- Cera operates in the sanitaryware, facuetware and tiles space
- The segments it is present in are linked with the growth of the real estate sector, which is expected to be in poor shape in the near future but has good long term growth drivers
- The industry has a high share of unorganised players and is moderately attractive with significant barriers to entry but high competitive intensity
- Cera’s financial performance (growth, margins, return ratios) over the last decade has been good but it has been linked with the real estate sector
- Cera has a strong homegrown management that has a good capital allocation track record and a culture of planting growth options
- The company has multiple growth levers (which include market size growth, growth in share of organised players, market share growth for Cera and introduction of new products)
Cera Sanitaryware is a company that operates in the building materials space, engaged primarily in the manufacturing and sales of sanitaryware, faucets and tiles. It was established in the 1980s and for the first 25+ years it focused primarily on the sanitaryware business and is a market leader in that segment in India. It ventured into faucetware in 2009 and tiles in 2014. As of FY20, it generates 49% of its revenues from sanitaryware, 26% from faucetware, 22% from tiles and from 3% from other wellness products.
The three markets that Cera is present in are characterised by a large share of the market being occupied by the unorganised segment. In sanitaryware, within the organised space Cera, HSIL (Hindware) and Roca (Parryware) are the three largest players. In faucets, Jaquar has a strong hold over the market. The tiles market has close to a dozen major players with Kajaria and Somany being the largest. The fortunes of the building materials industry in general and these segments in particular are linked with those of the real estate industry as new construction is a key driver of demand for building materials.
The real estate market has had a tough time for the last 4-5 years and is likely to remain weak for the coming few years; yet, the industry has a few long-term growth drivers
The nature of real estate cycles is that they tend to be extremely long. A period of rapidly increasing prices (broadly 2000-2015 in India) leads to increased construction activity. It takes a few years for this construction to be completed and when a lot of supply comes into the market at the same time, it causes a glut and the excess inventory often takes a long time to clear. Over 2016-2020 the industry has been hit with multiple shocks – demonetisation, the NBFC crisis, RERA, GST and the latest Covid-19 pandemic. These shocks have caused significant disruptions over the short term and have hampered the growth of the sector. Currently inventory overhang still exists in multiple subsegments (such as luxury housing in certain metros). Covid-19 has impacted the sector severely with sales and new launches slowing down as incomes have been impacted and people delay house purchases. Hence, the sector is likely to face certain challenges at least for the next couple of years. Yet, I believe that there some important growth drivers for the industry over the medium-long term, which are likely to support industry growth:
- Rising disposable incomes and under-penetration of quality housing: If India’s real GDP growth comes back to 5-6% over the medium term (and nominal GDP growth comes back to 9-10%), rising disposable incomes of India’s burgeoning middle class would mean steadily growing demand for housing. Housing is an aspirational purchase and the penetration of good quality housing is low especially in Tier 3 cities and beyond, which will continue to drive demand for housing.
- Urbanisation: Rising urbanisation has seen the growth of several Tier 2 and Tier 3 cities, where the real estate markets have been more resilient than some metros. Continuing urbanisation and growth of cities is likely to provide further boost to housing demand.
- Regulatory push: Certain reforms such as RERA and GST have hampered the real estate sector, especially the smaller/unorganised players, in the short term. However, they are likely to be beneficial for the long term growth of the sector. They are likely to bring in greater transparency and allow buyers to trust the commitments of developers, which will be beneficial for the sector’s growth. Further, government support for affordable housing and a commitment to provide housing for all is likely to provide further tailwinds to the sector.
- Access to credit: The government and financial institutions are committed to making credit easily accessible (especially in the affordable housing space), which is likely to support housing demand.
The biggest risk to the sector is a prolonged slowdown induced by the Covid-19 pandemic. Raghuram Rajan in a recent article mentioned that if the crisis is not handled well, it could mean a decade of lost growth for certain EMs. If we have a period of sustained slowdown and falling incomes, the sector could take much longer to recover.
Structural attractiveness: The sanitaryware, faucetware, tiles industry is moderately attractive with significant barriers to entry but increasing industry rivalry
From FY10-FY19, Cera delivered a robust set of numbers but FY20 has been a difficult year
From Cera’s financial metrics we see a lot of its numbers are broadly linked with the real estate cycle.
- Revenue: Cera’s Revenues grew by a strong 34% CAGR between FY10-15, supported by the growth in the general real estate market and market share gains in sanitaryware. Since FY15, the real estate market has been relatively sluggish. Despite this Cera managed to grow its revenues by a respectable 13% CAGR between FY15 and FY19. From FY15-19 sanitaryware recorded muted growth (7% CAGR) but growth was boosted by faucetware and tiles (21% CAGR). This is shown in the evolution of the revenue split as well. Non-sanitaryware revenues have risen from 34% of revenues in FY15 to 51% of revenues. This indicates Cera’s ability to scale the new businesses it has entered in. Given the low market share Cera currently has in faucetware and tiles, it augurs well for the future. On the other hand, it also shows Cera’s inability to continuously drive market share gains in sanitaryware. Once Cera achieved 15-20% market share (depending on various industry estimates), it grew broadly in line with the industry. This could also be the result of increased competitive intensity in sanitaryware (with the entry of players like Jaquar and Kajaria). So going ahead one can expect revenue growth to be supported by market share gains in faucetware and tiles, but the growth of the market would be important to support sanitaryware sales growth. FY20 was not a good year for Cera or its competitors (such as HSIL) as revenues and margins have suffered. The real estate industry was already weak and the covid-19 pandemic made the situation worse. For the first 9 months of FY20, Cera’s revenues were flat (-1% YoY growth) and the majority of the fall in revenue came in Q4FY20 (-28% YoY) because of the lockdown. In the near term, revenue will probably suffer till the pandemic subsides as people delay house purchases, construction activity slows and people delay replacement/refurbishment purchases.
- Margins: EBITDA margins have been broadly stable in the 14-16% range, again governed by dynamics in the broader real estate industry.
- Cash Conversion: CFO/EBITDA has been moderately healthy at ~60%, indicating that the company is converting its EBITDA to cashflows. However, this ratio has been volatile with it ranging from 35% to 80% (dropping to 7% in FY12), governed by changes in working capital requirements for the different business segments.
- Return ratios: Cera has maintained healthy ROTCE and ROE ratios, across the market cycle despite being in a capital-intensive industry. Although these ratios have trended downwards because of industry pressures and after expansion to faucets and tiles, they are still comfortably above the cost of capital. This is primarily because of the management’s ROCE (Return on Capital Employed) mindset, which is discussed below.
Moats: Cera has a number of competitive advantages but competitors in the space share some of the same advantages
I think Cera has a number of competitive advantages and strengths. However, a challenge I faced was in trying to assess how durable these advantages are and whether they are easy for a competitor to replicate. Below I discuss some of these competitive advantages and my views on them.
- Brand: Cera has always maintained a significant advertising budget (~4% of revenues) and worked to establish its brand in the market. It has cultivated its image as a value for money (good quality at a reasonable price) player and has strong brand recall in the mid-market segment. It has extended this brand from sanitaryware to faucets and tiles and has potential to extend it further. The flagship Cera brand is a mid-market brand (and the segment that earns the most revenue for Cera). It has also introduced Jeet and Senator, brands that cater to the mass market and premium market respectively and has tied up with the Italian brand Isvea to cater to the luxury segment. With this Cera has brands to cater to all market segments. As the sanitaryware and faucetware market becomes increasingly brand conscious, Cera’s brand positioning is a significant strength.
- Strong Distribution network with after-sales service: Cera has invested significantly over the last 3 decades in developing a pan-India distribution network that consists of 19 company warehouses, over 1,400 and over 11,000 retailers. After its entry into faucetware, the company has also invested in building an after-sales service network (Cera Care) to cater to consumer complaints. It will be difficult for any new entrant or an unorganised player to build such a large distribution network.
- Cost advantage in a capital intensive industry: Cera enjoys economies of scale and has been making regular investments in automation to improve efficiencies at its plants, which gives it a cost advantage and superior quality control over some unorganised players and potential new entrants.
Cera has done well over the last couple of decades to build these strengths, however I believe that these moats are not completely bulletproof. While these strengths are likely to protect it from new entrants, the competition in the building materials space is rising from within the industry with existing players like Kajaria, Jaquar, HSIL, Somany Ceramics entering into each other’s spaces. Some of these companies share similar competitive advantages (brand, distribution, scale efficiencies etc) so Cera will still have to work hard to capture market share from these companies.
Track record of execution and ROCE mindset
The management’s competence in running the business is proven by Cera’s superior performance of the last couple of decades. It emerged as a challenger brand in the sanitaryware business and is now the market leader, which is indicative of the management’s understanding of customer preferences and the company’s design and production expertise to deliver to those needs.
The capital allocation track record of Cera’s management has also been good. They have never risked their balance sheet by taking on too much debt to grow (which has helped them remain in a comfortable position even during the difficult years). The management is focused on the Return on Capital Employed (ROCE) of every investment and only deploy capital when they have reasonable certainty that the investment will yield good returns. When entering a new segment, they test the market using an outsourced model. They do not invest any significant capital upfront into the new business, procure products from third parties and sell it using their brand and distribution network. Only once they see initial success do they go for in-house manufacturing. This is how they scaled the faucetware business.
Event today roughly half their sanitaryware and faucetware products are outsourced. They manufacture the higher end, technologically intensive products that require more quality control and outsource the lower end products (whose quality can be checked through inspections). For their tiles business, they’ve invested a total of INR 27 Cr in their two JVs and they offtake the entire production from these two JVs. Yet, they procure ~65% of their tiles from outsourced partners. While outsourcing can potentially lead to lower margins, I think this is a good strategy in a very capital-intensive industry as it allows Cera to invest little capital, but still grow revenues and profits (by leveraging its brand and distribution network), thereby earning respectable returns on invested capital. Even during difficult times, Cera does not use loose credit terms to attract sales, which prevents large deployment of cash in receivables and maintains a stable working capital cycle.
Cera’s expansion has been measured and they have not entered too many segments together, which allows management to focus on earning good returns on invested capital and does not dilute management bandwidth. Cera’s capital allocation track record can be compared with that of HSIL, a close competitor. HSIL is not only present in sanitaryware, faucets and tiles, it has also expanded to areas such as pipes, kitchen appliances, air and water purifiers, home furniture, packaging products and other segments which may not have any synergies with the core businesses. This overexpansion has resulted in dilution of ROCE and ROE ratios and possibly a dilution of management focus as well.
Culture of planting growth options
Whilst maintaining a ROCE focus and a policy of controlled expansion, Cera has also developed a culture of experimentation and planting growth options. Cera has a vision of being a complete bathroom solutions provider and eventually a total home solutions provider – providing sanitaryware, faucets, tiles, water heaters, modular kitchens, mirrors, kitchen sinks, etc. In order to grow into adjacent areas, it conducts small experiments by introducing new products in a geography and if successful scales it up. The faucets business started off as a small experiment and once it gained traction it was developed into a separate segment. Over the last couple of years, Cera has experimented in a few new segments – customised shower partitions, water heaters and modular kitchens, especially in Kerala where it has a strong presence. They seed these experiments using outsourced production and hence minimal upfront investments. Since the management has a ROCE focus, if they see that some of these experiments are not doing well, they are likely to drop those products and focus on scaling those that are succeeding. Over a period of time, this culture of planting growth options at minimal cost is likely to pay off because even if a few experiments succeed, they can be significant growth drivers for the company.
Vikram Somany has been the driving force behind the company and has been leading Cera since its inception in the 1980s. As he’s crossed 70 now, he is likely to play a smaller role going ahead. When a successful founder-promoter passes the baton to the next generation or a professional management there is always the risk of a change in the culture or strategy of the company. In the case of Cera what gives comfort to potential shareholders is that all members of the top/mid management of Cera have been with the company for a long time (at least 10 years – in many cases over 20 years). Having been with the company for so long and demonstrated their competence, they are likely to have learned from Mr. Somany and imbibed Cera’s culture and business practices. This homegrown leadership is akin to companies like Asian Paints and Pidilite and should help in sustaining Cera’s unique culture.
I see four levers for growth for Cera:
- Market size growth: The overall market for sanitaryware, faucets and tiles is expected to grow in line with growth in the real estate market. While the growth outlook is muted for the short term, it is robust over the long term for reasons discussed above.
- Shift from unorganised to organised: The unorganised segment still holds a significant share in the three categories that Cera is present in but their market share has been steadily decreasing over the last decade. Measures such as GST and the crackdown on black money are likely to help organised players capture a larger market share. In sanitaryware and faucetware as the market becomes more brand conscious, organised players are likely to capture a larger share of the incremental market growth. In tiles, which suffers from overcapacity in India, a large part of the capacity (>60%) is with unorganised players based in Morbi. These players have been resilient despite numerous shocks and cashflow problems and the tiles market is not very brand conscious. Hence the shift from unorganised to organised may not be very rapid in tiles. Yet, incremental market share is likely to move to organised players driven by closure of some plants after the current crisis, better distribution reach and supply chain efficiencies for larger players.
- Market share growth: It is unlikely that Cera will substantially increase its market share in sanitaryware. Yet, it has tremendous headroom to capture market share in faucetware and tiles.
- New products: As discussed, Cera is already experimenting with a number of other products such as water heaters, shower curtains etc and has the vision of becoming a total home solution provider. Even if a couple of these product lines succeed, they can be good growth drivers for the company over the next 5-10 years.
The growth prospects for the near term look do not look great but if we take a 7-10 year view, I believe that Cera should be able to grow at ~15-20% per annum.
I have used two methods to value Cera. The first is a DCF based approach and the second is an exit multiple analysis.
I’m not a big fan of intricate DCF models as they give a false sense of certainty/accuracy. I like to use simple DCF models with reasonable assumptions and some sensitivity analysis to assess what the value of a company is likely to be in a reasonable range of scenarios. I’ve done something similar for Cera and have attached a copy of my model below. If you are interested, you play around with the approach and assumptions based on what you think Cera’s prospects are to assess it’s intrinsic value.
Based on my DCF model, Cera’s intrinsic value should be between INR 2,250 Cr and INR 2,800 Cr compared to its market cap of INR 2,958 Cr (as of 8 August 2020).
Exit-multiple based valuation
- Cera’s P/E multiple was 7-15 from 2010 to 2013, then the P/E steadily rose to hit a high of 55 in April 2015
- From 2015 to 2019, it fluctuated between 30 and 50
- From August 2019, it declined to reach 25 in July 2020 and is 30.9 as of 8 August 2020
- The 10 year average P/E is 26.6 and the 5-year average is 34.8
According to me, it would be reasonable to expect 14-16% CAGR in EPS and an exit multiple between 24 and 36, which would lead to a share price of INR 7,748 – INR 16,407 in 10 years. This would imply a share price appreciation of 13.0% – 21.8% CAGR from the Current Market Price of INR 2,275. The current dividend yield is ~0.5% which can rise to ~1% over time. Hence a shareholder can expect 14% – 23% annual returns over a 10 year holding period if things go as expected.
How long will the slowdown in the real estate sector last?
Cera’s fortunes are directly linked with those of the real estate industry, which is going through a really tough phase right now. The industry was already in a bad shape and Covid-19 has made matters worse. It is difficult to predict whether this slowdown will last 2, 3 or 5 years. A sustained slowdown in the real estate industry remains a key risk for investors.
How will the increased competitive intensity play out? Will Cera be able to defend its market share in sanitaryware and increase market share in tiles, faucetware?
Cera, Jaquar and Kajaria Ceramics, market leaders in sanitaryware, faucetware and tiles respectively have entered into each others segments and are aggressively trying to capture market share. Other players like Asian Paints are also venturing into these segments. Jaquar is a key threat to Cera because of its strong brand recall, strong management and good growth over the last decade. This increased competitive intensity means that Cera could lose market share in sanitaryware and may find it difficult to increase market share in tiles and faucetware. If the increased competitive intensity results in price competition, it could lead to lower returns on capital employed for all players.
Cera’s phenomenal share price appreciation between 2010 and 2015 (~90% CAGR) was driven by both strong earnings growth and multiple expansion. Even as the real estate industry started slowing down from 2015, Cera maintained a decent level of growth and was able to maintain strong return ratios. However, as growth slowed its P/E multiple halved and its share price saw a significant correction.
Cera is likely to deliver poor results at least for another couple of years because of the continued slowdown in the real estate industry. But if and when the industry recovers, Cera is likely to be a key beneficiary and should be able to deliver strong earnings growth. It is difficult to know when this will happen but I think that if we have a 5-10 year horizon, we are likely to see an upcycle at some point during this time period. What excites me most about Cera are its multiple growth drivers and a strong ROCE focused management. A sustained slowdown and increased competitive intensity remain the key worries.
Here is my excel sheet with the valuation and the calculations I’ve done to get the metrics & charts above (This post was written before the Q1FY21 results were announced so does not include them; however the analysis does not change even after the results because they were along expected lines)
Special thank you to Anik Ganguly and Anish Jobalia who helped with the analysis.
Please note that this is not investment advice. I am not a financial advisor. Please do your own research or consult a financial advisor before making any investment decision. Please assume that I have a position in any stock that I write about.