Investment Advisory Service

Monday, 23 December 2013

Can Cera Sanitaryware continue its growth streak ?

The idea of Cera Sanitaryware was shared here by Priyank Sanghvi. Long discussions with him on Cera ignited my mind to the advantages of investing in businesses with sustainable competitive advantages. Thank you, Priyank for sharing your thoughts.
In order to learn further about the competitive landscape around Cera, I checked the competitive position of its main competitors, HSIL and Roca-Parryware.The following post is a result of that exercise.

Over the last 5 years,the Indian sanitaryware market has grown at a rate of around 15% p.a while sales of Cera have grown at a rate of 32% p.a. which is double the market growth rate. Can Cera continue this growth streak?  [Streak] : To move very fast in a specified direction. 

The Indian sanitaryware market is close to 2500 crs per annum. The market is roughly divided equally between the organized market and the unorganized market. There are 3 large players in the organized market :Hindustan Sanitaryware or HSIL (~35-40% market share), Roca Parryware(~25-28%) and Cera (~24%). 

Sales (crs)
FY 2009
FY 2010
FY 2011
FY 2012
FY 2013
FY2014 (H1)
HSIL (building products)

Over the last 5 years (FY 2009-13); sales of HSIL grew at 23% while that of Cera grew at 32% p.a.
Over the last 3 years (FY 2011-13); sales of HSIL grew at 22% while that of Cera grew at 41% p.a.
Over the last 6 months (Apr-Sep'13); sales of HSIL grew by 16% while that of Cera grew by 42%.

HSIL has not been able to keep pace with the growth rate of Cera and has been ceding market share to Cera. Market share of Cera during the last few years has gone up from 18% to 24% currently. 

Not much is known about the recent sale and growth numbers of Roca Parryware. In CY2011, it had sales of 608 crs and EBITDA of 103 crs (17% margin). In 2007-08, Parryware had sales of 360 crs when Roca bought 47% stake from EID Parry. During the period 2007-08 to 2011, the turnover has grown at a CAGR of 18.5%. 

2 conclusions can be made from the above data :
  1. All 3 organized players have been growing better than the market. The customers are moving away from the unorganized players to the organized market. And hence the unorganized players are losing market share.
  2. Cera has been growing at a faster rate than the other 2 major players in the organized market and hence taking market share from them.
How has Cera been able to grow at such a fast pace? Branding and promotion, wide variety of products, distribution network etc are the usual reasons which come to mind. Another reason and probably the most important reason which comes to my mind is: Focus of the management. Instead of trying to be too intelligent, the management of Cera focused on not making dumb mistakes. This becomes clear if we study the actions of HSIL and compare them with the actions of Cera. In my view, HSIL has made some serious mistakes which has let the market share gradually slip out of its hands and has made Cera's job easier.

Mistakes made by HSIL :
  1. First. HSIL diversified into glass division which is a capital intensive business with poor returns on capital. 
  2. Second. Once into the glass business and having figured out that it's a poor business; instead of cutting losses, the management continued to put good money after bad money and expanded the glass business to achieve economies of scale.
  3. Third. Since the cash flows generated by the sanitaryware division were not sufficient for the needs of the glass business HSIL resorted to borrowings to fund the glass business.
  4. Fourth. HSIL decided to borrow partly in foreign currency and took a call on the currency by leaving a large part of the foreign currency borrowings unhedged. As per Annual Report of FY 13, HSIL had total borrowings of around 1040 crs out of which 488 crs were borrowings in foreign currency. Out of 488 crs, 324 crs of borrowings were left unhedged. In essence, HSIL invested in glass business which is a poor business and perpetually hungry for capital, funded it with borrowings in foreign currency and left the currency largely unhedged. Negative lollapalooza, it seems.
  5. Fifth. HSIL decided to focus more on the premium and luxury segment of the sanitaryware market.The luxury segment though growing at a faster rate than the mass and value-for-money segment is a small segment (10%) of the overall sanitaryware market and faces tough competition from the MNCs.
  6. Sixth. In order to cater to the demands of the luxury segment, HSIL invested money in setting up a retail chain,EVOK, which has been losing money since inception and more money is being invested in the division as mentioned in the following table.

EVOK (Hindware Home Retail Limited)

FY 2009
FY 2010
FY 2011
FY 2012
FY 2013
Sales (crs)

All the above mis-steps combined have spelt trouble for HSIL. The borrowings have grown at a fast rate and the interest cover ratio has slipped to a very low level. 

HSIL annual figures (Rs crs)

2014 (H1)
EBIT/ Interest

The effective borrowing cost of HSIL is working out to be around 5-6% which is far less than the market rate of borrowing. Since the borrowings are largely in foreign currency, any expenditure incurred to hedge part of the currency etc should be a part of the borrowing costs. The actual borrowing costs are hence much higher than reported and hence the interest cover ratio is probably poorer than what it appears. 

Poor business decisions coupled with leverage would have taken mind share of HSIL's management away from the core business.They would have spent more time in firefighting than capturing the market.

Cera on the other hand has kept its focus on the sanitaryware market. It did not diversify into unrelated capital intensive business and recent diversifications into faucetware,tiles etc have been cautiously undertaken.The growth of the sanitaryware division has been largely funded by the internal cashflows and the debt has been used sparingly. Instead of focusing on the fiercely competitive premium segment, Cera continued its relentless focus on the Tier 2 and non-metro towns which provided the growth for Cera. Also, instead of setting up its own retail chain,Cera concentrated on penetrating the market through setting up a large distribution network and aggressive brand promotion exercises.
The management of Cera has been extremely focused on discarding any move which didn't make prudent business sense.To me, that seems the most important reason for Cera's growth over the last 5 years. 

Roca-Parryware is a private company and not much is known about it except that Roca seems more interested in promoting its parent brand Roca and not much marketing investment seems to be happening behind the Parryware brand. I might be wrong in this assessment but I haven't come across even half the advertisements of Parryware as I have come across of Roca. But surely, Roca-Parryware has grown at rates far lesser than Cera as mentioned earlier in the post.

Will Cera be able to grow its sales between 30-40% p.a. in the future? That's a difficult question to answer. At some point of time, the sales growth rate of Cera will moderate due to external reasons like housing slowdown, slowdown in the economy etc or internal reasons like change in management. But if the management of Cera [family or professional] continues to practice the current philosophy of focus and prudent decision making while avoiding dumb mistakes, it's likely that sales of Cera would continue to grow better than the market and better than the other 2 competitors. 

(I hold shares of Cera Sanitaryware Limited. This post is not a recommendation to buy or sell shares of any company discussed in the post.)