Cera Sanitaryware Ltd. (NSE: Cera; BSE: 532443; ISIN: INE739E01017)
April 17, 2011. Current Market Price Rs. 194. Buy for duration of at least 3-5 years.
Investment Summary: A business that converts abundant and therefore inexpensive raw materials like Sand, Sandstone and Clay into branded products.
In the Berkshire Chairman’s letter to Shareholders, 2007, Warren Buffett writes: “Charlie and I look for companies that have a) a business we understand; b) favorable long-term economics; c) able and trustworthy management; and d) a sensible price tag”.
Analysis of Cera with respect to the above four filters:
a) Simple Business
Sanitaryware is a relatively slow changing business that does not require cutting edge R&D. Sanitaryware includes Wash Basins, Water Closets (WCs i.e. Commodes), Cisterns, Urinals etc. Cera also manufactures Shower Cubicles, Shower Panels, Bathroom fittings etc. Humans have been using some of these products since centuries and shall continue to use them in the future – so there is no risk of the products getting obsolete or of a threat of replacement. Cera is not into manufacturing of tiles, which, according to me, does not have a good moat.
Sanitaryware Industry
In India, Sanitaryware industry is 50-50 divided between the branded and the unorganized sector. Three major branded manufacturers are Hindware (HSIL), Parryware (owned by Roca - a Spanish company) and Cera. Other brands are Ess Ess, Kohler and Duravit - the last two are multinationals. Hindware, Parryware and Cera have market share of approximately 40%, 40% and 20% respectively. Ess Ess is relatively small while Kohler and Duravit are into ultra-luxury segments and into exports. While only HSIL and Cera are listed, HSIL has a high debt/equity of 1.0 relative to Cera’s conservative 0.3.
Moat
Moat for all three branded manufacturers is the pan India distribution network. Economies of scale as well as rapport with the distributors and dealers cannot be quickly replicated by an unorganized manufacturer. There is also a shortage of skilled labor for the industry giving the established players an advantage over new competition. Knowledge about and access to quality raw material leading to durable end products also works as a moat to a certain extent. The moat enjoyed by Cera is seen in its increasing ROCE from 21 to 28 and RONW from 20 to 22 between Mar’06 and Mar’10. During this period, HSIL’s ROCE and RONW decreased from 13.62 and 19.83 to 10.82 and 11.59 respectively. Also, I believe that the returns are high but not extra ordinary high for a big industrial house with deep pockets to setup scale and distribution network from scratch.
b) Long Term Economics – Demand Side
Demand for Sanitaryware products shall increase in tandem with that of the residential and commercial real estate industry. As the current middle class progresses economically, they shall start paying equal attention to their bathroom interiors as they do their room interiors.
India also has a large, young and educated population in smaller towns who are willing to migrate to bigger cities for white collar job opportunities. Eventually they marry but most often it is not feasible for their parents to follow them into the cities. This results in the creation of a new household. Increasing trend of nuclear families also results into creation of new households.
Long Term Economics – Supply Side
While these are favorable long term demand economics for Cera’s products, there is not much concern on the supply side as well since the raw material is abundant and hence inexpensive. Study of the past ten years’ books of Cera shows that there has never been an acute margin squeeze due to uncontrolled increase in raw material prices.
c) Able Management
Unlike HSIL, Cera’s management never went overboard with promised growth prospects resulting in higher leverage. At the same time, they have been prudent enough to use little leverage. Cera had been the first Sanitaryware Company to use natural gas resulting in lower cost of production relative to its competitors. The twin-flush model launched in India by Cera for the first time, reduces the water needs of households considerably. WCs designed to flush in just 4 litres of water is another notable innovation by Cera.
Trustworthy Management
While there is no evidence of honesty of Cera management, there is no evidence of dishonesty either. Management pay is reasonable. Directors have been regularly attending the board meetings and one of the independent directors has a 1.94% stake in the company as on Dec 31, 2010. This ensures that the director is not just interested in sitting fees but also has sufficient incentive to see that the company is well run. There are no high profile personalities on the board but this can be excused considering that the company is relatively small.
d) Valuing a business is a very subjective matter.
Calculating Owner Earnings:
Average Net Profit from Mar’07 to Mar’11E is Rs. 15 Cr.
Since this is not a capital intensive business, it is safe to assume that the depreciations costs equal the capital expenditures required to maintain the same level of business.
Estimating growth rate:
Top line CAGR from Mar’07 to Mar’11E is 17.7%.
Operating profit CAGR from Mar’07 to Mar’11E is 23%.
Net Profit CAGR from Mar’07 to Mar’11E is 29%.
To be ultra conservative, assume Net Profit CAGR of 14% for the next ten years and terminal growth rate of 3%.
Estimating Discount rate:
Since this is a simple, non-changing business with a good track record, it is safe to assume that investing in this business is relatively risk free. Hence use the discount rate as 10% i.e. slightly higher than the ten year G-sec rate.
Calculating Intrinsic Value:
DCF using the above values gives intrinsic value of Rs. 500 Cr.
Enterprise Value (EV) of the business is Rs. 270 Cr. as on April 17, 2011.
Margin of Safety is 46%.
At the Current Market Price of Rs. 194, PE (ttm) is 9.5 for a business that has four year Net Profit CAGR of 29%. PEG is 0.33.
EV/Sales is 1.35.
Note: I own shares of Cera Sanitaryware Limited. My average purchase price is Rs. 163.
Over long periods, stock price follow the performance of the business.
Do not buy to trade in this stock since this is a low volume stock.
