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Sandeep Gupta (S.Gupta@MotilalOswal.com); +91 22 3982 5544

Somil Shah (Somil.Shah@MotilalOswal.com); +91 22 3312 4975

Mehul Parikh (Mehul.Parikh@MotilalOswal.com); +91 22 3010 2492

Tiles Ground Reality

The Big Leapto a formal economy

Volume 2.1

Thematic | April 2017

Volume 1

28 April 2017 2

The Big Leap | Tiles

Contents: The Big Leap: Tiles Huge opportunity, but challenges too................................................................................... 3

Indian tiles industry – Third largest producer globally .......................................................... 5

Organized market share has been gradually rising ................................................................ 8

GST & demonitization– will it change industry dynamics? .................................................. 10

Kajaria – India’s largest tiles company ................................................................................ 15

Somany Ceramics – outsourcing model worked wonders ................................................... 16

Asian Granito – Chasing higher market share ..................................................................... 17

Prism Cement – Pioneer of ceranmic tiles in India .............................................................. 18

Tiles manufacturing Process ............................................................................................... 19

Investors are advised to refer through important disclosures made at the last page of the Research Report. Motilal Oswal research is available on www.motilaloswal.com/Institutional-Equities, Bloomberg, Thomson Reuters, Factset and S&P Capital.

28 April 2017 3

The Big Leap | Tiles

Huge opportunity, but challenges too Lower GST rates - the key catalyst

India is set to see a major overhaul in the trade structure in favor of the organized sector (Refer our inaugural edition of “The Big Leap” series). Although the government’s initiatives (demonetization, GST, etc.) are in the right direction, we continue believing that the shift will be prompt for some sectors, gradual for others and may remain challenging for a few. In this edition, we will focus on the INR260b Indian tiles industry. We chose to look at the tiles industry from the trade shift perspective, given that it is highly fragmented and has presence of numerous unorganized players (accounting for 51% of value and 60% of volume of the industry). Our ground research and channel checks suggest that the changes in administrative procedures under the GST using technology platform are unlikely to accelerate the shift trade toward formal trade in the tiles sector over the medium term. However, a reduction in indirect taxes (from the current ~25-28% to 18%) could be a key catalyst to accelerate shift toward formal trade. Organized market share rising…opportunity size still huge Tiles industry remains highly fragmented. Over the years, high indirect tax

incidence, liberal tax administration/monitoring and a short B2C supply chain have led the industry to remain dominated by unorganized players, which account for 51% of value and 60% of volume for the industry.

However, we note that rising per capita income, aspirational buying, brand awareness and product innovation have led to a gradual increase in value market share of organized players from 40% in FY08 to 49% now. Furthermore, the outsourcing model has helped organized players to ramp-up their businesses faster with minimal investments.

Administrative policy changes unlikely to bring cheers to the sector Over past few years, the Indian government has been taking a number of

initiatives to curb the shadow economy and shift trade from unorganized to organized. The government plans to move in this direction by bringing in new administrative procedures using technological platforms and altering tax rates under the GST. This will present investors with opportunities to take advantage of the shift in favor of organized names.

We believe that the tile industry with short B2C supply chain can continue operating end-to-end in a parallel economy and that the changes in administrative procedures are unlikely to accelerate the shift to organized trade in this industry.

The Big Leap: Tiles

28 April 2017 4

The Big Leap | Tiles

Lower effective tax rate can be a driver for the big shift Indirect tax incidence of ~25-28% for the tiles industry leads to a price

differential of 15%-20% between organized and unorganized players. As a result,unorganized players are able to attract price-sensitive Indian consumers withtheir low-cost offerings.

While the GST rate for the tiles Industry is still not made public, it is expected tobe either at 18% or 28%. Our discussions with various sector participants andexperts suggest that the potential reduction in the GST rate to 18% could aid theshift away from unorganized trade, with the price gap between organized andunorganized players lowering to a mere 5-10%.

However, if the GST rate is fixed at 28% (not materially different from currentrates), we believe the industry would miss a much-needed trigger in the form ofa lower effective tax rate to accelerate the shift to formal trade over themedium term.

Exhibit 1: Unorganized value market share at 60%in FY08..

Source: Industry, MOSL

Exhibit 2: …reduced to 51% in FY16

Source: Industry, MOSL

Exhibit 3: Narrowing of price differential under GST: Illustrative pricing summary pre and post GST

Particulars

Current Regime GST Regime @ 18% GST Regime @28%

Organized Player Organized Player Organized Player Unorganized

player RM cost + margin (A) 100.0 100.0 100.0 100.0 Excise (Cenvat not available) / GST (cenvat available) (B) 12.5 18.0 28.0 0.0 Cost for the dealer C = (A) + (B - if CENVAT not available) 112.5 100.0 100.0 100.0 Margin (5%) 5.6 5.0 5.0 5.0 VAT/ GST 14.8 18.9 29.4 0.0 Gross Price 132.9 123.9 134.4 105.0 Other Costs Additional branding cost (1-2%) 1-2 1-2 1-2Additional cost to manage trade channels (8-10%) - 0 0 8.5-10.5 Price to the consumer 133.9-134.9 124.9-125.9 135.4-136.4 113.4-115.5

Source: MOSL

Unorganized, 60%

Organized, 40%

Unorganized, 51%

Organized, 49%

26 April 2017 5

The Big Leap | Tiles

Indian tiles industry – Third largest producer globally

India is the third largest producer and consumer of tiles in the world. In terms ofvolumes, the country’s tiles industry grew at a CAGR (CY08-16) of 9.5% to 763m sq.mt,outpacing global growth of 5.5%. However, recent slowdown in real estate has led to asubdued growth over the last two years.

In terms of value, the Indian tiles industry is estimated to have grown at a higherCAGR of 16% (CY08-16), led by product improvisation and innovation.

Morbi, a small industrial town near Rajkot, is the second largest tiles manufacturingcluster in the world. Around 60% of tiles manufacturing in India happens at Morbi.

India – third largest tiles market globally India is the third largest producer and consumer of tiles in the world. As at FY16,

Indian tiles industry volumes are estimated at 763m sq.mt., with a market sizeof INR260b.

In volume terms, global tiles production CAGR stood at 5.5% over CY08-16. Overthe same period, the Indian tiles industry grew at a healthy CAGR of 9.5%,overtaking China’s 8.1% and Brazil’s 4.4%. However, slowdown in the real estatesector has impacted growth recent years.

This rapid pace of growth in the Indian tile industry can be ascribed to: (a)increasing urbanization, (b) real estate sector boom, (c) rising per capita incomeand (d) product improvisation.

Further, to protect the domestic tile industry, the government has imposed anti-dumping duty on tile imports from China, which were priced 30-50% cheaper.

Exhibit 4: Indian tiles industry growth (9.5%) higher than global growth (5.5%) (bn sq. mt.)

Source: Ceramic world review, MOSL

Exhibit 5: Indian tiles industry – volume CAGR of 9.5%

Source: Ceramic world review, MOSL

2.8 3.0 3.5 4.0 4.3 4.6 4.9 4.9

0.4 0.5 0.6 0.6 0.7 0.7

0.8 0.8 8.4 8.5

9.5 10.5 11.0 10.6

12.1 12.2

CY08 CY09 CY10 CY11 CY12 CY13 CY14 CY15

China Others India Brazil

403 494

557 625 681 718 756 763

22.6

12.8 12.2 9.0

5.4 5.3 0.9

CY08 CY09 CY10 CY11 CY12 CY13 CY14 CY15

Indian Tiles Industry (MSM) Growth (%) RHS

Indian tiles industry growth superior to global peers

28 April 2017 6

The Big Leap | Tiles

Exhibit 6: Share of urban population rising

Source: CENCUS,MOSL

Exhibit 7: Real estate market – CAGR of 14%

Source: KPMG, MOSL

Exhibit 8: Growth in per capita income (INR)

Source: CEIC, MOSL

Change in product mix, focus on innovation drive value growth Our discussion with sector experts suggest that in value terms, the Indian tiles

industry grew at a CAGR (CY08-16) of 16% to INR260b, with organized playersgrowing at 20% and unorganized players at 13%.

Product improvisation (greater focus on high-end tiles – PVT and GVT) andinnovation have led to value growth outpacing volume growth over CY08-16.

Exhibit 9: Structural shift toward better-value products (%)

Source: Industry, MOSL

285 377

742 833

FY01 FY11

Urban population (in m) Rurual population (in m)

72%

28% 31%

69% 50.1 53.3 55.6

66.8

121 126

FY08 FY09 FY10 FY11 FY13 FY15

Market size of real estate in India (USD b)

32,819 39,267

44,431 50,625

57,660 64,664

72,054 77,647

83,565

2008 2009 2010 2011 2012 2013 2014 2015 2016

Real Income

PVT, 39

GVT, 8

Ceramic, 53

PVT, 44

GVT, 12

Ceramic, 44

FY16

Product improvement and innovation drives value

growth higher than volume growth for tiles industry

FY10

28 April 2017 7

The Big Leap | Tiles

Morbi – the largest tiles manufacturing cluster in India Morbi, a small industrial town near Rajkot, is home to more than 600 tile

manufacturing units, and is also the second largest tile manufacturing cluster inthe world. Furthermore, 100+ units are under construction at Morbi. Around60% of tiles manufacturing in India happens at Morbi.

Access to key raw materials (clay, red and black soil, minerals, coal, frits andglazes), availability of dedicated gas lines from Gujarat State PetroleumCorporation and strategic location (close proximity to port, making it low-costtransport hub and facilitation for exports/ imports) have been the key drivers ofthe development of this location.

Morbi’s cumulative industrial investments for the sector amount to more thanINR80b, providing direct/indirect employment to 0.6m people.

Exhibit 10: Indian tiles industry clustered at Morbi (~60% of production)

Source: ICCTAS, MOSL

60% of Indian tiles manufacturing happens in

Morbi

28 April 2017 8

The Big Leap | Tiles

Organized market share has been gradually rising

The tiles industry in India has for long remained fragmented and dominated by

unorganized players. Unorganized trade in the sector is estimated at 60% by volume

and 51% by value as of FY16.

Tax arbitrage of ~25-28% between unorganized and organized players has primarily

led to a product price differential of 15-20% between these two segments.

Over FY08-16, organized players have been able to increase their value market share

from 40% to 49%, driven by rising per capita income, aspirational buying, brand

awareness and product innovation.

Further, the outsourcing model has helped organized players to ramp-up faster, with

minimal investment in terms of time and capital.

Unorganized players – significant participants in fragmented industry The tiles industry in India is highly fragmented, with small- and mid-sized players

accounting for a significant production market share. The industry has for longremained dominated by unorganized players.

As at end-FY16, unorganized players accounted for ~51% of value and ~60% ofvolumes of the industry.

Exhibit 11: Significant presence of unorganized players Particulars Organized Unorganized Turnover (INR b) 131 129 Production (MSM) 305 458 Share in Volume 40% 60% Share in Value 49% 51% Key players Kajaria, Somany, HR Johnson Morbi based players

Source: Company, industry data, MOSL

We believe that high indirect tax incidence, liberal tax administration/monitoring and a short B2C supply chain (wherein end-consumers do notdemand invoices as they cannot claim this as expense) have been among thekey reasons for significant existence of unorganized players.

Tax arbitrage – the key price differentiator The country’s tiles industry is levied with indirect taxes of ~25-28%, comprising

of 12.5% excise (tax on manufacturing), 12.5-14.5% VAT (tax on sale of goods)and other local taxes.

Players operating in the unorganized market usually skirt indirect taxes, thebenefit of which is usually passed on (either partially or wholly) to consumers tooffer an enhanced value proposition. This increases competitiveness ofunorganized players.

Further, there is high manual intervention/discretion in the current indirect taxadministration, which provides an opportunity for businesses to fare anyobjections which arise on opening of a tax scrutiny.

Our discussions with various sector participants/dealers indicate that the pricedifference between organized and unorganized players is generally in the rangeof 15-20%, which can primarily be attributed to tax arbitrage.

Unorganized sector accounts for 51% of the

industry

Current price differential of 15-20% mainly attributed to

tax arbitrage

28 April 2017 9

The Big Leap | Tiles

Exhibit 12: Sidestepping indirect tax leads to a big price differential Particulars Organized Player Unorganized Players RM cost + margin 100 100 Excise @ 12.5% 12.5 0 Cost for the dealer 112.5 100 Margin @ 5% 5.6 5 VAT on goods @ 12.5% 14.8 Other costs Additional branding cost (1-2%) 1-2 - Additional cost to manage trade channels (8-10%) - 8.5-10.5Price to the consumer 133.9-134.9 113.4-115.5

Source: MOSL

Market share of organized players has been gradually rising We note that organized players have grown (in volume terms) at a CAGR (over

CY08-16) of 14% v/s 7% for unorganized players. Higher growth of organized players is mainly due to (a) increased disposable

income, (b) brand aspirational buying, (c) product innovation and (d) brandawareness led by higher ad spends.

Further, the outsourcing model has helped organized players to grow faster, asthey are able to increase capacities without investing time or capital.

Consequently, the value market share of organized players increased from 40%in FY08 to 49% in FY16.

Exhibit 13: Unorganized value market share at 60%in FY08..

Source: Industry, MOSL

Exhibit 14: …reduced to 51% in FY16

Source: Industry, MOSL

Exhibit 15: Indian tiles industry dominated by three national brands (INR b)

Company FY16

Revenues Market

Share (%) Kajaria Ceramics 27.0 10.4% Prism Cement (TBK division)* 24.5 9.4% Somany Ceramics 18.0 6.9% Asian Granito 9.6 3.7% Nitco Tiles 8.6 3.3% RAK Ceramics* 7.6 2.9% Orient Bell Ceramics 7.6 2.9% Varmora* 6.5 2.5% Simpolo* 6.0 2.3% Sun Heart* 4.5 1.7% Murudeshwar Ceramics 1.2 0.5% Others (Swastic, Marbomax, Bell Granito etc)* 8.0 3.1% Unorganized players* 131 50.4% Total 260

*estimated Source: Industry, MOSL

Unorganized, 60 %

Organized, 40 %

Unorganized, 51%

Organized, 49%

Volume market share of organized players has

increased to 49% in FY16 (FY08: 40%)

Highly fragmented industry with unorganized players

contribute 51%

28 April 2017 10

The Big Leap | Tiles

GST & demonitization– will it change industry dynamics?

The Indian government has taken various initiatives (e.g. demonetization and GST) to

shift trade to the formal economy.

Our discussion with sector participants indicates that the administrative/procedural

changes under the GST are unlikely to lead to a shift toward organized trade in the

tiles industry.

However, lowering of indirect tax incidence under the GST to 18% or less (from ~25-

28% currently) can be a significant trigger to drive trade toward the formal economy,

with the product pricing gap between organized and unorganized players reducing to

~5-10% (from 15-20% currently).

GST and demonetization – the big drivers to shift trade to formal economy

India is set to see a major overhaul in the trade structure in favor of theorganized (formal) segment, with the government taking a number of initiativesto curb the shadow economy.

Demonetization of high-value currency notes has created fear amongunorganized players as transactions in this space were mostly cash-based andunaccounted. Even in the recent Budget announcement, cash transactions ofINR0.2m or more have been prohibited.

Also, with GST implementation nearing reality, the organized segment is wellpoised to confront the high presence of unorganized (informal) players.

We believe this will present opportunities to take advantage of the shift in favorof organized names. However, our discussions with experts and sectorparticipants highlight that the shift will be prompt for some sectors, gradual forothers and challenging for a few.

Will the drivers be effective for the tiles industry too?

As discussed in our previous report (click here for detailed note), to analyze thepace of the shift (to organized) for each sector, one has to carefully consider theadministrative/procedure changes and the tax rates decided under the GST.

We believe the following measures can potentially accelerate the shift towardformal trade: (a) reducing threshold limit for exemption from indirect taxes, (b)tracking flow of GST credit in the entire value chain by using technologyplatforms, (c) ensuring availability of seamless input credit and (d) reducingoverall effective tax rates.

our discussions with experts and sector participants

highlight that the shift will be prompt for some

sectors, gradual for others and challenging for a few.

28 April 2017 11

The Big Leap | Tiles

Measures that could lead to shift to organized trade

Source: MOSL

To estimate the pace of shift to formal economy for each sector, one needs tolook at: (a) supply chain the sector works with, (b) operational nuances ofplayers in the unorganized segment and (c) how government initiatives willchange the way in which unorganized segment players operate.

Exhibit 16: Critical determinants of shift to organized trade

Source: MOSL

Modalities of circumventing indirect taxes in tiles industry

Unorganized players in the tiles industry operate primarily through modalities ofunder-reporting/under-recording of purchases and sales (of rawmaterial/finished goods) and maneuvering thresholds for circumventing indirecttaxes.

Raw materials used in the tiles industry are easily available in the unorganizedmarkets. As a result, the whole chain (right from procurement of raw materialsto selling to end-consumer) remains outside organized trade.

Under recording of purchases/ sales facilitates

unorganized trade in the industry

Better Enforcement

Better Compliance

Reduction in threshold limits Through technology-enabled platform

Through availability of input credit Reduction in overall effective tax rate

28 April 2017 12

The Big Leap | Tiles

Short B2C supply chain may continue to be unorganized under GST

To determine the probability of shift in trade from unorganized to organized, itis imperative to understand the supply chain in which the entity operates. Wenote that any break in the organized chain leads to the beginning ofunorganized trade. We believe that in the GST regime, a conversion to organizedin the B2B chain will be relatively easy than in the B2C chain.

We believe the shift to organized trade in short B2C chains (wheremanufacturers/service providers source raw materials/inputs from unorganizedmarket, and continue supplying in unorganized manner throughout the supplychain) will be difficult.

This is primarily due to the fact that only businesses can register on the GSTnetwork and claim the benefit of input credit. End-consumers will not have anydirect benefits for being part of the organized chain. Also, most consumersusually are indifferent to choosing between organized and unorganized players;the focus is more on pricing.

Tiles: Escape from administrative and technology platform likely Under the GST, the government intends to employ technology to track end-to-

end credit flow in the value chain. Bilateral validation of invoices, onlineintegration of data and big data analytics will go a long way in addressing theloopholes in tax administration.

The IT portal can capture data even if at least one participant in the value chainsells goods through the organized chain (and hence is a part of the GSTN).However, in industries like tiles, it is possible for all participants in the valuechain to stay outside formal trade and thus escape from data capture bytechnology platform.

The tiles industry has a short B2C supply chain, wherein raw materials (primarilyclay, gas, coal, electricity, minerals, etc.) are sourced by the manufacturer andfinished goods are sold to end-consumers/builders via dealers and distributors.Thus, the end-to-end chain can easily remain outside the GST ambit.

The key inputs required for the manufacture of raw tiles are: Clay: It is available in abundance and can be easily sourced from the

unorganized market. The unorganized players procure clay without payingindirect taxes, thereby remaining outside the tax net.

Power: Electricity can either be sourced from organized channels (as donecurrently through state electricity boards) by managing the input/outputratio or is generated captively (through DG sets, which entail additionalcost).

Fuel: Most tiles manufacturing units have the provision of using piped gasdirectly or generating it captively via coal-gasification plants. Coal used forgasification can be procured from the unorganized channel.

it is possible for all participants to stay outside

formal trade and thus escape from data capture

by technology platform

End-to-end chain can easily remain outside the GST

ambit.

28 April 2017 13

The Big Leap | Tiles

Exhibit 17: Short supply chain of the tiles industry

Lower effective tax rates can be a big trigger for the shift As discussed earlier, indirect tax incidence (which is in the range of ~25-28%)

leads to price differential of 15%-20% between organized and unorganizedplayers.

While GST rates applicable for the tiles industry are yet to be made public, webelieve that they are likely to be either at 18% or 28%.

Our discussions with various sector participants and experts suggest that apotential reduction in GST rates to 18% for the tiles sector can be very beneficialfor organized players.

This will primarily be on account of a reduction in the pricing gap betweenorganized and organized players to 5-10% (from current 15-20%) as organizedplayers pass on the benefit of lower duties to consumers.

However, if GST rates are fixed at 28% for the tiles industry (not materiallydifferent from the current rates), then the current slow pace of shift toorganized trade may continue, lacking an additional thrust.

18% GST rate will reduce the price differential to 5-

10%

Clay

Can be sourced

from

unorganized

players

Power

Input output

ratio adjusted or

Captivity

generated

Fuel

Input output

ratio adjusted, or

Sourced from

unorganized

players

Manufacturer

Distributor

Dealer

End Consumer/ Builder

28 April 2017 14

The Big Leap | Tiles

Exhibit 18: Narrowing of price differential under GST: Illustrative pricing summary pre and post GST

Particulars

Current Regime GST Regime @ 18% GST Regime @28%

Organized Player Organized Player Organized Player Unorganized

player RM cost + margin (A) 100.0 100.0 100.0 100.0 Excise (Cenvat not available) / GST (cenvat available) (B) 12.5 18.0 28.0 0.0 Cost for the dealer C = (A) + (B - if CENVAT not available) 112.5 100.0 100.0 100.0 Margin (5%) 5.6 5.0 5.0 5.0 VAT/ GST 14.8 18.9 29.4 0.0 Gross Price 132.9 123.9 134.4 105.0 Other Costs Additional branding cost(1-2%) 1-2 1-2 1-2Additional cost to manage trade channels (8-10%) - 0.0 0.0 8.5-10.5 Price to the consumer 133.9-134.9 124.9-125.9 135.4-136.4 113.4-115.5

Source: MOSL

Outsourcing model to work wonders if trade shifts to organized We believe that the outsourcing model has worked very well until now in

growing organized trade in the tiles industry. We believe that if there isaccelerated shift to organized trade, then large companies having strong brandpresence will grow faster and the current unorganized players may continue tofunction as contract manufacturers.

Organized players benefit as capital employed is much lower than greenfieldexpansion and the gestation period is negligible. Outsourcing results in an assetlight model, which boosts return ratios despite slightly lower margins.

This model is also beneficial to unorganized players as they sell on cost plusbasis, eliminating risks and earning fixed RoE.

28 April 2017 15

The Big Leap | Tiles

Kajaria – India’s largest tiles company Kajaria Ceramics (KJCL) was incorporated in 1985 by Mr Ashok Kajaria in

technical collaboration with the world’s second largest tiles manufacturer,Todagres, SA.

KJCL is India’s largest tiles company with a market share of 10.4% (share of 20%in the organized market, up from ~14 in FY11). Over FY08-16, it reportedrevenue CAGR of 22% and PAT CAGR of 42%.

Focus on brand building, product launches, innovations and large distributionnetwork have been the key drivers of growth.

KJCL’s EBITDA margin of 19% is higher than peers, mainly due to pricingpremium of ~5-6% led by its strong brand equity, aggressive ad spends of ~2.5%of revenue, higher proportion of manufactured goods at 90%, and 66% ofvolumes being high-margin vitrified tiles.

Like peers in the industry, KJCL also follows an outsourcing-based model,whereby it forms JVs with Morbi-based entities as against the practice offorming associates by peers. KJCL’s revenue mix is skewed towardmanufacturing (owing to JV model) at 90%, which is a higher-margin business.This proportion is far higher than peers.

Exhibit 19: Revenue mix skewed toward vitrified tiles (FY16)

Source: Company, MOSL

Exhibit 20: Revenue mix skewed toward manufacturing

Source: Company, MOSL Exhibit 21: Financial snapshot (INR m) Kajaria Ceramics FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 Sales 5,005 6,649 7,355 9,533 13,130 15,833 18,363 21,869 24,185 YoY Change (%) 16.3 32.8 10.6 29.6 37.7 20.6 16.0 19.1 10.6 8YR CAGR (%) 21.8 EBITDA 819 949 1,149 1,489 2,064 2,455 2,858 3,484 4,634 Margin (%) 16.4 14.3 15.6 15.6 15.7 15.5 15.6 15.9 19.2 8YR CAGR (%) 24.2 PAT 150 89 359 606 809 1,045 1,242 1,756 2,292 YoY Change (%) 85 (41) 303 69 33 29 19 41 31 8YR CAGR (%) 41 ROE 10.1 5.6 20.4 27.1 31.9 31.8 28.6 29.1 28.1 ROCE 12.8 14.5 20.0 23.1 30.9 31.6 32.3 33.9 35.4 D/E 2.2 2.0 1.4 1.3 1.0 0.9 0.4 0.3 0.3 Capital Employed 4,922 4,872 4,522 5,166 5,737 7,173 8,157 10,571 13,113 Cash Flow - FCO 46 255 1,077 1,594 909 976 1,661 1,803 2,713 Cash Flow - FCF (20) 134 607 (72) 184 (533) 139 (843) 49Trailing P/E 28

Source: Capital line, MOSL

Ceramic tiles, 38

PVT, 36

GVT, 23

Others, 3

63% 76% 80% 83% 90%

37% 24% 20% 17% 10%

FY12 FY13 FY14 FY15 FY16

Manufactured Trading

28 April 2017 16

The Big Leap | Tiles

Somany Ceramics – outsourcing model worked wonders Set up in 1968 by Mr Hira Lal Somany, Somany Ceramics (SOMC) was formed in

technical collaboration with Pilkington’s Tile Holding (UK) and was named as‘Somany Pilkington Limited’. Later in 2007, it was renamed as Somany CeramicsLimited. SOMC started business by setting up a plant to manufacture 0.52msmceramic tiles at Kassar, Haryana in 1970.

SOMC is India’s third largest tiles company with a market share of 6.9% (14% oforganized share). Over FY08-16, it reported revenue CAGR of 23% and PAT CAGRof 41%.

Comprehensive product range, innovative products, aggressive brand spends,extensive distribution network and outsourcing model have been the majordrivers of growth.

SOMC’s main focus was growth via the outsourcing model, wheremanufacturing was outsourced to smaller players and the companyconcentrated on marketing/distribution. The outsourcing model resulted inattaining PAT growth on an asset light model, boosting return ratios. We believethat the low margins of SOMC are because of its outsourcing model (associate-based) where it holds a 26% stake, but this model is effective in generating highPAT growth.

Exhibit 22: Revenue mix skewed toward vitrified tiles (FY16)

Source: Company, MOSL

Exhibit 23: Revenue mix skewed toward trading

Source: Company, MOSL Exhibit 24: Financial snapshot (INR m) Somany Ceramics FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 Sales 3,311 4,463 5,423 7,199 8,790 10,539 12,648 15,431 17,177 YoY Change (%) 19.4 34.8 21.5 32.8 22.1 19.9 20.0 22.0 11.3 8YR CAGR (%) 22.8 EBITDA 365 423 558 677 741 857 814 1,076 1,385 Margin (%) 11.0 9.5 10.3 9.4 8.4 8.1 6.4 7.0 8.1 8YR CAGR (%) 18.1 PAT 38 88 204 239 251 320 289 464 647 YoY Change (%) 53 129 133 17 5 27 (10) 61 39 8YR CAGR (%) 42 ROE 6.8 14.3 27.6 25.6 21.9 23.4 14.1 19.1 19.1 ROCE 13.0 15.0 20.0 19.0 18.8 21.2 16.6 20.0 20.4 D/E 2.5 2.1 2.0 1.7 1.3 1.1 0.8 0.7 0.6 Capital Employed 2,008 2,024 2,447 2,971 3,090 3,322 4,195 4,771 7,154 Cash Flow - FCO 257 391 414 235 786 707 739 248 596 Cash Flow - FCF (12) 310 (48) (111) 476 330 149 (260) (768)Trailing P/E 36

Source: Capital line, MOSL

Ceramic tiles, 41

PVT, 35

GVT, 17

Others, 7

56% 51% 48% 47% 45%

44% 49% 52% 53% 55%

FY12 FY13 FY14 FY15 FY16

% Manufactured % Trading

28 April 2017 17

The Big Leap | Tiles

Asian Granito – Chasing higher market share

Asian Granito Ltd. (Asian) was established in the year 2000. It is India’s fastest-growing wall/ceramic wall and floor tiles company. Asian is among the top fourceramic tile brands in India, with a share of 3.7% in the organized tile market.

Over FY08-16, it reported revenue CAGR of 17%. However, PAT almost remainedflat over the same period due to high interest and depreciation.

The company has a strong distribution network of 4,000 dealers and sub-dealers. It sells its products under three brand names: Asian Granito, AGL andBonzer7.

The company exports to 50 countries. It plans to increase its export destinationsand also make further inroads into the US.

The company is focusing on increasing its share of retail customers from 35% inFY16.

Exhibit 25: Revenue mix skewed toward ceramic tiles (FY 16)

Source: Company, MOSL

Exhibit 26: Financial Snapshot (INR m) Asian Granito FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 Sales 2,275 3,320 4,055 4,804 6,238 7,084 7,752 8,460 9,939 YoY Change (%) 27.0 45.9 22.2 18.5 29.9 13.6 9.4 9.1 17.5 8YR CAGR (%) 20.2 EBITDA 535 531 463 581 667 698 632 596 903 Margin (%) 23.5 16.0 11.4 12.1 10.7 9.9 8.1 7.0 9.1 8YR CAGR (%) 6.8 PAT 296 250 190 201 181 171 121 148 243 YoY Change (%) 28 (16) (24) 6 (10) (5) (29) 22 64 8YR CAGR (%) (2.5) ROE 24.8 14.4 9.6 9.3 7.8 6.5 4.9 4.7 7.3 ROCE 26.9 18.1 11.2 11.2 11.7 9.7 8.3 8.5 10.7 D/E 0.4 0.6 0.7 0.6 0.8 1.0 0.8 0.6 0.9 Capital Employed 2,321 2,993 3,435 3,738 4,396 5,228 5,115 4,738 7,446 Cash Flow - FCO 209 35 387 249 23 192 350 1,042 207 Cash Flow - FCF (405) (534) (55) 28 (148) 61 53 668 (2,016) Trailing P/E 33

Source: Capital line, MOSL

GVT, 14%

PVT, 31%

Ceramics, 30%

Marbles, 16%

Others, 8%

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The Big Leap | Tiles

Prism Cement – Pioneer of ceranmic tiles in India Prism cement has two major segments with cement contributing 36% and TBK

division (HR Johnson) contributing 41% of revenue. HR Johnson was incorporated in 1958 with offering wide range of tiles, sanitary

ware, bath fittings, modular kitchens and construction chemicals. The company has 10 manufacturing plants (including JV’s) with capacity of

~58mn m2pa and is ably supported by distribution network of ~1000 dealersspread across the country.

The company operates through asset light business model as its six JV’s accountfor ~70% of overall capacity with 4 JV’s in Gujarat and 2 JV’s in A.P.

HRJ enjoys the reputation of being the only entity in India to offer end-to-endsolutions of tiles, sanitary ware, bath fittings, kitchens, and engineered marble &quartz. All the products are sold under 4 strong brands, viz. Johnson, JohnsonMarbonite, Johnson Porselano and Johnson Endura.

HRJ has addressed power and fuel issues in southern operations by installing 3coal gasifies in AP Plants and winning bids for onshore micro gas wells. It hascompleted pipeline connectivity for its Karnataka unit.

HRJ margins have been impacted and are lower than industry due to lowerutilization for its own manufacturing.

Exhibit 27: Financial snapshot (INR m) HR Johnson - TBK division of Prism Cements FY11 FY12 FY13 FY14 FY15 FY16 Sales 14,725 17,111 17,653 18,988 22,099 22,932 YoY Change (%) 24.0 16.2 3.2 7.6 16.4 3.8 6YR CAGR (%) 11.6 EBITDA 1,640 1,184 890 1,863 746 640 Margin (%) 11% 7% 5% 10% 3% 3% 6YR CAGR (%) -15.25ROCE 15% 8% 3% 11% 2% 1% Capital Employed 8,106 9,875 11,282 11,504 12,149 10,770

Source: Capital line, MOSL Exhibit 28: Financial snapshot (INR m) Prism Cements FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 Sales 8,763 6,474 28,749 34,474 45,962 48,206 50,266 56,544 56,216 YoY Change (%) 0.1 (0.3) 3.4 0.2 0.3 0.0 0.0 0.1 (0.0) 8YR CAGR (%) 26.2 EBITDA 3,323 1,595 5,200 3,783 3,119 3,116 1,847 3,538 3,850 Margin (%) 37.9 24.6 18.1 11.0 6.8 6.5 3.7 6.3 6.8 8YR CAGR (%) 1.9 PAT 2,390 921 2,598 1,050 (184) (625) (862) 26 33 YoY Change (%) 24 (61) 182 (60) (118) 239 38 (103) 268YR CAGR (%) (41.5) ROE 38.6 18.3 26.1 8.1 NM NM NM NM NM ROCE 51.3 30.3 30.3 10.6 5.8 4.7 0.3 6.8 6.5 D/E - - 0.5 0.9 1.2 1.5 1.8 2.1 2.1 Capital Employed 6,168 7,045 22,382 27,839 29,835 33,745 33,820 35,403 35,801 Cash Flow - FCO 2,424 1,005 3,716 2,884 2,667 2,599 566 1,986 4,379 Cash Flow - FCF 1,714 (275) (2,432) (1,940) (289) (772) (1,463) 291 2,390 Trailing P/E NM

Source: Capital line, MOSL

28 April 2017 19

The Big Leap | Tiles

Tiles manufacturing Process

Crushing and Grinding of raw materials Slurry is dried and put on conveyor belts

Shaping of tiles in pressing machines

Removing moisture using driers

Coke gasification plant

Kiln firing

Polishing

Designing and roll out of final product

THEMATIC/STRATEGY RESEARCH GALLERY

28 April 2017 21

The Big Leap | Tiles

N O T E S

28 April 2017 22

The Big Leap | Tiles

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