Progressively regaining its lost mojo
Systemic corrections initiated by Somany Ceramics (SOMC) over the past 4-6 quarters, namely 1) unwinding of treasury operations (majority of the ICDs being recovered); 2) systems and processes falling in place (post the employee fraud and broker default); and, 3) sharp curtailment in receivables, particularly, post Covid-19 outbreak, are likely to boost investor confidence. Besides these corrections, our checks suggest that recovery in volumes has been much faster than anticipated (Aug’20 is registering a growth over Aug’19). Improving operating leverage, benign gas costs and stable industry pricing are also likely to drive double-digit EBIDTA margin for SOMC going forward. With steadily improving balance sheet quality and earnings visibility, we expect the valuation gap between SOMC and the market leader (KJC) to narrow (which has widened sharply over the last one year) going forward. Maintain BUY.
* Valuation gap with the leader has widened significantly over the last 1 year. Despite sustaining its No. 2 brand equity status in tiles industry (since last 5 years in particular), Mcap of SOMC has now fallen to 1/12th of KJC’s Mcap. It is currently trading at 9.7x FY22E earnings (KJC at 29.4x) or 0.4x Mcap/sales (KJC at 2.8x). This is larglety due to the growing trust defecit of investors on account of various slip-ups from SOMC’s end leading to sharp multiple derating in the past. With majority of these issues being sorted, promoter increasing stake recently and the company gearing up to regain its lost volumes/market share, we expect the sanity in valuations to come through with likely balance sheet improvement and possible earnings recovery over near-to-medium term.
* Raise earnings expectations by 103/14.9% for FY21/FY22, respectively. Factoring in faster than anticipated volume recovery, stable pricing scenario and benign gas costs, we increase our revenue/earnings estimates for SOMC by 6.6%/2.7% and 103%/14.9%, respectively for FY21/FY22. Maintain BUY with a revised target price of Rs304 (18x FY22 earnings) vs Rs162 (11x earlier) valuing it at a discount of 40% to KJC’s valuations.
* Volume growth returns for SOMC – much earlier than anticipated. As per our channel checks, Jul’20 and Aug’20 have seen significant improvement in tiles volumes for top industry players. Our checks suggest SOMC has infact witnessed growth in Aug’20 as compared to Aug’19. This we believe is largely led by its stricter working capital discipline in the recent past and improving demand for tiles post the lockdown. Considering growth momentum in tiles will continue in near term, with metros and tier-I cities likely to open-up post Q2FY21, we expect SOMC to report 9% decline in its FY21 revenue.
* EBITDA margins may gradually improve led by operating leverage, cost rationalisation and lower fuel costs. SOMC’s EBIDTA has declined to Rs1.3bn in FY20 vs Rs2.3bn in FY17 largely due to industry-led pricing headwinds and operating deleverage. We, however, expect SOMC’s margins to improve gradually starting Q2FY21 driven by faster than expected volume recovery, recent cost cutting initiatives and benign gas prices. With this, we expect SOMC’s EBIDTA margin to increase to 11% in FY22 vs 8.2% reported in FY20.
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