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Playing safe in testing times
In an environment where ceramic tile industry is down due to slack in the real estate sector, deferment of renovation demand and liquidity constraints, Kajaria Ceramics (KJC) – as opposed to striving for aggressive market share gains (as guided earlier) – now seems content playing a waiting game by just keeping its basics right. The basics are: 1) maintaining tight control on working capital; 2) focusing on retail by expanding distribution & sustaining aggressive branding measures, and 3) improving FCF aided by muted capex. KJC is thus likely to report muted volume growth and margins in FY20 amid realisation pressures and operating deleverage. Maintain REDUCE.
* Valuation and Outlook: While our estimates already factor-in muted growth for the current fiscal; we now tweak our revenue/earnings estimates lower for FY21E by 3.5%/2.6% considering the likelihood of muted demand over the next 2-3 quarters. We maintain REDUCE on the stock with a revised target price of Rs487 (Rs500 earlier) valuing it at 25x FY21 earnings.
* Ceramic tile industry continues to decline amid testing times. Industry volumes continue to be in declining mode (low-single digits) due to muted growth in the real estate sector, deferment of renovation demand, and liquidity constraints. South India (excl. Tamil Nadu) appears to be the most impacted as compared to other zones. While realisations in ceramic wall and PVT categories are close to bottoming out, the existing glut in GVT is likely to impact overall realisations in the near term.
* Volumes likely to disappoint in FY20E. At the start of FY20, the management was guiding for >15% volume growth, which was scaled down to 12-13% post the Q2 numbers. However, with no sign of demand improvement post the festive season and with oversupply prevailing in the tile segment, the management has turned cautious on growth with greater focus on controlling receivables and maintaining pricing discipline. This falls in line with our estimated volume growth of 7.5% (5.2% in H1FY20) for FY20E, which we had built-in against the management guidance of 12-13% volume growth post the Q2 results.
* South India GVT plant in stabilisation mode; tangible benefits likely only in the medium term. After commencing its South India unit in Sep’19, KJC’s GVT plant is currently ramping up production. However, the company is unlikely to gain advantage of freight arbitrage as it will most probably pass on freight savings to the trade given overcapacity in the segment. We thus expect tangible benefits to accrue from the South unit only when demand starts improving. Also, with the GVT capacity getting freed in North India, which was earlier servicing the southern markets, the segment would continue to face realisation and margin pressures in the near term.
* Margin pressures likely to sustain despite benign gas prices. Despite the likelihood of benign LNG prices, we expect KJC’s margins to remain under pressure due to subdued GVT pricing and higher competitive intensity amid existing oversupply in the tile segment. We maintain our muted margin assumption for FY20/FY21E and expect KJC to post an EBIDTA CAGR of 6% over FY19-FY21E.
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