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)	313	367	491	612	731	396.5
Cera	160	191	243	319	488	285

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)	6.45	21.1	35.6	65.0	86.4
EBIT	(7.4)	(8.60)	(8.70)	(17.0)	(18.69)
Assets	20.6	33.5	26.1	42.5	72.63

 

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)

	2009	2010	2011	2012	2013	2014 (H1)
EBIT	68.28	82.47	151.01	184.75	165.49	55.6
Interest	16.81	40.19	36.44	41.95	69.39	31.58
EBIT/ Interest	4.06	2.05	4.14	4.40	2.38	1.76
Debt	470.7	492.6	397.47	864.50	1040	1230

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.)

What happend to Rick Guerin ?

In my previous post, I mentioned about a person who was working along with Mr Buffett and Mr Munger and was forced to sell his Berkshire stock to Buffett during the crash of 1973-74.

One reader, Vinay, has helped me with that name. That person was Rick Guerin. Thanks Vinay.

Search on Rick led me to this beautiful piece. It reinforces the idea to keep leverage [greed] under check. Mohnish Pabrai's interview at the end of that article is wonderful. Do listen in.

Life is too short to be short.

Bill Ackman of Pershing Square has lost a big amount of money in his short position on Herbalife. As per this article, shares of Herbalife have gone up by $6 per share to touch a 52 week high price of $77. Is Herbalife actually a pyramid scheme as claimed by Ackman? I don't have any clue about Herbalife. Only things I know are: I don't like the milkshake powder that Herbalife sells and secondly I don't like to short.

Shorting has its own set of vicarious examples to learn from. German billionaire Adolf Merckle committed suicide by jumping in front of a train when he got short squeezed in his bet on Volkswagen. In India, lot of investors [speculators] got trapped in the short squeeze of Akruti Nirman. There might be many more examples which one can read and try to learn from. However, it's easier said that done.The dope, excitement and mirage of getting rich quickly through shorts traps a lot of gullible and not-so-gullible investors.

There is another example which comes to my mind. Somebody shared an article a few months back about the third person in the team at Berkshire along with Mr Buffett and Mr Munger. I am unable to recollect the name of that person right now. That person had taken some margin positions in his personal book around 1973 or 1974 and the market went against his position. In order to fund the margin requirements, he had to sell his shares of Berkshire to Mr Buffett for $40 a share.The price of Berkshire stock is $170,000 now.Things on margin can cut you really deep.

  

I myself got trapped in a short position in the stock of Matrix Laboratories in 2006. The beauty of shorts is that for a while, the position will work in your favour. That will release a shot of dopamine and the eyes will move away from the underlying risk to the expected profits. Since Matrix position worked in my favour for a while, it led me to believe that my theory [of why Matrix stock should go down] is correct. I increased my position and that was the only time I liked Matrix. 

From then on, the shares of Matrix kept moving up and I kept on funding the margin requirements by selling my long equity positions. By the time, I squared up my position in Matrix, I had lost around 25% of my overall portfolio. That was a very costly lesson I learnt. And one thing which doesn't reflect in the calculations is the amount of stress I had to undergo due to that position. I decided thereon that I am not wired for such roller-coaster rides in F&O. I am happy that it happened early in my career. If that one position would have worked for me, it might have led me on to a lifelong trip of misery.

I want to get rich comfortably. And the emphasis is more on being comfortable.

Indian Courts

Courts in India have an invisible buggy whip which can set even the most stubborn horses in motion. Think about the all the scams which come to your memory where the judiciary acted tough.

Another instance came to light where the Allahabad High Court has rebuked the petitioner's (Noida residents association) counsel to study the case and argue more accurately next time.

"Case :- PUBLIC INTEREST LITIGATION (PIL) No. - 60214 of 2012

Petitioner :- Federation Of Noida Residents Welfare Association
Respondent :- Noida Toll Bridge Company Ltd. And Others
Petitioner Counsel :- Ranjit Saxena,Deepak Saxena
Respondent Counsel :- C.S.C,A.S.G.I.(2012/5640),Ajay Bhanot,Shivam Saxena,Shivam Yadav

Hon'ble Sushil Harkauli,J.
Hon'ble Manoj Misra,J.
List in the next cause list. Learned counsel for the petitioner may study the case and argue more accurately next time.
Order Date :- 30.4.2013."


Listen to this wonderful song written by Gulzar sahab in Vishal Bhardwaj's "Kaminey"and don't forget to appreciate the sound of the invisible buggywhip "fataak" which the courts in India are using more frequently nowadays.