Kajaria Ceramics: A changing pattern

While lower GST may benefit organised tile makers in the long run, there are other near-term concerns for Kajaria

The stock of Kajaria Ceramics has been trading flat over the last one month following negative sentiments. The first six months of 2017-18 have been bad for the company with sluggish demand from real estate and dealers reducing inventory post GST. However, given that the company is the largest player in the organised sector and is set to benefit from the push towards affordable housing and implementation of RERA (Real Estate Regulation and Development Act), the future is promising. The tweak in the GST rate last week bringing down the tax on ceramic tiles to 18 per cent from the previous 28 per cent, is also a positive.

Since our last buy recommendation on the stock in May 2015, the stock has rallied 80 per cent.

Investors with a long-term view can hold the stock. On trailing 12-month earnings, the stock is trading at 46 times — higher than the three year average of about 43 times.

The company expects the second half of 2017-18 to see strong sales growth. This seems difficult.

Given the drop in sales for realty developers and the snail’s pace progress in RERA implementation, it looks like demand recovery will take time. With the delay in the roll-out of e-way billing under GST, market share gains from unorganised players are not going to come quickly either.

The firm’s operating profit margin has shrunk in the last six months, because of higher power and fuel costs. Given the sharp rally in natural gas prices over the last two months, in the December quarter again, margins may take a hit.

Demand slowdown

Over the last five years, the company has grown sales at a compounded annual rate of 15 per cent, helped by strong demand and the company expanding capacity from 36 msm to 68.9 msm and seeing market share gains. However, similar growth may be difficult to come by in the current year as demand is weak.

In the first half year of 2017-18, poor consumer sentiment, GST-led de-stocking by dealers and drop in volumes at joint venture plants because of maintenance work, resulted in lacklustre growth for the company.

Sales growth was 6 per cent, y-o-y (volume growth 4 per cent). Net profit for the period was lower by 10 per cent on higher raw material costs.

The working capital cycle (or debtor days) was 61 days in the September 2017 quarter rising sharply from 46 days in the March 2017 quarter signalling difficulty in cash collection.

There are not many levers for the company to revive growth immediately.

The pain for real estate sector is far from over. A recent Crisil report indicated that the residential market may not look up soon as buyers are waiting for effective implementation of RERA.

Given that only about 30 per cent of Kajaria’s products are sold to institutions and the rest is direct to customers, the slowdown in the residential segment will be a big problem. Various stakeholders in the realty sector too feel that the buying sentiment is low.

Findings by Ficci-Naredco (National Real Estate development Council)-Knight Frank India shows that the real estate sentiment index hit the lowest in more than three years in the recent September quarter.

The lower GST rate of 18 per cent on ceramic tiles can help organised players gain market share.

As price difference between branded and unbranded tiles reduce, more consumers may buy branded tiles benefiting players such as Kajaria Ceramics. But, this is going to take time, and, not add to sales volumes right away.

Drop in margins

In the first half of 2017-18, the company’s operating profit margin was 17.42 per cent versus 20.69 per cent in the same period last year.

The contraction in profit margins was due to higher raw material and power costs.

Power and fuel costs as a percentage of net sales was 11.9 per cent, vis-à-vis 10.2 per cent in the previous year.

Margins may improve as sales recover and benefits are drawn from operating leverage. The input tax credit on GST can also help to some extent. But, given that crude oil and natural gas prices have been scaling up over the last two months, profit may come under pressure in the December quarter.

What the future holds

Increasing income and affordability of the middle-class, and the Centre’s push for affordable housing, with several tax sops, should augur well for makers of building materials including Kajaria Ceramics.

The company is the largest player in ceramic tiles in the country. It has a total manufacturing of capacity of 68.37 million sq m (of which 29.47 msm is ceramic floor and wall tiles). The company has joint venture with four players which together bring another 22.47 msm capacity. Recently, the company acquired a 51 per cent stake in Kajaria Floera Ceramics which is adding a capacity of 5 msm in AP – this is likely to be complete by this financial year.

Focus on JV-led expansion into new markets, right mix of high-value vitrified tiles in the portfolio, diversification into sanitaryware (stepped into the segment in 2014-15) and a market leader position that gives it pricing power, are all positives that should give the company a better than industry average growth in the long term.

Also, as benefits from input tax credit start to flow and e-way bill is rolled out, organised tile makers including Kajaria Ceramics will have a competitive advantage.

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