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Kajaria Ceramics: Expansion led growth
Jun 2, 2006

Performance summary
Ceramic tile major, Kajaria Ceramics, has announced results for the fourth quarter and fiscal ended March 2006. The company has recorded 18% YoY and 11% YoY growth in topline and bottomline respectively. While the company has outperformed our topline estimates by 7%, the bottomline is lower by 1% lower, mainly due to pressure on margins. Higher costs of fuel and goods purchased for trading have dented the company’s margins during both the periods.

Financial performance: A snapshot…
(Rs m) 4QFY05 4QFY06 Change FY05 FY06 Change
Sales 805 1,098 36.4% 2,804 3,309 18.0%
Expenditure 621 901 45.0% 2,192 2,631 20.0%
Operating profit (EBDITA) 184 197 7.1% 612 677 10.6%
Operating profit margin (%) 22.8% 17.9%   21.8% 20.5%  
Other income 1 4 250.0% 10 8 -20.6%
Interest 34 40 17.3% 146 143 -2.3%
Depreciation 35 41 17.4% 149 181 21.9%
Profit before tax 116 119 3.0% 328 361 10.3%
Extraordinary income/(expense) (15) -   (15) -  
Tax 41 30 -27.4% 58 80 37.9%
Profit after tax/(loss) 59 89 50.3% 255 282 10.5%
Net profit margin (%) 7.4% 8.1%   9.1% 8.5%  
No. of shares 73.6 73.6   73.6 73.6  
Diluted earnings per share (Rs)         3.8  
P/E ratio (x)         12.3  

What is the company’s business?
Kajaria Ceramics is the second largest player in the Indian ceramic tile market. The company has a manufacturing capacity of 18 m sq m, which it shall take up to 26.4 m sq m by 2HFY07 and 40 m sq m by mid-FY09. Kajaria is also present in the vitrified tile segment, where it imports the entire requirements and does not have/plan to have any manufacturing presence. It is the largest exporter of ceramic tiles from India. During the period between FY02 and FY06, the company has grown its revenues and net profits at compounded rates of 12% and 81% respectively.

What has driven performance in FY06?
Expansion leads the topline: In August 2005, Kajaria had expanded its capacity at the Sikandrabad plant by 4.2 m sq metres, the benefits of which have been seen in the revenue growth in the fiscal. The growth would have been higher but for the some delays in production from the expanded capacity during the initial period. Further, in anticipation of higher demand going forward, the company is increasing its manufacturing capacity from 18.0 m sq m to 26.4 m sq m by September 2006. This new capacity will be coming up at the company’s Gailpur plant. Kajaria has been able to produce and sell almost 100% of its capacity in the past few years and do not foresee any major issues going forward, considering increased demand from housing, organised retailing and hospitality sectors.

Moreover, Kajaria is also a major player in the ceramic tile export market (contributes to around 27% of India’s ceramic tile exports). This helps the company to maintain a mix between international and local sales through effective capacity utilisation (exports are not as profitable as domestic sales), which we consider a big positive.

Higher goods purchase costs dent margins: In order to diversify from the ceramic tile business, Kajaria trades in the vitrified tile segment, whereby it imports the product from China and sells in the domestic market. The management has also indicated that it has no plans to enter the manufacturing of vitrified tiles in the future. Apart from diversification, a move into the vitrified tiles segment also provides higher realisations for the company as such times are priced at Rs 40-100 per sq ft, compared to ceramic tile realisations of Rs 16-40 per sq ft.

Now, it is the cost on purchase of these goods (vitrified tiles) that has weighed heavy on the company’s margins during the fiscal. These costs have risen from 4.1% of FY05 sales to 15.2% of FY06 sales. While one must wonder that the entire cost must be pass through when the company sells these imported times, we believe that there might be an inventory buildup at the company’s side (in line with its peers), and as such, while costs have been recorded, commensurate revenues are yet to be earned. As far as other costs are concerned, while raw material costs declined from 33.0% of FY05 sales to 29.2% of FY06 sales, power and fuel costs declined from 18.9% to 18.2%.

Pressure on bottomline: Due largely to the contraction in operating margins and lower other income, Kajaria’s net profits growth has underperformed growth in the topline. A higher effective tax rate (from 17.6% in FY05 to 22.1% in FY06) has also impacted the bottomline growth during the fiscal. Also, excluding the lower base effect on the back of an extraordinary expense in FY05, the net profit growth stands reduced to 4.4% YoY, from the otherwise 10.5% YoY. The actual bottomline is 1% lower than our estimates.

What to expect?
At the current price of Rs 47, the stock is trading at a price to earnings multiple of 9.2 times our estimated FY08 earnings. The board has recommended a dividend of Rs 0.7 per share (dividend yield of 1.5%). While Kajaria’s results have almost been in line with our estimates, we remain cautious considering the rapid ramp up in capacity and intensifying competition (thus pressure on realisations and margins) for the company. We maintain our ‘Hold’ recommendation on the stock.

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