Somany Ceramics: Buy

Tile maker Somany Ceramics has delivered a good performance over the last year. From our buy recommendation last June, the stock has rallied 46 per cent. Still, it seems an attractive buy.

Strong revenue growth backed by capacity expansion, improving operating margin on sale of premium tiles and a strong balance sheet are positives.

At ₹345, the stock discounts its estimated per share earnings for 2016-17 by 16 times. Its peer Kajaria Ceramics trades at about 22 times its likely earnings for 2016-17.

Somany sells ceramic and vitrified tiles, and sanitaryware and bathroom fittings. The company is a key player in the north (which accounts for about 39 per cent to sales) and the south (28 per cent). The Indian tile market is expected to grow in double-digits over the next five years, thanks to the growing middle class population and increasing purchasing power. The organised players should see their market share go up. Many smaller players in Gujarat have closed down in the last year due to the Government’s ban on use of coal-based furnaces.

Somany has grown sales at a compounded annual rate of 24 per cent in the last five years while its profit has grown at 26 per cent. In the first nine months of 2014-15, sales have grown 26.5 per cent and net profit 75 per cent.

This was helped by lower fuel costs, higher margins on increase in revenues from premium tiles and higher other income.

In the December quarter, Somany reported revenue growth of 31 per cent buttressed by a 19 per cent increase in sales volumes and higher realisations.

The company’s sanitaryware segment did well with the division’s sales increasing 47 per cent over the year-ago period. The segment accounted for about 5 per cent of the company’s overall revenue. Somany ventured into manufacturing of sanitaryware only in 2014, post acquisition of stake in Sonec Sanitaryware.

In the last few years, a good part of Somany’s growth has come from expansion through associates. It has been on a buying spree, picking up stake in smaller companies, which in turn manufacture products exclusively for it.

This has helped improve margins as dependence on traded goods has reduced. The company’s own manufacturing units and joint ventures together accounted for 79 per cent of sales in the December 2014 quarter, up from 69 per cent in the year-ago period. Somany began 2014-15 with a capacity of 44.12 msm (million sq m) and is about to end the year with 55 msm.

A major portion of the new capacity added was in associate companies. Somany intends to add another 5 msm capacity in 2015-16. Sales should increase as a result of the company’s aggressive marketing plans. The company intends to increase its ad spend to 2-2.5 per cent of sales from less than 2 per cent now.

It has a pan-India distribution network with 10,000 point of sales (up from 6,500 in 2012-13). About 65 per cent of its sales is to the retail segment.

The drop in natural gas prices seems to be helping the company. This, combined with higher realisations due to change in product mix in favour of value-added tiles, helped operating margins rise to 6.5 per cent in the December quarter, up from 5.9 per cent a year ago.

This year, margins should improve further with the company planning more launches in the high-end premium tiles segment and natural gas prices remaining subdued.

The company has a strong balance sheet. Its debt-to-equity ratio has dropped from two times in 2009-10 to 0.8 times in 2013-14. Somany’s interest cover stands at a comfortable five times.