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Kotak Securities - Private Client Research Please see the disclaimer on the last page For Private Circulation 2

MORNING INSIGHT November 25, 2014

Kotak Securities Limited has two independent equity research groups: Institutional Equities and Private Client Group. This report has been pre-pared by the Private Client Group. The views and opinions expressed in this document may or may not match or may be contrary with the views,estimates, rating, target price of the Institutional Equities Research Group of Kotak Securities Limited.

CARBORUNDUMUNIVERSALLTD(CUMI)

PRICE: RS.174 RECOMMENDATION: BUY

TARGETPRICE: RS.240 FY16E P/E: 14.5X

We initiate coverage on Carborundum Universal Ltd (CUMI) stock with 'BUY'rating and a target price of Rs 240 based on 20x FY16E earnings. We believethat CUMI valuations can get rerated considering 1) potential case ofturnaround in the overseas business 2) strong growth in company'sestimated consolidated PAT through FY14-16E and 3) strong positioning inthe domestic abrasives market. We project 54% CAGR between FY14-16 inconsolidated profits from Rs.950 mn in FY14 to Rs 2.2 Bn in FY16E. Atcurrent price of Rs 174, CUMI stock is trading at 14.5 x P/E and 8.2 x EV/EBITDA on FY16E earnings.

Key Investment Rationale

Leadership position in the domestic abrasives market; strong positioningin global electrominerals and industrial ceramics market. CUMI is a promi-nent player which enjoys leadership position in Indian abrasive market on backof 1) strong brand in abrasive space 2) robust distribution network offering panIndia presence 3) efficient cost controls providing price advantage to the enduser.

Geographically diversified operations: Recovery expected in overseasbusiness; business uptrend across verticals. Management believes that thisshould result in improved sales across verticals and margin for the company overFY15-16. Overseas business that has been under stress for several quarters in thepast has stated to witness signs of revival. CUMI's South African business(Thukela and Foskor) been reporting revival and can further observe pick up in

revenue/margin profile over FY15-16. CUMI is also likely to benefit from ex-pected favourable product mix in Russia operation over the next few years. InAustralia CUMI is one of the leading players in lined equipment and industrialceramics. Management has indicated that the volumes have bottomed out andexpect recovery through FY15-16.

Sustained emphasis on research & development initiatives provides com-petitive edge to the company. CUMI pays considerable emphasis on the re-search and development capabilities. It constantly ventures into new initiativerelated to technological advancement. Company consistently deploys resourcesfor adding products valuable to the end users. R&D activities involve develop-ment of new products and improvement of existing products. Recently addedproducts contribute to over 15-18% of company's revenues.

Company to maintain high growth in revenue; recovery in operatingmargins likely to aid to free cash flow generation. We project 11% CAGRbetween FY14-16 in consolidated revenues from Rs.21.2 Bn in FY14 to Rs 26 Bnin FY16E and 54% CAGR in EPS from Rs 5.1 in FY14 to Rs 12 in FY16 on backof 1) recovery in demand for abrasives in the domestic/international market 2)pick up in international subsidiaries business and margin improvement at keysubsidiaries. Within the revenue streams, we expect volume growth across all thedivisions over FY14-16 and also expect that the pricing would likely improve onback of global economic recovery.

INITIATINGCOVERAGE

Ruchir [email protected]

+91 22 6621 6448

Stock details

BSE code : 513375NSE code : CARBORUNIV

Market cap (Rs.bn) : 32.61

Free float (%) : 57.9

52-wk Hi/Lo (Rs) : 221/113

Avg. Daily Volume BSE+NSE : 135000

Shares o/s (mn) : 187

Summary table

(Rs mn) FY14 FY15E FY16E

Sales 21,253 23,929 26,028

Growth (%) 9.5 12.3 9.0

EBITDA 2,514 2,871 4,295

EBITDA margin (%) 11.8 12.0 16.5

PBT 1542 1750 3161Net profit 950 1,243 2,245

EPS (Rs) 5.1 6.6 12.0

Growth (%) 5.5 30.8 80.6

CEPS (Rs) 9.9 11.9 17.4

BV (Rs/share) 59.0 63.7 72.1

DPS (Rs) 1.3 1.7 3.0

ROE (%) 8.8 10.8 17.6

ROCE (%) 6.4 8.3 13.4

Net cash (debt) (3,015) (2,917) (2,388)

NW Capital (Days) 89.7 87.4 90.9

EV/Sales (x) 1.6 1.4 1.3

EV/EBITDA (x) 14.3 12.6 8.4

P/E (x) 34.3 26.2 14.5

P/Cash Earnings (x) 17.5 14.7 10.0

P/BV (x) 2.9 2.7 2.4

Source: Company,Kotak Securities - Private Client Research

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Valuation

Current valuations appear attractive vis--vis the potential growth inprofits, estimated at 54% CAGR between FY14-16.At current price of Rs174, CUMI stock is trading at 14.5 x P/E and 8.2 x EV/EBITDA on FY16E earn-ings. We believe that company's stock can re-rate further to capture significantimprovement in company's margin profile and strong presence in Indian/overseas

market. We value CUMI stock at 20x FY16E (11x EV/EBITDA) earnings and ar-rive at a target price of Rs 240 per share. In view of adequate upside to our tar-get price we ascribe 'BUY'rating on company's stock.

Key Concerns

Delayed recovery in global manufacturing activity.Abrasives, ceramics, re-fractories and electrominerals are used by various industries in their manufactur-ing activity. Over the past few years, CUMI business has suffered due to lan-guishing macro environment. Global manufacturing has started to recoverthrough past few quarters. However we note that company business can getseverely impacted if there are any delays in the recovery

Increased volatility in input prices. In FY14, company has faced input cost

pressure in the form of hike in power cost, fuel cost and select raw material in-puts in Indian, Russian and South African operations. Company could containthese pressures by way of using alternate cost effective raw materials, improve-ment in raw material consumption and process improvements. We note that in-creased volatility in input prices could pose threat to company's operations.

INDUSTRY OVERVIEW

ABRASIVES

The global market for abrasives, estimated at USD 12.9 Bn is characterized by adiversified customer base. Abrasives are used extensively across industries such asautomobiles, gems & jewelry, electrical, machinery etc. The dependence on singleindustry is less than 15% and therefore typically, demand for abrasives gets affectedonly during economic slowdown.

Four major segments of global abrasives industry consists of:

Abrasive segments

Abrasives Application

Loose Abrasives Loose abrasive lapping is widely used to prepare optical glass

before its final polishing.

Coated Abrasives Surface-treatment applications including grinding, blending,

dimensioning, shaping, finishing, & polishing

Super Abrasives They are used to shape materials that are too hard or too fragile

for conventional abrasives: glass beveling in the automotive

and building sectors, as well as for high-precision grinding of

crystals and ceramic components.

Bonded Abrasives Presented in the form of wheels; used in automobiles,

construction, steel, bearing etc.

Source: Kotak Securities - Private Client Research, Industry

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Electrominerals

Electro minerals are used as basic raw material in the manufacture of abrasives andrefractories. They are also increasingly being used for silicon wafer slicing in solar cellmanufacture, dental care and skin therapy. Silicon carbide (one of the majorElectrominerals products) also finds application in metallurgical industries.

The global market size for electro minerals is estimated at around USD 2.5 billion.The key success factors in this industry are cost and quality. Entry barriers are highcapital investment, limited market and technology. Availability of alternatives andproduct differentiation are the main challenges in this business. In India, CUMI isone of the leading players in aluminum oxide grains. Apart from CUMI, GrindwellNorton, Orient Abrasives and SNAM Abrasives are the others. Imports from Chinaare also a major source of electro minerals in India.

COMPANY OVERVIEW

Incorporated in year 1954, Carborundum Universal Ltd (CUL)is a global supplierof abrasives, ceramics and electro minerals. CUMI was founded as collaboration

between the Murugappa Group, The Carborundum Co., USA and the UniversalGrinding Wheel Co. Ltd., U.K. Company currently manufacturers over 20,000 differ-ent varieties of abrasives, refractory productsand electro-minerals in ten locationsacross various parts of the country.

CUMIs focus on R&D initiatives and strategic alliances with global leaders in grind-ing technology ensured international recognition as a manufacturer of quality abra-sives and a provider of total grinding solutions. CUMIs products are being exportedto 43 countries spread across North America, Europe, Australia, South Africa andAsia. CUMI enjoys leadership positioning in Indian abrasives industry and globallysecond and third position in silicon carbide and zirconia respectively.

Key Revenue Streams

Source: Company, Kotak Securities - Private Client Research

Over the last five years, CUMI has grown consolidated revenues at 9% CAGRmainly boosted by electrominerals business. Company operate on 55-60% capacityutilization and major capex programs are over. With an extensive distribution net-work and highly qualified and motivated personnel base, CUMI aims at establishingitself as meaningful global player in its core products.

Carborundum Universal (CUMI)

Abrasives(40% of revenues)

Electrominerals(35% of revenues)

Ceramics(25% of revenues)

CoatedAbrasives

BondedAbrasives

SuperAbrasives

IndustrialCeramics

SuperRefractories

Anti corro-sives

fund carbo run iv 25112014093126

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