for private circulation only carborundum...

Carborundum Universal

ENAM Securities Direct 21st October 2010

ENAM DIRECT EQUITY RESEARCH

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For private circulation only

Company Background Carborundum Universal (CUMI) is part of the Murugappa Group. CUMI is engaged in the business of manufacturing abrasives, ceramics, refractories and electrominerals. CUMI is a fully integrated player. Investment Argument

Higher offtake to drive volume growth: CUMI has invested aggressively to augment capacities through both the organic and inorganic route which is helping it to capitalize on growth opportunities domestically as well as internationally. As demand picks up from various user industries like auto, auto ancillary, steel and engineering, we expect utilization level for bonded abrasives (except Russia), industrial ceramics, and refractories to move up from an average 65% to 90% by FY12. We expect company’s ROCE to improve to 22.7% from 19% currently. We have estimated revenue and PAT to increase at a CAGR of ~19% and ~27%, respectively, through FY10-FY12E.

Improved performance by the subsidiaries: With demand on an upswing we expect better performance by FZL and Jingri. We expect FZL to turn profitable as offtake from its prime consumer i.e. steel refractory industry has improved significantly along with the user industry diversification steps taken by CUMI have started paying off. We expect Jingri to break even as it has stepped up the operations after demerging from the joint venture.

Value added products to augment margins: CUMI is focusing on niche products like Metallised cylinders (Metz cylinders) and Silicon carbide microgrit (SiC microgrit) wherein it enjoys high margin. In order to capitalize from these niche segments, CUMI is significantly ramping up its capacities and moving up the value chain. In Metz cylinders, CUMI is planning to double its capacity to .75 mn pieces by FY10. Furthermore, SiC microgrit’s capacity is expected to increase 2.5 times to 12,000 tons by FY12 but we have assumed only 9,600 tons capacity to be operational by FY12.

Changing product mix to boost margin in abrasive segment: CUMI is realigning its product mix to address high value and better margin products. CUMI is focusing more on customized products which yield high realization and better margin than the standard products. Also, increased offtake from auto, auto ancillary and steel markets in Russia and other CIS countries will drive the Russian bonded abrasive business. Thus segmental margin is set to improve to 13.5% from 11% currently by FY12 on a consolidated basis.

Factors to monitor Foreign currency fluctuation: The increased global exposure has enhanced

the foreign currency risk for the company. Valuation We believe that CUMI is well placed to capitalize on the growth opportunities domestically as demand continues to be robust in industries like auto, auto ancillaries and engineering industries. Internationally, CUMI subsidiaries should perform well as demand recovers in Europe, US and Russia. We have estimated revenue and PAT to increase at a CAGR of ~19% and ~27%, respectively, through FY10-FY12E driving the overall ROCE to 22.7%. We initiate BUY on the company with a target price of Rs. 288 over the next one year based on FY12E PE of 16x.

CMP (Rs) 230 Target price (Rs) 288 Potential upside 25%

Stock data

No. of shares (cr) 9.34

FV (Rs) 2

Market cap (Rs cr) 2,148

52 week high/low (Rs) Rs 258/ Rs 135

Avg. daily vol.* (shares)

68,761

BSE Code 513375

NSE Code CARBORUNIV

Bloomberg code CU IN

Reuters Code CRBR.BO

* BSE & NSE 6 monthly

Shareholding (%)

Sep-10 QoQ Chg

Promoter 43.03 (0.01)

FIIs 11.84 0.63

MFs / UTI 7.50 0.33

Banks / FIs 7.73 (0.24)

Others 30.14 (0.71)

Price performance

040008000

12000160002000024000

Sep-09 Nov-09 Jan-10 Mar-10 May-10 Jul-10 Sep-10

050100150200250

Sensex Carborundum

Source: Cline, ENAM Direct Research

Financial summary (Consolidated)

Y/E March Sales (Rs cr) PAT

(Rs cr) EPS (Rs.)

Change (YoY %)

P/E (x)

RoE (%)

RoCE (%)

EV/EBITDA (x)

DPS (Rs)

2009 1,177 75 8.0 21 9.8 14.4 16.9 7.4 2.0 2010 1,266 102 11.0 37 20.9 17.2 18.9 9.5 2.0 2011E 1,479 127 13.6 23 17.0 18.1 19.6 10.1 2.0 2012E 1,802 168 18.0 33.0 12.8 20.2 22.7 7.9 2.0

Source: *Consensus broker estimates, Company, ENAM estimates

BUY

21st October 2010 ENAM Securities Direct 2


COMPANY BACKGROUND

Carborundum Universal (CUMI) is part of the Murugappa Group. It was incorporated in

1954 as a joint venture between Carborundum Company (USA), Universal Grinding

Wheel Company (UK) and Murugappa Group (India). CUMI is engaged in the business of

manufacturing abrasives, industrial ceramics, refractories and electrominerals. Apart from

this, CUMI is also engaged in non-core business of Information technology and power.

CUMI operates Southern Energy Development Corporation Limited (SEDCO) which is a

natural gas based power generation facility that aids the various manufacturing facilities

of CUMI located in Tamil Nadu. It also operates a hydel power plant which meets approx.

40% to 45% of the total power requirement of the electrominerals division in India. CUMI

derives 44% revenue from outside India. It has exposure to various countries like

Europe, North America, Canada, South Africa and Russia.

CUMI is a fully integrated player which manufactures raw material like silicon carbide,

brown and white fused alumina and zirconia which are used as raw material for

manufacturing abrasives as well as refractories.

With the acquisition of Foskor Zirconia Limited (‘FZL’) CUMI is now the world’s third

largest producer of zirconia and second largest producer of silicon carbide grains after the

acquisition of Volzhsky Abrasive Works(VAW), Russia.

Business Overview


(Market Cap. – Rs. 2,148 Cr.)Revenue – Rs. 1,282 Cr.

EBIT – Rs. 217 Cr.Capital Employed – Rs. 1,102 Cr.

Ceramics BusinessRevenue – Rs. 286 Cr.

EBIT – Rs. 56 Cr.Capital Employed – Rs. 284 Cr.

Electro mineralsRevenue – Rs. 430 Cr.


Abrasive BusinessRevenue – Rs. 551 Cr.


IT & PowerRevenue – Rs. 15 Cr.



(Market Cap. – Rs. 2,148 Cr.)Revenue – Rs. 1,282 Cr.

EBIT – Rs. 217 Cr.Capital Employed – Rs. 1,102 Cr.

















Source: Company and ENAM Direct Research; All nos. are on consolidated basis



Company Structure

CUMI has substantial operations outside India. It derives 44% of total revenue from its international operations. VAW, FZL and CUMI Australia are one of the most important subsidiaries. JingRi-CUMI Super Hard Materials Company, China was demerged into two separate divisions i.e. Abrasives and diamond tool. The abrasives business is taken over by CACCL (a subsidiary) from Dec.’ 09 and the diamond tool business is taken over by the other joint venture partner.

Subsidiary and JV companies

Subsidiary Holding as on

Mar-10 Total Assets

(Rs cr) Revenue

(Rs cr) PAT

(Rs cr) Direct holding CUMI America Inc., 100% 2.9 3 (0.5) Net Access (India) Pvt Ltd 100% 5.0 10 1.0 Southern Energy Development Corporation Ltd 84.7% 20.6 16 5.1 Sterling Abrasives Ltd 60% 24.4 32 5.5 CUMI Australia Pty Ltd 51.2% 40.4 57 11.3 CUMI Canada Inc 100% 21.8 12 (3.1) CUMI Middle East FZE 100% 6.8 13 0.4 CUMI Fine Materials Ltd 100% 0.1 CUMI Abrasives & Ceramics Company Ltd(CACCL) 100% 45.3

CUMI International Ltd 100% 236.1 10 4.419 Holding through CUMI International Volzhsky Abrasive Works (VAW) 97.4% 193.2 325 45.6 Foskor Zircnia Pty. Ltd. (FZL) 51% 60.4 81 (0.4)

JV Mar-10 Total Assets

(Rs cr) Revenue

(Rs cr) PBT

(Rs cr) Murugappa Morgan Thermal Ceramics Ltd 49% 34.6 40 7.3 Wendt (India) Ltd 39.8% 28.7 26 6.1 Ciria India Ltd 30% 5.8 11 2.4 JingRi CUMI Super-Hard Materials Co., Ltd* 0% 0 6.1 (6.3)

Source: Company and ENAM Direct Research; * Jingri is now a part of CACCL

Business Mix

Abrasives contribute 43% of revenue, while ceramics account for 22%. Electrominerals account for 34% of revenue and IT and power contribute the rest 1%. Abrasives and ceramics contribute 24% and 26% of the total EBIT, respectively while a whooping 47% of EBIT comes from electrominerals segment. Power and IT contribute the rest 3%.

Revenue Break-up EBIT Break-up

43.0%

22.3%

33.6%

0.7% 0.4%

Abrasives CeramicsElectrominerals Information technologyPower

23.9%

25.7%

47.4%

0.7% 2.4%

Abrasives CeramicsElectrominerals Information technologyPower




BUSINESS OVERVIEW Abrasives

Abrasives Overview

AbrasivesSales-Rs. 551 Cr.EBIT – Rs. 52 Cr.

Capital Employed – Rs. 412 Cr.

ChinaRevenue – Rs. 6.09 Cr.

PBT - Rs. (6.3)Cr. Capacity - 3000 tons (in bonded)Low Capacity utilization in FY 10. In FY11 utilization rate expected

to be higher given the order inflow

VAW, RussiaRevenue – Rs. 41 Cr. Capacity - 35,000 tons

Capacity Utilization-14%

Other. reselling operationsCanada, US, Middle East

Total Revenue – Rs. 28 Cr. PAT – Rs. (3.2)

These subsidiaries are expected to pare losses

BondedRevenue – Rs. 304 Cr.Capacity - 19,640 tons

Capacity Utilization - 73%Average Realizations -

Rs. 204,732/ton

CoatedRevenue – Rs. 145 Cr.

Capacity - 17.83 Mn. Sqm.Capacity Utilization - 50%

Avg. Realizations -Rs. 144/sqm.

OtherRevenue– Rs.123 Cr.

EBIT – Rs. 5.4 Cr.Capital Employed – Rs. 149 Cr.

Indian standaloneoperation

Revenue – Rs. 428 cr.EBIT – Rs. 46.6 cr.

Capital Employed – Rs. 263 cr.

Subsidiaries

Joint VentureWendt India

Revenue – Rs. 25.7 Cr.PBT – Rs. 6 Cr.

Manufactures super abrasivesand precision components

Sterling Abrasives, IndiaRevenue – Rs. 32 Cr.

PAT - Rs. 5.5 Cr.Manufactures Vitrified & Resin

Bonded Grinding Wheels

AbrasivesSales-Rs. 551 Cr.EBIT – Rs. 52 Cr.

Capital Employed – Rs. 412 Cr.

ChinaRevenue – Rs. 6.09 Cr.

PBT - Rs. (6.3)Cr. Capacity - 3000 tons (in bonded)Low Capacity utilization in FY 10. In FY11 utilization rate expected

to be higher given the order inflow

VAW, RussiaRevenue – Rs. 41 Cr. Capacity - 35,000 tons

Capacity Utilization-14%

Other. reselling operationsCanada, US, Middle East

Total Revenue – Rs. 28 Cr. PAT – Rs. (3.2)

These subsidiaries are expected to pare losses



Rs. 204,732/ton






Rs. 204,732/ton














Subsidiaries




Subsidiaries




Sterling Abrasives, IndiaRevenue – Rs. 32 Cr.

PAT - Rs. 5.5 Cr.Manufactures Vitrified & Resin

Bonded Grinding Wheels

Source: Company and ENAM Direct Research

Abrasives are used for diverse applications ranging from material removal, polishing and finishing in multiple industries like automobile, auto ancillaries, fabrication, construction and wood-working. CUMI manufactures 3 types of Abrasives- bonded, coated and super abrasives.

The size of global bonded abrasive market is close to US$5 billion, while the market size for coated abrasive stands at US$4 billion. In India, CUMI and Grindwell hold close to 65% market share in abrasive. In abrasives, 50-60% of the products are sold through channel partners.

The company has a capacity of 19,640 tons in bonded abrasives (standalone) and 17.8 mn. sqm. in coated abrasives (standalone). 1/3rd of abrasives manufactured by CUMI are customized and meet the demand of industries like auto, auto ancillary, bearing and cement. The realization and margin is higher in customized products vs. the standard products in abrasives. Internationally, VAW is an important subsidiary which has a capacity of 35,000 tons of bonded abrasives. VAW caters to demand in Russia and also



exports abrasives to CIS countries. Jingri (Chinese subsidiary) has a capacity of 3,000 tons in bonded abrasives. This plant supplies into India and Russia.

In the Bonded Abrasives space, the company has leadership position in India and Russia. The segment offers significant growth opportunities. In coated abrasives, CUMI is a significant player in hard wood floor market in North America. CUMI also manufactures super abrasives through its Indian JV with Wendt India.

Silicon carbide and alumina are the two key raw materials for abrasives while zirconia is

used in high-end abrasives and ceramics. CUMI has secured the supply of silicon carbide

after the acquisition of VAW. China controls 50% of abrasive grade alumina and the prices

have doubled (even during the downturn). This has impacted the margin in abrasives

coupled with slowdown in demand particularly from North America and Russia. To get

access to alumina, CUMI has entered into a joint venture with GMDC (Gujarat mineral

Development Corporation) to put up a brown fused alumina plant in Gujarat.

The average realization for bonded abrasives is around Rs. 204,000/ton and coated

abrasive is Rs.144/sqm over the last four years (on a stand-alone basis). Realization in

Russian bonded abrasive is around Rs. 100,000/ton. Margin in abrasives took a hit due to

slowdown in demand from India, Russia and North America. Chinese operations also

incurred loss of Rs. 6.3 cr. in FY10. In Dec 2009, Chinese joint venture was demerged into

two separate entities, one for abrasives and the other for diamond / diamond tools

business. Consequently, the assets and liabilities of the Abrasives division were transferred

to a wholly owned subsidiary CACCL. We believe that the utilization levels in the Chinese

subsidiary will improve substantially and the operations will break even this fiscal year.

The other smaller reselling operations in Canada and US also incurred losses whereas the

Middle East operation was marginally profitable. We expect demand to bounce back

leading to paring of losses in these subsidiaries. Also, CUMI is diversifying CUMI

Canada’s revenue stream by supplying ceramic tiles which should help in improving the

overall profitability of the business.

We believe favorable product mix and revival of demand internationally should improve

realizations and margins in this segment in the medium term. Due to burgeoning strong

demand from various user industries, we expect the utilization levels in India to be 92%,

China-80% and Russia-45% by FY12. We expect margin to be close to 13.5% (on a

consolidated basis) by FY12.



Abrasives

(Rs. cr.) 2007 2008 2009 2010

Revenue 388 500 532 552

EBIT 61.9 67.0 52.1 51.7

EBIT Margin 16.0% 13.4% 9.8% 9.4%

Capital Employed 270.6 352.0 417.5 412.7


Bonded Abrasives Assumptions

Utilization assumptions (%) Realization(Rs./ton) Capacity (in Tons) FY11 FY12 FY11 FY12

India 19,640 82% 92% 220,469 224,878

Russia 35,000 25% 45% 103,312 106,411

China 3,000 70% 80% 103,312 106,411

Source: ENAM Direct Research

Coated Abrasives Assumptions

Utilization assumptions (%) Realization(Rs/sqm.) Capacity ( in Mn. Sqm.) FY11 FY12 FY11 FY12

India 17.83 55% 65% 163 165




Ceramics

The size of the global ceramics market is around USD 2 bn. Ceramics includes two

segments- Industrial Ceramics and Refractories. Products are sold directly to the

customers. This business has high entry barriers as it is a highly capital and technology

intensive business.

Industrial Ceramics

Industrial Ceramics Overview

Industrial Ceramics

Australia

Revenue – Rs. 56 Cr.PAT - Rs. 11 Cr.

Servicing and installation for wear resistant liner

Indian standalone operation

Revenue – Rs. 90 Cr.Capacity - 5,870 tons

Metz cylinder

Capacity (in nos.) - 360,000Capacity utilization – 61%

Avg. Realization - Rs. 800/cylinder

Wear Resistant Liner, Lined equipmentEngineered ceramics, Grinding Media

Capacity – 5,400 tonsCapacity Utilization – 61%

Avg. Realization – Rs. 150,000/ton

Industrial Ceramics

Australia





Australia





Metz cylinder

Capacity (in nos.) - 360,000Capacity utilization – 61%

Avg. Realization - Rs. 800/cylinder

Wear Resistant Liner, Lined equipmentEngineered ceramics, Grinding Media

Capacity – 5,400 tonsCapacity Utilization – 61%

Avg. Realization – Rs. 150,000/ton

Source: Company and ENAM Direct Research.

Industrial Ceramics offers Alumina and Zirconia products of technical ceramic grades

addressing wear protection, electrical resistance, thermal protection and ballistic

protection requirements. Industrial ceramics includes products like wear resistant liner,

grinding media, armour and engineered ceramics and metallised ceramics. Grinding

media goes into the cement and other ceramic products like potteries and the realization is

about Rs.45-50/kg. Wear and corrosion resistant tiles is most important product for

CUMI and the realization is close to Rs.120-150/kg. Wear and corrosion resistant products require replacement in every 2-4 years. Realization for Armour and engineering

ceramics is about Rs.600/kg.

CUMI has two pronged strategy for this business. Firstly, to offer end to end services and

secondly, to move up the value chain. In wear resistant liner, the company is providing

end to end solutions and is moving up the value chain through its Metz ceramic products.



The industrial ceramics manufacturing operation is predominantly based in India. It has a

capacity of 5,400 tons in wear resistant liner and engineered ceramics and another 0.4 mn.

pieces in metz cylinders. 34% of the total ceramic sales (in standalone) comes from

exports. The average realization for wear resistant liner is around Rs. 150,000/ton. Metz

cylinder realization is around Rs. 800/cylinder.

The export business of wear protection products to Europe and North America was

severely impacted due to slow down in these geographies. So, CUMI is focusing on new

markets like South America, South Africa, and China to diversify its revenue stream. Internationally, CUMI Australia is an important subsidiary with an annual turnover of

Rs. 56 cr. in FY10. CUMI Australia provides servicing and installation for ceramic tiles.

Here, CUMI has a strong position in coal washery industry. Of late, the Australian

operation faced stiff competition from imports which led to pricing pressure. CUMI is now

focusing on consolidation of the strong market position it enjoys in supply of products to

coal washeries and also expanding customer base by adding clients from other mining

sectors.

The metz cylinder is used in vacuum interrupters/bottles which are used in the power

plants transmission equipment. The company enters into long term contracts in this

business. CUMI is targeting a capacity expansion from current 0.4 mn. pieces to 0.75 mn.

pieces by September this year. CUMI faces stiff competition from ABB, Crompton Greaves,

Areva, Siemens etc.

We believe utilization level to be upwards 90% for wear resistant liner and metz cylinders by FY12.

Industrial Ceramics Assumptions

Capacity Utilization

assumptions(%) Realization(Rs./ton) FY11 FY12 FY11 FY12 FY11 FY12

Wear resistant linear (in Tons) 5,400 5,400 80% 95% 150,000 151,500

Realization (Rs./cylinder) Metz Cylinder (in nos.) 750,000* 750,000 64% 90% 800 800

Source: ENAM Direct Research; capacity doubled to 750,000 cylinders



Refractories

The growth in this segment is largely driven by off-take from iron and steel, cement,

carbon black, non ferrous, ceramic and glass industries. Global market for fired refractories

is about $2 billion, while for castables it is close to $3 billion. For CUMI, refractories is

largely an India centric business. Iron and steel industries account for 80% of India’s

refractory usage. Steel industry which is at 50mmt currently is expected to grow to

150mmt in the next 5 years. Until now CUMI could not cater to steel refractory business as

it had entered into a 10 yr. non-compete agreement with Vesuvius. This agreement expires

in the current year giving CUMI a huge growth opportunity in this business. Refractories

are consumables which require replacement frequently. So, the business opportunity arises

at two stages. First, at the setting up of the project and second, for regular maintenance of

refractories.

Refractories Overview

Refractories

VAW, Russia & Vulcan RefectoriesCapacity - 1800 tons


Revenue – Rs. 109 Cr.Capacity – 36,450 tons

Joint Venture(MMTCL, CIRIA)

Revenue - Rs. 52 Cr.PBT – Rs. 9.7 Cr.

Anticorrosive products

Capacity - 10,000 tonsCapacity Utilization – 80%

Realizations - Rs. 47,730/ton

Monolithic

Capacity - 20,000 tonsCapacity Utilization – 70 % Realizations - Rs. 23,865 /ton

Fired Refractories

Capacity - 6,000 tonsCapacity Utilization – 67% Realizations - Rs. 95,460/ton

Refractories

VAW, Russia & Vulcan RefectoriesCapacity - 1800 tons


Revenue – Rs. 109 Cr.Capacity – 36,450 tons

Joint Venture(MMTCL, CIRIA)

Revenue - Rs. 52 Cr.PBT – Rs. 9.7 Cr.

Anticorrosive products

Capacity - 10,000 tonsCapacity Utilization – 80%

Realizations - Rs. 47,730/ton

Monolithic

Capacity - 20,000 tonsCapacity Utilization – 70 % Realizations - Rs. 23,865 /ton

Fired Refractories

Capacity - 6,000 tonsCapacity Utilization – 67% Realizations - Rs. 95,460/ton


CUMI has a capacity of 36,000 tons which includes 20,000 tons of monolithics, 6,000 tons of

fired refractories and 10,000 tons of anti-corrosive products. Realization of fired

refractories is around Rs. 95,000/ton, anti-corrosive products is close to Rs. Rs. 48,000/ton

and monolithic is Rs. 24,000/ton. CUMI is looking to expand its capacity in monolithics.

CUMI has successfully produced Nitride Bonded Silicon Carbide (along with Vulcan

Refractories, UK). This has strengthened CUMI’s position in aluminium and non-ferrous

industries. It has a capacity of 1,800 tons in Russia.



CUMI has two joint ventures in refractories- MMTCL and Ciria. MMTCL and Ciria is the

joint venture with the Morgan Crucible plc. (it is in fibre refractory business). Ciria is

engaged in designing and installation of refractory systems. MMTCL and Ciria together

contributed revenue and PAT of Rs. 51.5 cr. and 9.7cr. , respectively in FY10.

We expect demand to remain buoyant and utilization levels to stay above 90% in FY12.

Refractories Assumptions

Utilization assumptions(%) Realization(Rs./ton) Refractories Capacity (In Tons) FY11 FY12 FY11 FY12

Fired 6000 90% 95% 98,324 100,290

Monolithics 20,000 80% 95% 24,581 25,073

Anti-corrosive products 10,000 75% 90% 48,685 49,171

Source: ENAM Direct Research.

Ceramics (on a consolidated basis)

We believe 20% margin (on a consolidated basis) for ceramics segment as sustainable.

(Rs. cr.) 2007 2008 2009 2010

Revenue 170 213 257 286

EBIT 39.3 44.1 52.5 55.7

EBIT Margin 23.2% 20.7% 20.4% 19.5%

Capital employed 103.1 166.7 267.5 284.5




Electrominerals

Electrominerals Business Overview

Electro minerals Revenue– Rs. 430 Cr.


VAW, RussiaManufactures SiC

Revenue– Rs. 236 Cr.Capacity-70,000 tons

Capacity Utilization-91%Realization–Rs.47,000/ ton

FZL, SAManufactures ZirconRevenue – Rs. 81 Cr.Capacity - 4,500 tons

Capacity Utilization - 90%Avg. Realization–Rs.190,000/ton


Capacity - 25,340 tonsRevenue – Rs. 112 Cr.


SIC Macro

Capacity- 4,000 tonsAvg. Realization - Rs. 55,000/ton

Alumina Macro grit

Capacity – 18,940 tonsAvg. Realization - Rs. 45,000/ton

SIC Micro grit

Capacity - 2,400 tonsAnother 2,400 tons added in April,10Avg. Realization –

Rs. 180,000/ton

Electro minerals Revenue– Rs. 430 Cr.


















SIC Macro

Capacity- 4,000 tonsAvg. Realization - Rs. 55,000/ton

Alumina Macro grit

Capacity – 18,940 tonsAvg. Realization - Rs. 45,000/ton

SIC Micro grit

Capacity - 2,400 tonsAnother 2,400 tons added in April,10Avg. Realization –

Rs. 180,000/ton


Global market size is close to US$3 bn. CUMI manufactures silicon carbide, brown and

white fused alumina and zirconia. The company has relatively smaller operation in India

and has a larger operation in Russia and South Africa. A substantial portion of SiC from

Russia is exported to Europe. FZL also exports zirconia to Europe and Asia. In

Electrominerals, CUMI has positioned itself as

Commodity player- It is based on global cost positioning. VAW is world’s lowest

cost producer of Sic. FZL is among one of the lowest cost manufacturer of zirconia.

After the JV with GMDC comes up, CUMI will be become large player in brown

fused alumina as well.

Manufacturer of Value added products based on in-house technology - CUMI is

looking to develop range of value added products using silicon carbide, zirconia and

alumina. These are high end products attracting higher margin and realization. In

this, CUMI produces silicon carbide microgrit which is supplied to the photovoltaic

industry.



Pet coke and power are the key inputs in electrominerals. Of late, pet coke prices have

risen sharply followed by increase in the cost of power in Russia, South Africa and India.

This has hampered the margin but we believe the price increase taken by CUMI and other

steps by the company should help in bringing back the margin in the business.

In Electrominerals, the current capacity in India is close to 27,740 tons which includes

silicon carbide macros-4,000 tons, brown and white fused alumina macrogrit-18,940 tons

and SiC microgrit-4,800 tons. The capacity of silicon carbide in Russia is close to 70,000

tons while South Africa has a capacity of 4,500 tons of Zirconia. The average capacity

utilization levels of these plants are approx. 90%. The average realization for SiC macros is

around Rs. 55,000/ton and alumina Rs. 45,000/ton in India. The average realization in

Russia and South Africa is Rs. 47,000/ton and Rs. 190,000/ton, respectively.

CUMI has huge expansion plan for its electrominerals division. The company is looking to

set up SiC fusion plant with a capacity of 100,000 ton in phases, at its VAW plant, with an

investment of US$75 million. Secondly, CUMI is looking to add another 4,500 tons of

zirconia capacity with an investment of $8 mn. in FZL. Thirdly, CUMI is planning to enter

into a joint venture with GMDC (Gujarat mineral Development Corporation) to acquire

bauxite resources and set up a 35,000 ton brown fused alumina plant with an investment

of Rs.100 cr. The timeline for these projects is not known.

The company is focusing on manufacturing silicon carbide microgrit. These are value

added products which are predominantly supplied to the photovoltaic industry. In the

photovoltaic, poly silicon and mono-crystalline silicon are used to make the wafers which

are used finally to make the cells and then the panels for the photovoltaic electricity

generation. The current capacity stands at 4,800 tons. The capacity is expected to increase

2.5 times to 12,000 tons by FY12 but we have assumed only 9,600 tons capacity to be

operational by FY12. This would require a capex of Rs. 36 cr. The realization for SiC

microgrit is around Rs. 180,000/ton.

We expect the capacity utilization to stay above 90% for electrominerals considering the

strong demand from various end user industries. The margin in electrominerals division

is under pressure due to rise in the input costs like petcoke and power. We expect margins

to be stay close to 18%, going ahead.



Electrominerals

(Rs. cr.) 2007 2008 2009 2010

Revenue 52 184 389 430

EBIT 15.3 26.5 75.8 102.7

EBIT Margin 29.5% 14.4% 19.5% 23.9%

Capital Employed 57.3 155.5 208.9 266.5


Electrominerals Assumptions Realization

(Rs./ton) Electrominerals manufactured Capacity in FY12

(in tons) FY11 FY12

Capacity utilization

VAW, Russia Silicon Carbide 70,000 47,840 48,797

FZL, South Africa Zircon 4,500 198,030 207,932

Silicon carbide macros 4,000 56,100 57,222 Brown and white fused alumina 18,940 45,900 46,818 CUMI India

SiC Microgrit 9,600 181,800 183,618

Capacity utilization to stay above 90%




INVESTMENT ARGUMENT

Higher offtake to drive volume growth: CUMI has invested aggressively to

augment capacities (around Rs.600 crores over the last four years) through both the

organic and inorganic route which will help it capitalize on growth opportunities

domestically as well as internationally. In FY08, it had acquired VAW Russia to

become second largest producer of Silicon Carbide grains and in FY09 it acquired

FZL and is now world’s third largest producer of zirconia. We have estimated

utilization in bonded abrasives to stay above 90% in FY12 (except Russian bonded

abrasive business). In CY09, Russia did a volume of only 5,000 tons. We believe that

by FY12 the volume should treble to 15,000 tons. In industrial ceramics and

refractories we have estimated capacity utilization to stay in excess of 90% by FY12.

In electrominerals, FZL and Russian capacities are already peaking out and we

believe that this momentum would sustain.

Utilization levels to drive growth….

Segment Current Capacity Current Utilizations levels In FY10 Margin levels

Abrasives

Bonded Abrasives (Tons) 57,640 37%

Coated Abrasives (Mn. sq. meter) 17.8 50%

Margins to improve from current 9.4% to 13.5% over the next two years

Ceramics

Industrial Ceramics (Tons) 5,870 61%

Refractories (Tons) 38,250 70%

Margins to remain stable in the range of 20%

Electrominerals

Grains (Tons) 102,240 90% 18% margins sustainable Source: Company and ENAM Direct Research

Capacity utilizations to move towards 90% over the next two years leading to increase in ROCE to 22.7%



Improved performance by the subsidiaries: With demand on an upswing we expect

better performance by FZL, Jingri and CUMI Canada.

We expect FZL to turn profitable: FZL incurred a net loss of Rs. .4 cr. in FY10 as

demand from its prime customer i.e. steel refractory industry was severely

impacted by the downturn. The plant was closed for the 1st quarter of FY10. The

demand from steel refractories is now reviving coupled with FZL expanding

into other geographies and diversifying its user industry segments. We believe

that this business should turn profitable this year.

Jingri to break even in FY11: JingRi-CUMI Super Hard Materials Company,

China was demerged into two separate divisions i.e. Abrasives and diamond

tool. The abrasives business is taken over by CACCL (CUMI’s subsidiary) from

Dec.’09. The Chinese JV incurred loss of Rs. 6.3 cr. in FY10 due to significant

lower capacity utilization. The Chinese bonded abrasive capacity is mainly meant

for exports into Russia and India. We expect this plant to run at full capacity,

going ahead.

CUMI Canada to pare losses- CUMI Canada is hit by the downturn in the

housing market. To counter this, CUMI is diversifying customer base by

focusing on ceramic product lines. This should help CUMI Canada to pare

losses in FY11.

Value added products to augment margins: CUMI is moving up the value chain by

focusing and expanding the niche businesses viz. Metz cylinders and SiC microgrit.

These are technology intensive business wherein it enjoys high margin. In Metz

cylinders, CUMI is targeting a capacity expansion from current 0.35 mn. pieces to

0.75mn. pieces by FY11. The realization in Metz cylinder is Rs. 800 per cylinder on

an average. In SiC microgrit, CUMI has capacity of 4,800 tons and the realization is

around Rs. 180,000/ton. The company is targeting an additional capacity of 7,200

tons (in three phases) of SiC microgrit to come up in Cochin SEZ in the next 18-24

months. Of this, we have assumed only 2,400 tons to be operational by FY12. This

would require a capex of Rs. 36 cr.



Expectations of favourable product mix in the abrasive segment: CUMI is

realigning its product mix to address high value and better margin products. CUMI

is focusing more on customized products which yield high realization and better

margin than the standard products. 1/3rd of the abrasives sold by CUMI are

customized. Also, increased offtake from auto, auto ancillary and steel markets in

Russia and other CIS countries will drive the Russian bonded abrasive business.

Thus segmental margin is set to improve to 13.5% from 11% currently by FY12 on a

consolidated basis. Abrasives currently contribute 43% of revenue and 24% of EBIT,

on consolidated basis.

Capacity expansion in Electrominerals to change the landscape- CUMI is

undertaking three large projects which would be very crucial to its growth strategy.

These projects are under finalization stage and if any of these projects materialize it

would lead to the re-rating of the stock. We have not factored any of these projects in

our valuation. These projects include-

Adding SiC Fusion capacity: CUMI is planning to add 100,000 tons of SiC fusion

capacity at VAW II in phases. This would require a capex of US$ 75 mn. For this,

CUMI is scouting for a strategic partner.

Joint venture with GMDC: CUMI is entering into joint venture with Gujarat

Mineral development Corporation (GMDC) to get access to bauxite resources.

The plant will have a capacity of 35,000 tons of brown fused alumina and would

entail an investment of Rs. 100 crores. This is an important project as this would

help CUMI to get access to abrasive grade alumina (which is a key raw material

for abrasives and refractories). Currently, China controls 50% of the abrasive

grade alumina and prices have remained high even during the downturn.

Doubling of capacity at FZL: CUMI is planning to add another 4,500 tons of

zirconia capacity in FZL. It largely caters to steel refractory business in Europe

and Asia.

Demonstrated growth in Sales and EBITDA- Net sales and EBITDA has increased

at a CAGR of 27% and 22% over FY06-10, respectively. We have estimated net sales



and EBITDA to grow at a CAGR of 19% and 23% over the next two years. As a result

the company’s ROE and ROCE is set to improve to 20% and 22.7%, respectively by

FY12.

Increasing Net Sales and sustainable EBITDA margin Improving ROCE and ROE profile

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Maintained strong revenue growth and Margin across segments: CUMI has grown

revenue at a CAGR of 5%, 15% and 52% for abrasives, ceramics and electrominerals,

respectively over the last three years. The EBIT margin for ceramics has been pretty

stable while for electrominerals it has improved over the last three years. For

abrasives, we believe that the margin should get back to 13.5% by FY12. We expect

the EBIT margin in ceramics and electrominerals to be sustainable at 20% and 18%,

respectively, going ahead.

Segmental Break-up

(Rs. cr.) Abrasives Ceramics Electrominerals Others Total Revenue FY08 500 213 184 12 909

FY09 532 257 389 15 1193

FY10 552 286 430 14 1282

EBIT FY08 67 44 27 6 144

FY09 52 52 76 5 185

FY10 52 56 103 6 217

EBIT Margin (%) FY08 13% 21% 14% 50% 16%

FY09 10% 20% 20% 33% 16%

FY10 9% 20% 24% 43% 17%




RISKS TO VALUATION

Increase in input costs-Increase in raw material prices such as pet coke, brown fused

alumina could hamper the margin of the company. Also fuel and power cost is one of

the major component of the overall cost structure constituting 12-13% of the sales.

Any further increase in these costs can dampen the margin profile for CUMI if it is

not able to pass on the cost.

Availability of raw material- Availability and pricing of brown and white fused

alumina remains a challenge. Abrasive grade alumina is controlled by China, which

had put quantitative restriction on its export. In India, Gujarat state government

tweaked its mineral policy and allowed private players to export bauxite. All this has

posed supply side issues for alumina. To mitigate this risk CUMI has signed an MOU

with GMDC to set up a brown fused alumina facility.

Exchange rate movements- Around 18% of company’s revenue comes from export.

So appreciation of Indian Rupee will reduce the competitiveness as well as the

profitability of the business. Also, ruble appreciation impacts the margin negatively

as Russian SiC is exported to Europe. CUMI Australia is also impacted by weakening

of dollar as imports become cheaper.



VALUATION Revenue growth of ~19% CAGR during FY10-FY12E

EBITDA margins to improve by 100bps to 17.6% by FY12E

EPS growth at ~27% CAGR over next two years

Scalable business model and stable earnings growth

Strong Corporate governance

Comfortable leverage ratio at 0.6x

Our 1-yr. target price of Rs. 288 (upside 25%) is based on a target P/E multiple of 16x FY12E

Carborundum Universal - 12mth fwd EV/EBITDA (x)

Carborundum Universal - 12mth fwd P/E (x)

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FINANCIALS Income statement (Rs Cr)

Y/E March (Consol) 2009 2010 2011E 2012E Net sales 1,177 1,266 1,479 1,802 Other operating income 16 16 17 18 Total income 1,193 1,282 1,497 1,820 Cost of goods sold 823 895 1,046 1,269 Contribution (%) 31 31 30 31 Advt/Sales/Distrn O/H 204 174 195 231 Operating Profit 166 213 256 320 Other income 33 32 15 17 PBIDT 199 244 271 337 Depreciation 35 41 50 54 Interest 32 31 27 27 Other pretax 0 0 0 0 Pre-tax profit 131 172 194 257 Tax provision 55 56 60 80 (-) Minority Interests 11 14 7 9 Associates 10 0 0 0 Adjusted PAT 75 103 127 168 E/o income / (Expense) 29 (1) 0 0 Reported PAT 104 102 127 168

Balance sheet (Rs. Cr)

Y/E March (Consol) 2009 2010 2011E 2012E

Total assets 1,109 1,126 1,215 1,371 Gross block 775 811 955 1,025 Net fixed assets 485 488 582 598 CWIP 32 44 0 0 Investments 61 78 78 78 Wkg. cap. (excl cash) 366 385 435 515 Cash / Bank balance 60 47 35 95 Others/Def tax assets 104 85 85 85 Capital employed 1,109 1,126 1,215 1,371 Equity capital 19 19 19 19 Reserves 534 623 736 892 Borrowings 515 439 415 415 Others 41 45 45 45 Source: Company and ENAM Direct Research



Key ratios (%)

Y/E March (Consol) 2009 2010 2011E 2012E Sales growth 31.3 7.5 16.9 21.8 OPM 14.1 16.8 17.3 17.8 Oper. profit growth 18.1 28.0 20.3 25.4 COGS / Net sales 69.0 69.8 69.9 69.7 Overheads/Net sales 17.1 13.6 13.1 12.7 Depreciation / G. block 4.5 5.1 5.2 5.3 Effective interest rate 7.2 6.4 6.3 6.5 Net wkg.cap / Net sales 0.27 0.30 0.28 0.26 Net sales / Gr block (x) 1.7 1.6 1.7 1.8 RoCE 16.9 18.9 19.6 22.7 Debt / equity (x) 0.9 0.7 0.6 0.5 Effective tax rate 42.0 32.5 31.0 31.0 RoE 14.4 17.2 18.1 20.2 Payout ratio (Div/NP) 17.9 18.4 14.8 11.1 EPS (Rs.) 8.0 11.0 13.6 18.0 EPS Growth 20.9 37.2 23.2 33.0 CEPS (Rs.) 11.8 15.4 18.9 23.8 DPS (Rs.) 2.0 2.0 2.0 2.0

Cash flow (Rs Cr)

Y/E March (Consol) 2009 2010 2011E 2012E Sources 222 64 138 210 Cash profit 143 194 211 258 (-) Dividends 28 42 21 21 Retained earnings 115 152 189 237 Issue of equity 0 0 0 0 Borrowings 75 (65) (24) 0 Others 31 (24) (27) (27) Applications 222 64 138 210 Capital expenditure 88 59 100 70 Investments 33 24 0 0 Net current assets 87 (7) 51 79 Change in cash 13 (13) (12) 60




CONFLICT OF INTEREST DISCLOSURE

We, at ENAM, are committed to providing the most honest and transparent advice to our clients. However, given thenature of the capital markets, from time to time we are faced with situations that could give rise to potential conflict ofinterest. In order to provide complete transparency to our clients, before we make any recommendations, we arecommitted to making a disclosure of our interest and any potential conflict IN ADVANCE so that the interests of ourclients are safe- guarded at all times. In light of this policy, we have instituted what we believe to be the mostcomprehensive disclosure policy among leading investment banks/brokerages in the world so that our clients may make an informed judgment about our recommendations. Thefollowing disclosures are intended to keep you informed before you make any decision- in addition, we will be happyto provide information in response to specific queries that our clients may seek from us. Disclosure of interest statement (As of20st June, 2010) 1. Analyst ownership of the stock No 2. Firm ownership of the stock No 3. Directors ownership of the stock Yes 4. MBD Relationship No 5. Broking relationship No We are committed to providing completely independent and transparent recommendations to help our clients reach a better decision.

This document has been prepared by Enam Securities Direct Private Limited – Privileged Client Group. Affiliates of Enam Securities Direct Private Limited focused on Institutional Equities may have issued other reports that are inconsistent with and reach different conclusion from the information presented in this report. The views and opinions expressed in this document may or may not match or may be contrary with the views, estimates, rating and target price of the Affiliates research report. The report and information contained herein is strictly confidential and meant solely for the selected recipient and may not be altered in any way, transmitted to, copied or distributed, in part or in whole, to any other person or to the media or reproduced in any form, without prior written consent. This report and information herein is solely for informational purpose and may not be used or considered as an offer document or solicitation of offer to buy or sell or subscribe for securities or other financial instruments. Nothing in this report constitutes investment, legal, accounting and tax advice or a representation that any investment or strategy is suitable or appropriate to your specific circumstances. The securities discussed and opinions expressed in this report may not be suitable for all investors, who must make their own investment decisions, based on their own investment objectives, financial positions and needs of specific recipient. This may not be taken in substitution for the exercise of independent judgement by any recipient. Each recipient of this document should make such investigations as it deems necessary to arrive at an independent evaluation of an investment in the securities of companies referred to in this document (including the merits and risks involved), and should consult its own advisors to determine the merits and risks of such an investment. The investment discussed or views expressed may not be suitable for all investors. Certain transactions -including those involving futures, options and other derivatives as well as non investment grade securities - involve substantial risk and are not suitable for all investors. Enam Securities Direct Private Limited has not independently verified all the information given in this document. Accordingly, no representation or warranty, express or implied, is made as to the accuracy, completeness or fairness of the information and opinions contained in this document. The Disclosures of Interest Statement incorporated in this document is provided solely to enhance the transparency and should not be treated as endorsement of the views expressed in the report. This information is subject to change without any prior notice. The Company reserves the right to make modifications and alternations to this statement as may be required from time to time without any prior approval. Enam Securities Direct Private Limited, its affiliates, their directors and the employees may from time to time, effect or have effected an own account transaction in, or deal as principal or agent in or for the securities mentioned in this document. They may perform or seek to perform investment banking or other services for, or solicit investment banking or other business from, any company referred to in this report. Each of these entities functions as a separate, distinct and independent of each other. The recipient should take this into account before interpreting the document. This report has been prepared on the basis of information that is already available in publicly accessible media or developed through analysis of ENAM Securities Direct Private Limited. The views expressed are those of the analyst and the Company may or may not subscribe to all the views expressed therein. This document is being supplied to you solely for your information and may not be reproduced, redistributed or passed on, directly or indirectly, to any other person or published, copied, in whole or in part, for any purpose. Neither this document nor any copy of it may be taken or transmitted into the United State (to U.S. Persons), Canada, or Japan or distributed, directly or indirectly, in the United States or Canada or distributed or redistributed in Japan or to any resident thereof. 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