Buy Somany Ceramics; target of Rs 426: ICICIdirect

ICICIdirect.com is bullish on Somany Ceramics and has recommended buy rating on the stock with a target price of Rs 426, in its research report dated March 24, 2015.

Somany Ceramics (Somany) emerged as the third largest tiles player in the Indian tiles industry. It witnessed 23.3% CAGR in topline in FY10-14 (industry average: 16.6%) through aggressive capacity expansion from 16.7 msm in FY10 to 42.5 msm currently largely through a JV model. Going ahead, we remain positive on Somany’s growth prospects considering the structural shift in the industry post the Morbi development, its aggressive expansion plans and shift towards JV model. Consequently, we expect Somany’s earnings to grow at 44.4% CAGR in FY14-17E without any significant incremental capex resulting in an improvement in return ratios. Hence, we initiate coverage on Somany with a BUY rating with a target price of Rs 426 (19x FY17 EPS).

Somany has emerged as the third largest player in the growing tile industry and is expected to grow its capacity to 47.5 msm (excluding outsourcing tie-ups) in FY16E largely through an asset light model such as JV with local players (currently: 21 msm & FY16E: 26 msm). Consequently, revenue share from the JV model is expected to increase from 20% in FY14 to 48.0% in FY16E with minimal incremental capex (~Rs 75-80 crore in FY15-16E) leading to improvement in the return ratios.

In November 2013, Gujarat Pollution Control Board issued closure notice to Morbi (unorganised players hub) based ceramic units that run on coal gas furnace. This development is structurally positive for organised players like Kajaria & Somany as i) the organised pie will grow faster in the absence of cost advantage enjoyed by unorganised players due to coal gas furnace, ii) tone has been set for consolidation in the industry.

One of the major overhangs for Somany was its leverage position. However, it managed to reduce its debt to equity from 1.7x in FY11 to 0.8x in FY14 through higher internal accruals and better WC management. Furthermore, Somany raised Rs 50 crore by diluting 11.2% stake to private equity firm Creador in January, 2014. Going ahead, with more focus on the JV model, we expect its debt to equity to come down to 0.3x.

"We highlight that we remain positive on Somany’s growth considering a structural shift in the industry, its strong brand recall, wide distribution network and stable natural gas prices. With its renewed focus on growth using asset light model translating into strong earnings growth and improvement in return ratio, we initiate coverage on Somany with BUY rating with a target price of Rs 426. We value Somany at 19x FY17 EPS, which is at a 25% discount to Kajaria and implies a PEG of 0.4x", says ICICIdirect.com research report.

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