The Hindu Business Line : Carborundum Universal: Buy

Strong growth in revenues, a highly diversified geographical base and increasing focus on the high-growth solar wafer business spell long-term potential for Carborundum Universal (CUMI), a leading player in the abrasives and industrial ceramics space. Those with a two-three year investment horizon can consider buying this stock.

Valuations

At the current market price of Rs 102, CUMI trades at about 11 times its likely FY09 per share earnings. While this may appear pricey when compared to some of the other manufacturing companies whose price earning multiples have been reduced to the single digits, that CUMI is fairly shielded from the impact of an economic slowdown may justify the ‘premium’ valuation accorded to it. For one, it has a highly fragmented user industry base, which may cushion it from the fallout of any significant slowdown in a particular user industry. That despite the slowdown in the auto industry, CUMI has managed to put in modest growth numbers is a case in point.

Two, CUMI’s access to low-cost funds for sustaining its capacity expansion and working capital requirements (at an average of 9 per cent) also allays concerns regarding funding constraints, the reason oft cited for marking down manufacturing companies. Three, a chunk of the demand for CUMI’s products is ‘maintenance and repair’ driven. So, to that extent the demand for its products will continue to remain healthy.

Access to minerals

Another factor in CUMI’s favour is access to rich yet cheaper reserves of minerals (alumina and SiC), essential raw materials for all its products. The company has strategically set up manufacturing facilities in countries such as China and Russia, which not only hold rich reserves of minerals but are also the target market for some of its products; Russian presence also holds significance in terms of providing proximity to CUMI’s clients in Europe.

Financials

For the quarter ended September 2008, helped by a strong performance in India, Russia and Australia, CUMI’s consolidated revenues and profits registered an increase of over 67 per cent, each. It has also turned around its Canadian operations. Further, Volzhsky Abrasive Works, the Russian company that CUMI acquired last year, is expected to report higher revenue contributions from this year. On a standalone basis, the company registered a sales growth of over 20 per cent. Margins, however, remained flat at 16.3 per cent as the quarter saw a 41 per cent increase in power costs. This was because CUMI’s manufacturing facilities in TN and Kerala have been battling with intermittent power cuts. An increase in raw material costs across all business segments also led to a cost push.

Segment-wise, abrasives registered 15 per cent growth in sales, while the sale of ceramics and electrominerals increased by 28 per cent and 27 per cent respectively. Forex loss and high interest outgo during the quarter however capped the profit growth at 6 per cent.

Margins to remain stable

The mismatch in supply and demand of minerals globally had driven CUMI to raise the price of its products to the extent of 5 per cent twice this year. The company may yet again hike the price of its products this quarter. Despite the price hikes, CUMI still counts among the low-cost manufacturer of abrasives and ceramics and this may help it sustain both revenue growth and margins.

Margins may also get a lift from the improving product mix and addition of ‘high value’ products to its kitty. From over 10 per cent of revenues last year, the contribution of value-added products has increased to 25 per cent last quarter.

On that note, the company’s proposal to set up a Silicon Carbide Microgrit facility (high-margin products) to cater to the increasing demand from the photovoltaic industry also leaves sufficient scope for margin expansion in the long-term.

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