Hindustan Sanitary ware & Industries Limited (HSIL)

- A Play on Indian Consumption Growth

Content Index
HSIL Investment Snapshot :- Slide #3 Indian Sanitary ware Market An Overview :- Slide #5 Container Glass Segment An Overview :- Slide #9 HSIL Business Overview :- Slide #13 Investment Rationale :- Slide #23 HSIL Financials:- Slide #31 Conclusion :- Slide #37

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HSIL Investment Snapshot (as on August 25, 2011)

Recommendation :- BUY Accumulation Range :- 180-210 Target Price range :- 340-360 Investment Period :- 15 to 24 months
Current Market Price Rs. 201.85 Bloomberg / Reuters Code HSI IN / HSNT.BO BSE / NSE Code 500187 / HSIL Mkt Cap (INR BN / USD Mn) 13.31 / 289.31 [1 USD Rs. 46.05] Total Equity Shares [Mn] 66.2 Face Value Rs. 2 52 Week High / Low Rs. 245.85 / Rs. 106.8 Promoters Holding 51.34 % Institutional Holding 25.97 %

HSIL was incorporated as Hindustan Twyfords Ltd in 1960 by Somany family (Promoters) in collaboration with Twyfords Ltd, UK to introduce vitreous China ceramic sanitary ware in India. AGI Glaspac, glass division of HSIL was acquired by the company in 1981 through a state government sale and it turned a loss making company into a profitable and healthy venture through various changes at both the operational and organizational levels. Thus, HSIL now has two business units of sanitary ware and container glass contributing almost equally to its revenues and positioned firmly in both the segments through its long standing experience. HSILs sanitary ware brand Hindware is the market leader and has acquired a strong mind space of the customer. It has been voted as a super brand continuously for the past 5 years. HSIL has a pan Indian presence in the sanitary ware segment and a dominating share of South Indian market in the container glass segment. HSIL has built a strong moat through extensive distribution network, strong clientele and low cost manufacturing presence across its two business divisions.

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Key Investment Highlights

Market Leader with Pricing Power HSIL is the market leader in Sanitary ware segment with more than 40 % market share and its container glass segment being a regional business (glasses are not economically viable to transport over 700 Kms) has more than 70 % market share in South India. This strong market leadership in both segments gives good pricing power for HSIL through aspirational brands and strong clientele. Market Leadership along with strong pricing power enables HSIL to grow profitably on the back of Indian Consumption boom. Healthy Industry Trends India is hugely underpenetrated in terms of sanitation (~40%) and the demand for housing is expected to grow healthily for many more years thus helping sanitary ware manufacturers to grow. Indian sanitary ware market is moving towards premium products and brand consciousness is increasing. All the end user industries of container glass segment is witnessing healthy growth and currently the demand for glass is much more than supply. The main advantage for HSIL is that both the industry segments where it operates are concentrated between 3-4 players having more than 90 % market share, showing the strength of the incumbents and the difficulty for a new player to scale up. Strong CAPEX to drive growth HSIL is undergoing strong CAPEX to expand its manufacturing presence across both its lines of business which will help it to grow for the next 5 years. At present, all the manufacturing plants of glass and sanitary ware division are operating at more than 100 % capacity and thus there is no need to worry about the capacity utilization of the up coming facilities as the demand is strong. HSIL is spending about 300 Crs in sanitary ware expansion and 350 Crs for creating new capacities in container glass division. Healthy Balance Sheet and inorganic growth HSIL did a 150 Cr QIP last year and its balance sheet is strong enough to absorb the CAPEX plans through internal accruals and by raising debt. Its current debt: equity is around 0.6: 1 and hence there is enough strength to add capacities without diluting equity. HSIL is not averse to inorganic growth as the company is pragmatic about synergistic and value adding acquisitions at a good price as can be seen from its acquisitions of Barwood, Crabtree Faucets and Garden Polymer over the past 2 years. Attractive Valuations HSIL is available at attractive valuations considering its strong growth and operations, at about 10 times its FY-12 expected earnings and is one of the few reasonably valued consumption stocks.

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Indian Sanitary ware Market - An Overview

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Strong Structural Demand

Housing Shortage in Millions
40 35 30 25 20 15 10 5 0 2001 2005 2008 2010 2014 Urban Rural

Country Developed Countries Thailand Malaysia Sri Lanka Pakistan India

Sanitation Coverage % ~ 100 96 94 65 50 40

The total housing shortage in India is huge at over 35 Million units and hence there is a strong structural story for the growth of new housing units thus signaling demand for sanitary ware and other bathroom products. The average growth of new housing is expected to be around 16 % CAGR for the next 3-5 years. Indias sanitation coverage compared with even our poorer neighbors is low and hence the scope for increasing coverage will act a growth catalyst for the sanitary ware manufacturers in India. Commercial segment though now is weak considering the high interest rate and costly real estate, it will pick up in the coming years through the construction of new malls, office spaces, IT Parks, SEZs etc. Sanitary ware industry is a wonderful proxy play on the growing construction demand.

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Sanitary ware Market Scenario

Fresh Demand Developed Countries India Market Share in Revenue Volumes 20 % 93 % Organized Sector 60 % 55 % Replacement Demand 80 % 7% Un-Organized Sector 40 % 45 %

Sanitary ware market world over is a very brand conscious product and is dominated by a few players who have strong brands and distribution networks. Even in India, sanitary ware segment is dominated by the top 3 players who account for more than 95 % of the organized market. Indian sanitary ware players have constantly increased their market shares over the last decade as consolidation forced several smaller players to move out as the business requires size and scale to compete across various price points and across different products. Replacement demand which has been very low in the Indian markets has started to pick up on the wake of changing social trends like, people re-furnishing their bathrooms during big events like childrens marriage and also younger generation replacing their sanitary ware of their ancestral homes.

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Changing Attitudes & Supporting Trends

Most important trend is the changing customer mindset about their bathrooms. Increasingly, bathroom products are becoming more fashionable and people are aspiring for better designed products and looking at bathrooms as a place to unwind after a tiring day and are willing to spend on branded products to build a classy bathroom. This trend is also witnessed amongst commercial spaces likes malls and multiplexes where developers are willing to spend lavishly on their toilets to project a premium image. This shift in attitudes is improving the demand for premium products like Bath-tubs, Jacuzzi's, shower panels, high end faucets, fittings etc. Thus, the spend on the entire bathroom has risen which has naturally increased the revenue share of the organized sector. Premium end of the market is growing at a better pace when compared with the low end of the segment thus helping the branded players to out-perform the growth rates of un-organized sector. Un-organized players still dominate the lower end of the market as they do not pay excise duties, sales tax etc thus helping them to price much cheaper than the organized segment. Un-organized players have also been growing though exports to African countries and other poorer countries. Cost of producing sanitary ware in India is low when compared with developed countries because of the low labor cost and abundance of raw materials at cheaper costs from the states of Gujarat, Rajasthan from where most of these manufacturers operate. Considering Indias production is low cost, there is a good scope to increase the % of Indian sanitary ware compared with the global market from the present 3.5 %. Indian sanitary ware market is expected to be around 1600 Crs and is growing at over 20 % in revenue terms and this growth is expected to accelerate with more premium and new products. Improved housing scenario will also augur well for the growth of the bathroom products once the interest rate scenario improves. Indias per capital income is expected rise to 1000 Ss will spur consumption of housing as homes become more affordable and hence better demand for sanitary ware products.

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Indian Container Glass Industry An Overview

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Glass Packaging Industry

Indian Packaging Industry (by Value) Glass Consumption Industries

Indian packaging industry is a 14 Bn $ industry and is growing at ~ 15 % for the past few years and in that Glass packaging industry is growing at a rate of ~ 12 % and is more than a billion dollar industry. Glass has been growing slower than the industry because of the high costs involved in production when compared with other packaging and also because of the lack of flexibility like plastics. But Glass has maintained its status as a premium packaging material and is also environmental friendly because of its capacity to get recycled and it does not get adulterated with chemicals like the other packaging materials. Glass is inert and safe and more importantly has a better emotional connect with the customers than other packaging materials like cans and PETs.

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Significant Growth Opportunity

Indias per capita consumption of glass is one of the lowest amongst all countries at 1.4 Kgs per person and the

glass consumption has a direct co-relation with the growth of its end industries.

If we believe in the Indian consumption story and the fact that Indians will get affluent over the next decade and start consuming more liquor, soft drinks etc, there is a huge scope for growth. Even if we assume 5 times the glass consumption per capita as of now, to be reached in the next decade, it would require huge production of glass. Scope of the opportunity is pretty huge and the entire glass production in this country is concentrated amongst the top 3-4 players and the main moat is the capital intensity in setting up a glass plant.

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 Glass is a regional industry and its economic viability depends on the distance of the service industries. A glass plant will be able to service industries within 700 Sq. Km of its presence thus rates depend upon the local demand supply and discourages captive glass plants as most industries dont have the volumes at one location to justify captives.

Strong Industry Trends

Main deterrent for entrants is the capital intensity of manufacturing glass as any furnace which produces less than 400 tonne per day (tpd) is not viable and the cost involved will be greater than 350 Cr. But a Brownfield expansion can produce the same capacity at a much lower cost of around 200-250 Crs. Thus giving the incumbents a huge advantage and that is one of the main reason for consolidation in the industry and the presence of few large players across India. Since it takes more than 2 years to put up a glass plant, it is not difficult to analyze the demand- supply equation and from the present capacities, it is said that the demand will exceed supply for at least the next 2-3 years. This gives the companies better pricing power and it can seen from the rate revisions happening with a smaller lag than before depending upon the increase in cost of manufacturing thus allowing glass manufacturers to maintain margins over a period of time. Glass industry is also moving towards more clean and better designed glasses as liquor and soft drink manufacturers start looking at glass packaging as a source to attract customers and maintain competitive advantage. At present, very high end glass bottles are being imported but since volumes are picking up, local glass manufacturers are also starting to produce these high value bottles thus improving their average realizations. At present, the three major varieties of glass which are manufactured are flint, umber and green glass. The main growth drivers of glass consumption in its end industries are increasing disposable incomes, low per capita consumption of liquor, increasing social acceptability to drinking, changing lifestyles, penetration of soft drinks in rural markets and increased acceptance of pharma products.

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HSIL Business Overview

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Key Highlights
Strong Moats
HSIL has strong moats in the building products division through its well entrenched brands and in the container glass segment through the strategic location of low cost manufacturing plants.

Capable Management
HSIL is promoted by Somany family who have a great understanding of the business through their long association in the industry. They have also reached their previous guidance's which gives us comfort for its execution of future plans

Product Expansion
HSIL s has leveraged its brand and distribution network in building products division to introduce a wide variety of products. Even in Glass division, HSIL has been introducing bottles with higher EBIDTA margins.

HSIL

Strong Distribution Network + Clientele

HSIL in sanitary ware has a 40 % higher distribution network than its nearest competitor. HSIL has a strong set of Institutional clients in both its line of business, especially in glass segment which is very vital.

Good Growth & Healthy Guidance

HSIL has been growing at significantly higher rates than the market and hence is gaining market share in Building products division. HSIL has also guided for a healthy growth of 25-30 % in both the top line and bottom line.

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Strong Brands
Volume Pyramid Brand Kermag ( Tie-up with Sanitec) Hindware Art + Hindware Italian Collection Hindware Raasi Bene Lave ( Premium Faucet Brand ) Price Point (Rs) 10,000 75,000 5,000 2,00,000 300 - 5300 200 - 350 2,000 Onwards

HSIL is the only sanitary ware player with various brands straddling across the entire market pyramid from low end to premium segment. HSILs brands through its aggressive marketing has a strong top off the mind recall and is usually associated with quality products which people aspire for. HSILs brand management has been excellent which can be seen from the creation of sub-brands of Art and Italian collection from the mother brand of Hindware, 5 years ago. HSIL also has introduced premium faucets under the brand name of Bene Lave without affecting the perception of the existing brands. HSILs focused marketing and gradual shift to the high end segment can be seen from the fact that, in Q1-FY 12, more than 54 % of its sales were from the Art and Italian Collection brands thus giving it better margins. HSILs brands in the premium segment has been very well received in the market as it is at a very competitive price.

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Strong Distribution Network

Distribution Strength Distributors Retailers Depots Exclusive Distributors Service Centers Service Professionals in No's 1,550 13,000 21 60 % 18 > 230
HSIL has one of the strongest Pan- India distribution strength amongst all building product manufacturers with a large network of dealers and retailers ( 40 % higher than nearest competitor) covering each and every town which has a population of more than 50,000 people. HSIL has considerably increased its depots from over 2 to 21 to cover all parts of the country in the past 2-3 years. This has enabled distributors to have a low inventory cycle and thus efficient working capital which increases their ROI. This has made the distributors happy and loyal to HSIL products which gives them better returns. Thus the sales push from these retailers and distributors has been good.

HSIL has implemented ERP and a strong IT platform amongst its distribution network to keep track of the market and hence work efficiently depending upon the demand for various products. HSIL has been active to build the brand amongst the plumbing community who have a great influence in buying of sanitary ware through better interactions and providing them good service. HSILs strong network of service centers addresses service calls within 48 hours through its focused after-sales service professionals. HSIL plans to strengthen its distribution network by addition of over 400 distributors and 3000 retailers in the next 2 years and thus covering each and every town in India with a population of over 25,000 people. This strong network of distribution is difficult to replicate and helps in increasing its market share.

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Forward Integration through Retail presence

Display Center
Hindware Boutiques

Nos
33

Location
All India

Details
Exclusive to HSIL (600-1500 Sq.ft)

Future Plans
To open 10 boutiques each in 3 years To open 8 arcades in 3 years To open 2 stores every year To open 4-5 stores annually and expand foot print. 35 Cr investment has been planned To open 30 stores in 3 years

Store-Type
Selling Point

Ownership
Dealer owned but maintained by HSIL. Special dealer discounts for boutiques. Dealer Owned but maintained by HSIL Company owned exclusive showrooms for brand display HSIL owned through subsidiary

Hindware Arcade Lacasa

Hyderabad , Chennai Mumbai, Cochin NCR

Over 3000 Sq.ft

Display center + Selling Point Display centers Large Format Home Retail with over 9000 SKUs

Over 3200 Sq.ft

EVOK

Over 10000 Sq.ft retail stores selling home furnishing, lighting, flooring, bath & kitchen products 200-500 Sq.ft, shops within showrooms for exclusive display of HSIL products

Shop in shop

80

All India

Selling Point

Dealer Owned

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 HSILs strong distribution and retail presence has enabled it to expand into other building products other than sanitary ware like wellness products and modular kitchens. HSIL has concentrated into expanding product portfolio where the margins are higher and it has competitive advantages. HSILs retail presence gives it a better brand experience amongst the users and helps mainly in getting large institutional customers away from foreign brands like Kohler and TOTO. EVOK, retail subsidiary of HSIL has been doing pretty well and except for one store it has become EBIDTA positive in all its stores and is in an expansion mode. EVOK provides all the products required to furnish and decorate your bare constructed house though its wide range of SKUs. EVOK though now produces 8-9 Cr losses on PAT level, is an important strategic initiative which along with its other retail formats will allow HSIL to sell high end products and leverage its brand positively, thus creating a sustainable competitive advantage. Retail presence helps in gauging the demand for various products and HSIL also has a well established trading business in building products where it imports from outsourced manufacturers and sells through its distribution networks items like high end tiles, shower rooms etc. HSIL faucet manufacturing plants are being set-up only after the trading of faucets has been able to generate enough volumes for the plant to become viable. The strength of HSIL can be seen from the fact that it has able to scale up the faucet business at a rapid pace and aims to be the number 2 player in the business within next year. HSILs brand strengthening and retail presence can be compared to TTK Prestige which used its brand and Prestige Stores retail format to morph from a cooker manufacturer to covering all kitchen related products thus growing profitably at a rapid pace like HSILs transformation from sanitary ware to total bathroom solutions.

Product Portfolio Expansion

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Strategic Manufacturing plants

Sanitary ware Production
Manufacturing Location Bahadurgarh, Haryana Bibin Nagar, AP Existing Capacity 1.5 Mn Pieces 1.3 Mn Pieces

Container Glass Production

Manufacturing Location Hyderabad, AP Bhongir, AP Manufacturing Location Bhiwadi, Rajasthan (Crabtree Acquisition) Existing TPD 650 475 Mn bottle Pcs 1110 690 Existing Capacity 0.3 Mn Pieces

Faucet Production

HSILs existing manufacturing plants are at strategic locations with clear linkages to raw materials, like the Haryana sanitary ware plant which sources raw materials from the mines of Rajasthan and Gujarat. In container glass segment, the main reason for the good performance of HSIL over competitors is its two manufacturing plants in AP which is by far the biggest market for liquor and soft drinks even on a per capital basis and is growing at over 20 % CAGR compared with the all India growth rate of 12-14 %. HSILs furnaces has been de-bottlenecked and hence operating at great efficiency and there is no need for any furnace shutdown for maintenance purpose in the next 3 years. Its Bhongir plant is a dual fuel furnace and can operate on both natural gas and LSHS/ FO. HSILs low cost manufacturing operations helps it in better margins over its competitors in both segments. Though, Parry-Roca has higher manufacturing capacity than HSIL its market share is less than HSIL, showing the efficient management of its manufacturing facilities.

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AGI Glaspac Operations

Volume
Food Products 22% Beverages 21%

Revenue
Food Products 26% Beverages 21% Beer 38%

Beer 43%

Pharma 14%

Pharma 15%

AGI Glaspac has a wide range of customers across various industries helping it to take advantage of the growing demand for glass bottles in the south India. HSIL is also foraying into high end specialty glasses which have 8 % higher margin than the ordinary bottles thus expanding its profits. HSIL has recently acquired Garden Polymers which is into packaging using PET bottles, caps and closures for about 89 Crs. This acquisition will enable it to provide a wide range of packaging solutions to its customers and also leverage its strength to grow the business of Garden Polymers at 30-40 % CAGR. Garden Polymers is already a profitable company with a revenue of 104 Cr, EBIDTA of 22 Cr and PAT of 10.4 Cr for FY-11. Thus, the acquisition will be EPS positive for HSIL and gives a boost to the growth of packaging division through a new form of packaging. HSILs glass division has seen improving realizations due to better product mix, cost efficiencies and lower lag in price revision from large customers and we expect the supply demand situation which is the main reason for stable margins, to stay for at least the next 2-3 years.

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Strong Institutional Clientele

Sanitary ware Segment
Real Estate
DLF Group Unitech Omaxe Construction Mahindra Gesco Lokhandwala Construction Mahadev Homes Oberoi Group NCC Shapoojee Palonjee Purvankara IVRCL Projects

Container Glass Segment

GlaxoSmithKline Pharma Ranbaxy Dr.Reddys Laboratories Pfizer Wyeth Amruntajan Aurobindo Pharma PepsiCo India Hindustan Coca- Cola United Breweries McDowell & Shaw Wallace Seagram Radico Khaitan Parle Agro Fosters India

Hotels
Taj Hotels Group ITC Hotels The Park Hotels Group Grand International Hotels Hyatt Hotels

Pharma Beverages

Corporates
Larsen & Tourbo Infosys Technologies Bengal Ambuja The Prestige Group Everest Group

Foods
Hindustan Unilever GSK Consumer Dabur Healthcare Priya Foods Global Green

It can be seen from above that HSIL has a very strong customer portfolio in all its segments of business and it has
been only growing over the years, showing the quality of HSILs products and its services. At present the sales between Institutions: Retail in sanitary ware is 25: 75 and HSIL aims to maintain it going forward as Institutions give better volumes and retail sales have better margins. In Glass business, requirements are given by customers before-hand and pricing is variable on cost pressures.

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Barwood Products :

Inorganic Growth

HSIL acquired Barwood products in June, 2010 which is a small boutique manufacturer of specialized bathroom ceramics in UK and other European countries. HSIL paid 1 million pounds for the company which had revenues of about 2 million pounds. This acquisition gives HSIL the much needed distribution strength and entry into the European markets which have much higher realizations than Indian markets. HSIL targets to grow the revenues of Barwood from the current 2 million pounds to about 8-10 million pounds in the next 4 years through introducing more products. Considering the turmoil in European markets, this might be a aggressive target.

Crab Tree Acquisition :

HSIL had acquired Crabtree faucet plant from Havells in 2010. It has been able to ramp up the production of the unit and increase the capacity utilization from 45 % to over 100 % in the past 12 months showing the capability of the management to make synergistic acquisitions. The brand has recently been changed to Bene Lave and being positioned as a high end faucet maker.
HSILs management has not been averse to acquisitions and has along the way made good acquisitions like Krishna Ceramics (1989), Raasi Ceramics (1999) and AGI Glaspac (1981). They have turned around loss making businesses. HSIL all three latest acquisitions will add substantially going forward. Especially the Garden Polymer acquisition has still not been consolidated in the accounts and we expect it to contribute at least 13 Crs to HSILs bottom line. HSIL also plans for backward integration by buying out mines and also entering new markets through acquisition of front end companies in developed markets to increase realizations and grow margins. HSIL has the balance sheet strength for mid sized acquisitions and the company is always on the look out for good assets at fair price.

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Investment Rationale

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Total Bathroom Solutions Provider

Sanitary ware
Water Closets Wash Basins Pedestals Squatting Pans Urinals Bidets

Building Products Faucets

Showers Kitchen Faucets Bathroom Faucets

Allied Products Kitchen Appliances

Hobs Chimneys Cook Tops Sinks

Wellness Products
Bath Tubs Shower Panels Shower Enclosures Whirlpools Concealed Cisterns

Accessories
PVC Cisterns Fittings/ Seat Covers High End Tiles

HSIL has leveraged its brand and distribution strength to venture into several allied products and now morphed into a total bathroom solutions provider. The moat of brand and distribution is difficult to build for any new player. At present, nearly 77 % of building products revenues comes from sanitary ware, 18 % from faucets and other allied products constitute the remaining. If HSIL, is able to scale up the wellness products and Kitchen appliances, which have huge potential then % of revenues from sanitary ware will come down. Once the volumes pick up, HSIL will put up its own manufacturing plant for high end ceramics and usually the margins of outsourced products are at least 4-5 % lower than own manufacturing. HSIL is well positioned to capture profitably the strong Industry trends of higher discretionary spending for bathrooms and changing social mindset.

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Strong CAPEX Plan

Manufacturing Location Bahadurgarh, Haryana Bibin Nagar, AP Gujarat Manufacturing Location Existing Capacity 1.5 Mn Pieces 1.3 Mn Pieces -Incremental Capacity 0.3 Mn Pieces 0.7 Mn Pieces 1.2 Mn Pieces Existing Capacity 0.3 Mn Pieces -Existing Capacity 475 tpd Type Cost Of Expansion in Mn Rs Operational Timeline

Sanitary ware

Brownfield Brownfield Greenfield 1,250 Cost of Expansion in Mn Rs 900

Sep, 11 Mar, 12 Mar, 13 Operational Timeline Aug, 11 1000 Mar, 13

Incremental Type Capacity 0.2 Mn Pieces 2.5 Mn Pieces Incremental Capacity 425 tpd Brownfield Greenfield Type

Faucets Faucets

Bhiwadi, Rajasthan (Crabtree Acquisition) Bhiwadi, Rajasthan ( Near the old plant ) Manufacturing Location

Container Glass

Cost of Expansion in Mn Rs 3200

Operational Timeline Jan, 12

Bhongir, AP

Brownfield

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Strong Utilization Ratios

120.00% 100.00% 80.00% 60.00% 40.00% 20.00% 0.00% 2007 2008 2009 2010 2011 Sanitary ware Container Glass HSIL had more than 100 % utilization ratio in both its business segments, thus spreading fixed costs and improving margins of the company at both EBIDTA level and PAT level. With a CAPEX of 650 Crs, spread over 3 years which will add capacity in a phased manner we can expect the utilization ratios to dip but strong demand will help utilization in the long term and these increased capacities will prove vital for the growth of HSIL. Margins which gets decreased due to reduced capacity utilization will get partly offset by revenue shift from outsourcing to manufacturing products.

HSILs planned capacity addition in container glass segment of 425 tpd will increase its capacity significantly but considering the fact that market has been growing at over 14 % and only HNG is putting up a glass plant in South India, we expect the plant to operate at good utilization ratios. HSIL has also acquired gas connection for its AP plant from one of the city gas distributors and expects the gas supply to start before the end of this year. This alone could fetch HSIL nearly 6-10 Crs of additional profits each year which is a significant improvement. Considering all the happenings in the company and taking the demand situation into account, we feel that HSIL will be able to maintain its margins for the next 2-3 years. We are not factoring in any huge changes in the interest rate scenario.

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Consistent Growth
Revenues In Cr Rs 576 2008 666 2009 851 1050

HSIL has seen consistent growth for the past 4 years in all parameters and is set for another cycle of growth through increased capacity.

2010

2011 87.35

One of the major plusses of this growth has been the improving margins in both the business. Bottom line has significantly outperformed top line growth. EPS has grown well in spite of taking equity dilution into consideration. Main reasons for the improvement in margins are improved product mix, higher average realizations, cost efficiencies and increased capacity utilization. Except for the dip in capacity utilization, all the other margin levers are only expected to get strengthened going forward. HSIL in spite of volume growth of just under 12 % , has been able to generate value growth of over 30 % in sanitary ware industry and similarly in container glass also value growth has outperformed volume growth by over 5 % which indicates the strength of the underlying business model.

PAT in Cr Rs 26.8 2008 31.73 2009 43.65

2010

2011 14.09

EPS in Rs 4.61 2008 5.49 2009 7.59 2010

2011

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Healthy Balance Sheet

QIP Money Working Capital Loans Long Term Debt Debt: Equity CAPEX Plan Internal Cash Generation/ Year 150 Crs around 30 Crs 270-300 Crs 0.6: 1 650 Crs Phased over 3 Yrs ~ 165 Crs
HSIL has strengthened its balance sheet by raising 150 Crs of money through QIP during Oct, 2010 at the rate of around 136.5 Rs/ Share. HSIL reduced its interest cost lost year by using some amount of its QIP money in working capital and hence interest costs will rise considering the increased deployment of cash for creating capacities and increased cost of funding in high interest scenario which we expect for the medium term.

HSILs implementation of CAPEX is spread as 180 Crs in 2012, 245 Crs in 2013 and 75 Crs in 2014. This phased implementation of cash outflow will allow the balance sheet to expand without any strain. HSIL has a land in Hyderabad which doesnt currently house any manufacturing plant and is available for monetization. The value of the land is estimated to be about 100-150 Crs. HSIL can fund all its expansion plans without diluting any equity and dilution may happen only if the company acquires a very large asset, possibility of which is less. Even in case of acquisition, company has said that it will be ready to sell the land to fund it. HSIL cash generation is very healthy and since the depreciation of glass plants is pretty high, the cash profits will be much more than the reported PAT in the next 3 years.

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Competitor Analysis in Sanitary ware Industry

Company Name Production Capacity ( Million Pieces/ Annum) 4.5 5.0 2.8 2.0 0.3
HSIL in spite of having less manufacturing capacity than Parry- Roca, has higher market share signifying the higher realization/ unit which Hindware gets because of its premium positioning in market. HSILs other competitor CERAs realization is just over half of what HSIL commands in the market. HSIL has been out performing the market and has extended its market share from about 32 % which it had 5 years ago to over 40 % currently.

Parry - Roca HSIL Cera Sanitary ware Kohler

Jaguar which is the largest player in Faucet segment with more than 45 % market share of the 3000 Cr market is aggressively expanding into sanitary ware segment leveraging its brand and distribution strength. A significant disadvantage for Jaguar is the lack of manufacturing capacity, in spite of which it will carve a part of growing market. But, sanitary ware segment has been a tough business and there has been a lot of consolidation over the years and hence it is difficult for new players to scale up. Bigger building product players like HR & Johnson, Kajaria and Somany Ceramics have tried to enter this market for the past few years but unable to get hold as sanitary ware is a much more brand conscious market when compared to other building products. It is also difficult to compete in the market without a wide variety of products across different price points and more importantly just by importing outsourced products without manufacturing them or having a strong sales and service team. It can be seen from the fact that Kohler in spite of being in the market for over 10 years has been unable to scale up and has just 108 distributors and it concentrates on just the top end of the market. Thus penetrating this market is tough and incumbents have a strong moat, thus fending off new players like Jaguar.

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Competitor Analysis in Container Glass Industry

Company Name Production Capacity in Key Segments of Glass Supply tonnes per day (tpd) 2,825 1,115 950 Liquor, Beer, Pharma & Food Specialty glass to cosmetics, pharma and perfumery Liquor, Pharma, Food & Beverages

HNG Piramal Glass HSIL

Container glass industry like sanitary ware industry is a concentrated industry and dominated by a handful of players indicating huge competitive advantages for the incumbents and market leaders taking full advantage of the growth in the industry profitably. Market leader HNG which has 55 % market share of organized market is expanding capacity in South India by putting up a 650 tpd plant in Naidupet, Andhra Pradesh. Considering the volume growth in the South Indian markets and no capacity addition except for the two players, absorption of the increased capacity will not be a problem and the demand- supply situation will be in favor of glass manufacturers. Brownfield expansions usually have a Revenue/ Capital invested ratio of around 1.2 compared with 0.8 for green field plants, thus creating huge advantages for the incumbent players. HSILs new Greenfield expansion also has provisions for further expanding capacity in the future.

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Financials

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Earnings Projection (without integrating Garden Polymers)

Income Statement (INR Crs)
Net Sales EBIDTA Depreciation & Amortization Interest Other Income PBT Tax Net Profit Diluted EPS - EPS Growth %

FY 09
615.8 104.2 28.4 16.8 -9.6 49.3 16.7 31.7 5.8 13.4

FY 10
804.2 145.8 50.3 40.2 1.6 56.9 9.1 43.6 7.9 37.6

FY 11
1078.6 206.3 55.4 36.5 3.8 118.2 40 78.3 12.9 63.1

FY 12E FY 13E
1395.2 290.5 74.0 40.5 10.9 187 63.5 123.5 18.7 45 1680.5 370.5 80.0 44.5 14.6 260.6 88.6 172 26 38.6

Cash Flow from Operations ROE %

118.4 13.9

18.3 12.4

165.9 13.7

198.0 17.5

305.5 19.8

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Management Quality
Key Person
R K Somany Sandip Somany Arun Kumar Dukkipati RB Kabra

Designation
Chairman & MD Joint MD President, Container Glass President, Building Products

Background
55 Years of experience & leading HSIL since inception. Active participant in Industry associations. Associated with HSIL since 1985 and director since 1994. He is the driving force behind the organization. Associated with HSIL since 1996 and a qualified mechanical engineer with 39 years of experience. Associated with HSIL since 1981 and is a qualified chartered accountant with 30 years of experience. It can be seen that, Somany family has been leading the glass industry and sanitary ware manufacturing in this country and have very detailed knowledge about the business. HSIL, though a family business has professional people in key positions and a well diversified board with 7 independent directors. Sandip Somany at the age of 48 is well positioned to drive the company through the next decade with his vast experience and industry knowledge.

Other Somany Family firms ( Each independent and no inter relationships between firms ) HNG Cera Sanitary ware Somany Ceramics C K Somany Vikram Somany Indias largest glass manufacturer Indias 3 largest sanitary ware manufacturer Premier Tile manufacturer

Shreekanth Somany

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Investor Support
Share Holding % Promoters FII DII June 2011 51.34 24.14 1.83 Mar 2011 51.34 22.29 3.76 Dec 2010 51.01 21.58 4.13 Sep 2010 60.49 1.14 7.39 June 2010 60.49 0.47 6.44

Notable Investors
HFC Mauritius Royal Bank of Scotland T. Rowe Price International discovery fund

Share Holding %
9.09 3.99 3.60 3.39 2.92 1.78 1.72 1.57 1.04

HSIL has been enjoying good investor support and it can be seen Commonwealth Equity Fund from the fact that its QIP fund raising last year had strong foreign The India Fund Inc investors appetite and easily raised 150 Cr Rs. HSIL has been a consistent dividend paying company and also a very profitable and healthy company, since its inception. Hence it has rewarded its share holders well. HSILs stock performance has been good as investors are starting to recognize its potential and its competitive advantages. Henderson PE has been associated with HSIL since 2005, when it picked up a 14.99 % stake in the company for 12.2 Million $s and the investment has rewarded it well. GMO Emerging Markets Fund Sundaram Mutual Fund Jupiter South Asia Investments California Public Employees Retirement System

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 Raising Interest Rates : RBI has been raising interest rates continuously and recently raised 50 bps for a consecutive 11th time since March, 2011 to control the spiraling inflation. This has led to a serious slow down in the economy and especially the real estate sector with new housing projects getting delayed. Raising interest rates will also put more pressure on the earnings due to increased interest costs. Though the raising interest rates will have some negative effects, we have factored in higher interest cost in the earnings projection and it will look better if the interest rate cycle peaks and cost of funding falls. Though, the new housing is delayed there is 12-16 % volume growth for sanitary ware industry on the back of which strong brands like Hindware will grow their value by over 30 %.

Concerns

Demand Slow down: Indian consumption demand though pretty robust on the long term, might slow down
temporarily due to un favorable macro economic scenario. But the key end users of glass industry have been growing robustly in spite of these. This years monsoon has been widely spread with good rainfall across India and this will boost demand in rural areas. More over, the supply in container glass being less than supply should keep the manufacturers steady.

Increasing Cost Pressures: Container glass division is slightly vulnerable to increased soda ash prices. We
believe though, high cost may be a concern companies will be able to pass on the increased costs with a small time lag. Presently, power and fuel consists of 33 % of the production cost in container glass segment and any un favorable changes will affect the company. Margin Concerns : A dip in utilization ratios will create pressure on margins but considering the fact that presently all its capacities are running at greater than 100 % capacity, the utilization ratios will remain stable. HSIL has good margin levers in the forms of moving to high end specialty glass, improved product mix in sanitary ware and reduced dependence of outsourced products. We have considered all these effects and the earnings projection is pretty conservative.

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Attractive Valuations
Parryware was acquired by Roca in 2008, valuing the company at over 1500 Cr Rs from the M-Cap in Price/ Book strong Business group of Murugappa. Company Name Crs Net Sales P/E (TTM) (TTM) Now considering it with the valuation HSIL is getting for its sanitary ware business at about HNG 1754 1685 26.5 1.61 700 Crs, it is definitely cheap in spite of it having Piramal Glass 1054 1252 10 2.26 larger market share than Parry ware and higher growth rates. Cera Sanitary ware 251 255 8.8 2.26 The acquisition also shows the difficulty for a new player even like Roca ( Worlds largest and HSIL 1331 1050 17 2.4 most renowned bathroom brand) to scale up and the need for an acquisition to grow. VIP Industries 2370 759 24.4 10.6 HSIL doesnt have any peer comparison as such, since it is into two business segments. Hence, we have taken companies from both the business segments and also a company on the domestic consumption theme. ( VIP Industries ) Though HSIL like VIP Industries is not a small ticket domestic consumption item, its still a proxy play on the rising affluence of the Indian Middle class and the changing consumption patterns in the country. HSIL is piggy backing on the changing customer preferences to grow profitably. Considering the superior growth rate of HSIL with respect to its competitors, it deserves a premium rating especially when companies like TTK Prestige, Titan, Hawkins etc are quoting at over 30 times P/E.

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Conclusion

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Price chart

HSIL stock price has been on a strong run and the markets have acknowledged the performance of the company in the last two years. Stock has climbed from below 50 levels to 200 in the past 2 years showing the strong buying interest in the counter. But considering the run up in stocks of other similar consumer focused industries, HSIL still has a lot of room to rise and with the increased institutional investors interest in the stock, the buying interest will be strong. Stock is definitely a buy on dips for many investors and hence the downside is pretty much limited.

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HSIL is a one-off company with strong business operations and market leadership in two consumer focused industry segments. There are very few companies which have little competition in their industry segments in spite of the industry showing strong growth trends. Main reason for little competition being strong moats for the incumbents in its businesses. The fact that the companys volumes in sanitary ware segment can improve once the housing scenario improves and the continuous increase in realizations of 6-8 % each year in sanitary ware segment, gives us tremendous confidence in the future of the company. Both the segments have strong and sustainable growth momentum. Though, everyone acknowledges the Indian consumption story and the middle class boom, there are very few companies in the market which can take full advantage of the growth in their sector in a profitable manner by expanding margins, having market leadership and more importantly quoting at a fair price. HSIL has posted strong Q1 results with a PAT of over 28 Crs. Considering the fact that Q1 is the weakest quarter for both its business segments and business improves over the year with the peak quarter being Q4, we can extrapolate the numbers and easily see the company posting nearly 130 Crs of PAT for FY-12. Consolidating Garden Polymers numbers, PAT can be above 140 Crs and at the current M-Cap of around 1300 Crs it is by far one of the cheapest consumption stocks at less than 10 P/E on projected earnings. Considering the projected EPS growth of over 40 % over the next 2 years and sustained business growth of over 25-30 % expected for the next 3-5 years, we expect the company to get re-rated and quote at around 14 P/E which on projected growth comes to over 350 Rs in the next 2 years which is nearly a 75 % return from the current prices. On a conservative basis, even if the company posts 24 Rs EPS in FY-2013 the share can easily rule over 300 Rs which itself is a 50 % return in share capital appreciation in 24 months which is great in this volatile environment. Thus, we feel there is enough margin of safety in the stock investment.

Conclusion

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HBJ Market Performer Service is focused on helping Institutional Clients beat market returns by a wide margin without taking large risks through in-depth research and analysis of the stock. inFor more information on HSILs business and the opportunity in it, feel free to discuss with Gokul Raj. P

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