Somany Ceramics: Improving product mix to drive gradual margin expansion, ADD on rich valuations | Somany Ceramics: 5% ATR in 16 months|

Somany Ceramics Limited (SOMC), India’s second largest tiles player with a 7% market share (14% in organized tile industry) has substantially transformed its product mix from commoditized ceramic tiles to high-margin vitrified tiles and value-added products over the last four years, leading to continued improvement in its revenues and EBITDA margins. Volume growth ahead would be supported by production ramp-ups at own/JV capacities and a favorable GST rate of 18%. Margin improvement would continue with focus on product innovation, a higher share of value-added products, rising contribution from the sanitary-ware & faucet-ware (S&F) segment, and increased retail penetration among brand-conscious customers. We expect SOMC to post a 13%/18% revenue/EBITDA CAGR and a 129bps expansion in consolidated EBITDA margins over FY17-FY20E. Initiate coverage with ADD and Mar’19 TP of Rs 910 set at a 30x TTM EPS of Rs 30.32.

High-margin tiles to drive revenue growth, margin improvement: SOMC’s tiles business posted a 15% revenue CAGR over FY12-FY17 as it moved away from low-margin and commoditized ceramic tiles (39% of FY17 revenues vs. 67% in FY12) and increased the share of higher-margin value-added products, including vitrified tiles (53% in FY17 vs. 30% in FY12). It also ramped up its manufacturing capacity from 24.5msm to 49.5msm via expansion and JVs over the last five years. Going forward, we expect SOMC to post a tile volume/revenue CAGR of 12%/11% over FY17-FY20E with contribution from vitrified tiles increasing from 53% to 59% during this period.

Contribution from sanitary-ware & faucet-ware to increase gradually: While SOMC has been present in S&F since FY08, it contributed 8% to FY17 revenues (34% revenue CAGR over FY10-FY17) as the company increased focus on this segment only over the last 3-4 years. The company has recently expanded its sanitary-ware JV capacity from 0.3mn to 1.15mn pieces/annum. It is also considering setting up a JV for manufacturing bath fittings given similar operational dynamics as sanitary-ware, with an opportunity to capitalize on the Somany brand. We expect the S&F segment to deliver 24% revenue CAGR over FY17-FY20E and contribute 10% to FY20E revenues with margins improving due to a better margin profile of products.

ROIC improvement to be led by better product mix, JV capacity addition: SOMC will continue to add capacity via JVs and taking up majority stakes in them as (a) the capital commitment is normally 1/5th of that required for setting up an own unit, and (b) there is excess capacity available in Morbi. Also, EBITDA margins are expected to improve by 129bps as the product mix turns in favor of high-end vitrified tiles and value-added products. Due to these factors, we expect core ROIC to improve gradually over FY17-FY20E. Key risks include slower-than-expected pick-up in real estate demand and higher competition from unorganized and new branded players.

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