banking, investment advisory and brokerage group. AMBIT Capital is a Stock Broker, Portfolio

Manager and Depository Participant registered with Securities and Exchange Board of India Limited (SEBI) and is regulated by SEBI 2. AMBIT Capital makes best endeavours to ensure that the research analyst(s) use current, reliable, comprehensive information and obtain such information from sources which the analyst(s) believes

to be reliable. However, such information has not been independently verified by AMBIT Capital and/or the analyst(s) and no representation or warranty, express or implied, is made as to the accuracy or completeness of any information obtained from third parties. The information, opinions, views expressed in this Research Report are those of the research analyst as at the date of this Research Report which are subject to change and do not represent to be an authority on the subject. AMBIT Capital may or may not subscribe to any and/ or all the views expressed herein.

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therefore the analyst(s) is/are not subject to supervision by a U.S. broker-dealer, and is/are not required to satisfy the regulatory licensing requirements of FINRA or required to otherwise comply with U.S. rules or regulations regarding, among other things, communications with a subject company, public appearances and trading securities held by a research analyst account.

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Disclosure 26. Ambit and/or its associates have financial interest in Pidilite Industries. 27. Ambit and/or it associates have received compensation for investment banking/merchant banking/brokering services from Astral Poly. 28. Ambit and/or it associates have actual/beneficial ownership of 1% or more in the securities of HSIL.

Analyst Certification Each of the analysts identified in this report certifies, with respect to the companies or securities that the individual analyses, that (1) the views expressed in this report reflect his or her personal views about all of the subject companies and securities and (2) no part of his or her compensation was, is or will be directly or indirectly dependent on the specific recommendations or views expressed in this report. © Copyright 2015 AMBIT Capital Private Limited. All rights reserved.

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