Royal Ceramics [RCL.

N0000]
Attractive valuations and conglomeratization - BUY
YEAR END MAR - LKR mn Net revenue FY12 6,956 FY13E 7,687 FY14E 8,838 FY15E 10,046
Current Price (LKR)

98
Fair Value (LKR)

Growth in net revenue

Net profit

21%
1,958

11%
1,631

15%
1,854

14%
2,047

128
Recommendation

Growth in net profits

Recurring profits

36%
1,689

-17%
1,631

14%
1,854

10%
2,047

BUY
Date

Growth in recurring profits

EPS PER (x) P/BV (x)

36%
17.7 5.6 1.7

-3%
14.7 6.7 1.3

14%
16.7 5.9 1.1

10%
18.5 5.3 1.0

15-Feb-13
Market Capitalization (USD): 86Mn 6mos avg. Daily T/O (USD): 30K Free Float: 41%

Royal Ceramics is the market leader in the local tile and sanitary ware segments, with a market share of c.45%. CAL expects FY13-15E profitability to grow at a c.12% Cagr (2013-15E) driven by market share gains (45% in FY13 to 51% in FY16E) from higher cost imports, growth in non-governmental construction (FY12-15E Cagr of c.2%) and their ability to effectively turnaround and incorporate loss making companies into the Group. However, escalating energy prices (c. 30%), which constitute c.40% of total costs in FY12, could have detrimental effects on RCLs tile segment profitability if energy prices are increased by 20% (c.17% decline in profitability). CALs SOTP valuation is LKR 128, an upside of 31% (71% of the value is from its core business). At current price levels (LKR 98; -c.41% since Jan 2012), the decline in FY13E earnings and probable energy hikes have been factored in, and an investor will be getting RCLs associates for free. BUY Attractive valuations (5.9x PER & 31% discount to fair value) - CAL expects a c.5% growth in sales volumes in FY14E resulting from market share gains from tile importers (c.35% of the market) as the 35% cess imposed on imported tiles from Dec 2012 and LKR depreciation (15% since Mar 2012) raised imported tile prices. Further, rising hotel and apartment construction projects may drive non-governmental construction (c.2%p.a.) supporting volume growth. CAL expects RCLs overall profitability to grow at a c.12% Cagr 2013-2015E. RCLs 9MFY13 profits came in 21% lower at LKR1.2bn as a result of a c.30% increase in energy prices, reduced volumes (-c.5% YoY) and higher interest rates (+263bps since February 12) that decreased tile segment profitability. CAL expects RCL to end FY13 on a negative note with a 17% profitability decline (3% decline in recurring profits) and profits to reverse post FY13 at a c.12% Cagr (2013-15E). Based on a DCF valuation, RCLs fair value is LKR 128 (upside of 31%), trading on a FY14E PER of 5.9x, P/BV of 1.1x and an EV/EBITDA of 4.4x. Possibility of another energy hike and rising interest rates remains a challenge for RCL Energy costs constitute c.40% of cost of sales. In turn, a 20% surge in energy prices would erode overall profitability by 17%, if this isnt matched by a c.7% corresponding increase in tile prices. During 2012, energy prices increased 30% and RCL was able to increase prices by 15%. In addition, higher interest rates would also affect profitabilty as RCLs gearing currently stands at 43% (D/E) and interest coverage at 3.8x. RCLs 9MFY13 finance costs grew 113% to LKR468mn due to higher interest rates (263 bps since February 2012) and additional borrowing (+LKR 1.17bn). CALs base case valuations factor

CAL Securities
Level 5, Millennium House, No.46/58, Nawam Mawatha, Colombo 2 Tel: +94 11 2231 7777 Email:ananya@capitalalliance.lk

Ananya Udeshi

1 Refer page 5 for important disclaimer

in a c.15% increase in energy prices, a retail price increase of 8% and a 5% increase in volumes for FY14E, leading to overall profits growing 14% YoY to LKR1.9bn. Backing of a strong entrepreneur - RCLs strategy on diversification may hold in their favour. RCL increased its stake in LB Finance to 26% in FY13 which resulted in the associate stake contributing LKR 435mn (37%) to overall profits in 9MFY13. In recent times, RCL has been on an acquisition drive, having acquired subsidiary, Asia Siyaka (commodity trader), Colorbrite (paint manufacturer) and obtaining an associate stake in Delmage (F&B). Historically, the management has had a proven track record in identifying and acquiring underperforming businesses and effecting successful turnarounds, such as Hayleys Plc, which has increased profitablity at a Cagr of c.101% (FY09-12) and Amaya leisure which has increased profitability at a Cagr of c.107% (FY10-12). Furthermore, RCLs FY14E Free cashflow to Cash intrerest expense coverage stands at 3x compared to industry avg. of 2.5x, indicating that RCL could raise an additional LKR 547mn in debt if it were to finance further acquisitions. With no major capex required for plant expansion in its core business (capacity increased by c.48% FY11-13), RCL may eye possible opportunities for further diversification. CAL adds a LKR20/share to the base DCF value of LKR97/share (tile + bathware + commodity trading + paints) for RCLs stake in LB Finance, a LKR6/share for their stake in Delmage and LKR5/share for RCLs investment portfolio thereby providing an overall DCF Value of 128/share.

Appendix 1: RCL Consolidated Income Statement FY11-FY16E

FY11 5,751 (3,097) 2,655 214 (706) (424) (204) 1,535 (94) 1,441 1,441 1,242 FY12 6,956 (3,664) 3,292 304 (859) (399) (81) (328) 81 2,012 (53) 1,958 1,958 1,689 FY13E 7,687 (4,063) 3,624 61 (1,065) (720) (618) 612 1,894 (233) 1,661 1,631 30 1,631 FY14E 8,838 (4,736) 4,102 63 (1,225) (790) (693) 692 2,149 (261) 1,888 1,854 34 1,854 FY15E 10,046 (5,451) 4,595 72 (1,393) (885) (787) 780 2,383 (297) 2,085 2,047 39 2,047 FY16E 11,253 (6,289) 4,964 81 (1,557) (980) (853) 882 2,536 (335) 2,201 2,158 43 2,158 Net revenue Cost of Sales Gross Profit Other Income Distribution Expenses Administrative Expenses Other (Expenses)/Reversal Finance Cost Share of Associate Company's Profit Prot before Tax Income Tax (Expense)/Reversal Prot for the period Profit to Equity holders of the parent Minority Interest Recurring profit attributable to E/H

RCL - Income statement - LKR mn

Profit growth Recurring profit growth

49% 29%

36% 36%

-17% -3%

14% 14%

10% 10%

5% 5%

Source: Company Data and CAL Research estimates

Appendix 2: RCL Consolidated Balance Sheet FY11-FY16E

Balance Sheet - LKR mn ASSETS Non-Current Assets Property, Plant and Equipment Investments in Associates Intangible Assets Other Receivables Total Non-Current Assets Current Assets Inventories Trade Receivables Other Receivables Other Investments Income Tax Recoverable Cash and Cash Equivalents Total Current Assets Total Assets EQUITY AND LIABILITIES Capital and Reserves Stated Capital Reserves Retained Earnings Minority Interest Total Equity Non-Current Liabilities Interest Bearing Loans and Borrowings Deferred Tax Liabilities Retirement Benefit Obligation Total Non-Current Liabilities Current Liabilities Trade and Other Payables Other Liabilities Interest Bearing Loans and Borrowings Total Current Liabilities Total Equity and Liabilities 730 51 1,471 2,252 8,460 589 27 2,517 3,133 11,483 1,151 23 2,604 3,778 15,044 1,313 33 2,846 4,193 17,075 1,491 39 3,085 4,615 19,213 1,696 45 3,300 5,042 21,350 995 62 101 1,157 1,583 69 133 1,785 2,332 85 188 2,605 2,574 85 231 2,890 2,813 85 277 3,174 3,028 85 326 3,439 1,369 101 3,581 5,051 1,369 101 5,096 6,566 1,369 571 6,352 370 8,661 1,369 571 7,650 404 9,993 1,369 571 9,041 442 11,423 1,369 571 10,444 486 12,869 1,920 1 61 4,010 8,460 805 9 121 3,721 11,483 1,381 647 1,917 869 2,115 1,258 519 813 9 558 5,271 15,044 2,463 1,438 519 813 9 1,460 6,701 17,075 2,834 1,624 519 813 9 2,385 8,183 19,213 3,270 1,812 519 813 9 3,173 9,596 21,350 184 4,450 4,266 4,351 3,147 72 192 7,762 5,650 3,758 173 192 9,773 5,559 4,450 173 192 10,375 5,435 5,231 173 192 11,030 5,277 6,112 173 192 11,754 FY11 FY12 FY13E FY14E FY15E FY16E

Source: Company Data and CAL Research estimates

Appendix 3: FY14E Profitability growth sensitivity to energy price hikes and retail tile price revision
Retail price revision

Energy price hike

0% 0% 5% 10% 15% 20%

0% -4% -1% -13% -17%

5%
14% 10% 13% 1% -3%

10%
28% 24% 27% 15% 11%

15%
42% 38% 41% 29% 25%

20%
56% 52% 55% 43% 39%

Source: Company Data and CAL Research estimates

Appendix 4: RCL DCF- Breakup value

RCL core business Target capital structure (D/E) Cost of Equity Cost of Debt Terminal Growth rate WACC

VALUE 40/60 20% 13% 1% 17%

LKR mn EBIT Total FCFF Terminal Value EV NPV/share

FY14E 2,842 2,177 16,011 15,164 97

RCL breakup value DCF value for core business (Tiles, bathware, commodities & paints) FV of RCL's stake in LB Finance RCL's stake in Delmage at cost FV of RCL's investment portfolio Overall DCF Value for RCL
Source: Company Data and CAL Research estimates

LKR/share 97 20 5 6 128

Contacts
Research Team
Tel No: +94 11 231 7777 (General) Email : teamresearch@capitalalliance.lk Purasisi Jinadasa Tel No: +94 11 231 7813 Email: purasisi@capitalalliance.lk Udeeshan Jonas Tel No: +94 11 231 7746 Email : udeeshan@capitalalliance.lk Reshan Wediwardana Email : reshan@capitalalliance.lk Dushan De Silva Email: dushan@capitalalliance.lk Thushani De Silva Email: thushani@capitalalliance.lk Ananya Udeshi Email: ananya@capitalalliance.lk

Disclaimer
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