The Hindu Business Line : Murudeshwar Ceramics: Buy

While increased competition from unorganised and foreign players will be a looming threat, expected surge in volumes and cost rationalisation are likely to drive earnings growth.

Expanding facilities to cash in on the realty boom.

Murudeshwar Ceramics has recommenced production at its ceramic division and is expanding its vitrified (glazed tiles that are break-and-scratch resistant) and ceramic tile capacity. While increased competition from the unorganised and foreign players will be a threat, expected surge in volumes, cost rationalisation measures and robust demand because of the domestic construction boom, are likely to drive earnings growth.

Investors can consider exposure to this small-cap stock with a perspective of one/two years. The stock trades at nine times its expected FY-06 earnings.

A Karnataka-based tile producer, Murudeshwar Ceramics has an overall market share of about 12 per cent and in vitrified tiles 30 per cent.

Expanding volumes

Murudeshwar is expanding its vitrified tile capacity by 40 per cent to 21,000 sq m per day; the expanded capacity will become operational by the first quarter of FY-07. This additional capacity set up at Pondicherry is likely to yield cost advantages. Murudeshwar has entered into an agreement with GAIL that will give the former the option of using natural gas, a relatively cheaper option to LPG. The power costs at the facility are also less compared to Hubli where another unit is located. Tax holidays over the next 10 years will also boost the bottomline. These factors are likely to keep the margins stable despite pressure on prices on the back of increased competition in vitrified tiles.

The company had stopped production of ceramic tiles in 2003-04 due to the high cost of operations and lower margins. Surging demand for ceramic tiles from the low-cost housing segment has now driven Murudeshwar to not only revive production but also double capacity by 2007.

Although this space offers less attractive margins, we expect the volume expansion as a result of boom in the housing segment to sustain overall operating profit margins.

Operating efficiencies

Murudeshwar has a captive quarry in Karnataka for China clay — one of the key raw materials — which will meet 80 per cent of the company's requirementsfor the expanded capacity. It further has its own processing unit for another input, feldspar. This is likely to give the company an edge over peers in keeping raw material costs under check.

A common practice in the tile industry is the use of the wet production process where fuel and power consumption is high. Murudeshwar has recently procured an Italian technology using the dry process. This technology, to be set up at its new facilities, will lead to significant reduction in per unit consumption of electricity and fuel.

Costs at the existing Hubli plant will continue to remain relatively high due to the wet process of production. The company has, however, adopted the strategy of producing value-added products such as larger-sized tiles from this facility.

Although capacity utilisation is likely to be less than optimum due to frequent change in product mix, the higher realisations from such unique products are likely to off-set the constraints of capacity utilisation.

Spurred by realty boom

Murudeshwar Ceramics appears well-poised to gain from the demand for office and retail space in the country. Apart from plans to increase its showroom and depots to other states, the company has a network of over 300 dealers. Hi-Tech city in Hyderabad, Infosys and Reliance are some of the clients for its vitrified brand — Naveen Diamontiles. The demand for ceramic tiles from the middle and low housing segments, has also risen as a result of the housing boom.

Murudeshwar's capacity expansion appears well-timed to meet the demand in this space. Raheja and Mahindra Gesco are some of the builders who specify the company's tiles for their projects.

Risks

Murudeshwar's operating profit margins (OPM), at 30 per cent, is significantly higher than peers such as Kajaria Ceramics.

Price wars, as a result of rising competition from the unorganised market, are likely to bring the company's operating profit margins under pressure. Although the current OPM may decline, it is likely to remain superior to peers on the back of various cost rationalisation measures adopted. The price war may also bottom out over a couple of years as it may prove to be unviable for unorganised players to trade on low margins.

Levy of anti-dumping duties on cheaper imports from China and the United Arab Emirates (UAE) has so far protected domestic manufacturers from unhealthy competition resulting from low-cost foreign tiles. The waiver of anti-dumping duty on China by 2008, may see huge inflow of cheap quality tiles at low prices.

Although such products may find demand in the lower level housing segment, we expect Murudeshwar's business share to remain firm, given that 60 per cent of its revenues are from institutional clients who are likely to be brand-conscious.

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