Modi’s Cleanliness Drive Will Boost Profitability

From the ramparts of the Red Fort, Prime Minister Narendra Modi in his Independence Day speech made the ambitious announcement of ‘Clean India’ to provide sanitation facilities to all citizens by 2019, the 150th birth anniversary of Mahatama Gandhi. As per the industry estimates, India would be requiring 80 million toilets in the next five years to achieve this objective as currently more than 60 per cent of the total population has no access to basic toilet facility and defecate in the open. This announcement really is a kind of jackpot for companies providing sanitation solutions in the country and we have seen a spurt in the stock prices of companies that are into sanitary ware and the cleanliness sector.

Companies like CERA Sanitary ware, Somany Ceramics and Kajaria Ceramics are sitting pretty at their 52-week high and riding high on the potential of this announcement they have provided multifold return to the investors. HSIL (earlier Hindustan Sanitary ware & Industries) is also one such company whose stock of late has had a decent increase on the bourses, touching its 52-week high of Rs.  341.05 on September 2. During the last one year the company’s stock has given a fabulous return with a jump from Rs.  76 - a whopping return of around 350 per cent. However, despite this return, in view of some recent developments, DSIJ decided to do a deep dive into the company’s business, which has 40 per cent market share in the organised sanitary ware market in the country, ahead of Parryware and CERA.

BUILDING PRODUCTS TO PROPEL GROWTH

The main forte of the company is the sanitary ware market that comes under the building product division (BPD). Currently the company derives 70 per cent of its topline from this segment. Continuous focus on quality for the last so many years has helped the company achieve market leadership in India and slowly and steadily HSIL is moving towards selling in the high-value luxury product segment. “Today 55 per cent of the revenue in the sanitary ware segment comes from high-end products that account for 30 per cent of our volume. On the other hand, low-value products account for just around 10 per cent. Therefore, in the future too we will stick to this kind of product mix as it has helped us to grow at 20 per cent during the last three years even though real estate growth has remained quite subdued,” explains RB Kabra, President, HSIL.The company seems quite bullish on the growth of the sanitary ware market in the country and will keep on augmenting capacities in time to come both for domestic as well as exports’ consumption. Currently HSIL has a capacity 3.8 million pieces, while the total capacity of the country is 25 million pieces (10 million pieces in the organised sector). Considering the organic growth that will come in the sanitation space, HSIL is building a new plant for 4 lakh pieces, which will be operational in the next 15 months. “Also we would be constructing a greenfield plant in Jagadia, Gujarat for a capacity of 1.2 million pieces that would be ready in the next 2.5 years, taking our overall capacity to 5 million pieces. Then we will be in the club of the top ten manufactures of the world,” Kabra informs.

This seems quite reasonable considering the size of the Indian market which is opening up growth possibilities of 9-10 per cent CAGR in volume terms. On the other hand, HSIL is also focusing on its faucet business and putting up a new facility of 2.5 million pieces with an investment of Rs.  120 crore in Haryana, which will be fully operational by March 2015. After this the total capacity will reach 3 million and it aims to become No. 2 player in the faucet market after Jaguar. Currently 19 per cent of the revenue of its BPD business comes from the sale of faucets. The company also wants to place greater emphasis on its tile business and is on the lookout to acquire a company with turnover of at least Rs.  300-400 crore.

GLASS BUSINESS A LAGGARD

Quite in contrast to the BPD business, the company’s glass business has remained laggard during the last two years, undoing all the good work done by its BPD business. In fact, during FY14 its glass business posted net loss of Rs.  66 crore while revenue from the segment remained at Rs.  863 crore, which is almost 50 per cent of the total business. The glass business has undergone sea change during the last four years as FY11 and FY12 were exceptionally good years for the glass manufacturing sector of the country. Due to this, every manufacturer, including HSIL, had gone on an all-out spree of augmenting capacities. “We have also added a new furnace of 475 tonnes but soon after that this segment went into a tizzy due to the lowering of demand and rising fuel and power costs,” explains Kabra.

The current situation is such that the company had to close a furnace of 300 tonnes in September 2013 out of its total capacity of 1,600 tonnes and adopted various cost-cutting measures after it posted loss of Rs.  25 crore during Q2FY14. “After all these measures we now have curtailed all our losses in the glass segment and achieved breakeven during Q4FY14. For this year we expect to remain at breakeven position and could even earn Rs.  10 crore profit from the business if we get the expected price increase,” says Kabra. Though the company management is tightlipped over the future of the glass business, it seems quite sensible to demerge this segment from its BPD business so that appropriate valuation can be achieved for performing in the latter segment.

“It is true that now glass and BPD businesses are big enough to be separated, feelers for which have been received from our investors as well. We will take a decision at the right time,” Kabra states. What is important to note is that the company has a 33-acre glass producing facility near Hyderabad that is valued at Rs.  500 crore. Also, HSIL had taken a long-term debt of Rs.  475 crore in 2012 for augmenting its glass business capacity and the company is now trying its best to repay the same. “By next year we will repay Rs.  340 crore of the debt as out of the total interest burden of Rs.  68 crore during last year, Rs.  60 crore relates to the glass business, explains Kabra. Considering all this it seems quite sensible if HSIL decides to hive off its glass business to a strategic investor and concentrate on its building products’ division.

FINANCIAL PERFORMANCE

HSIL has posted a consistent performance during the last 4-5 years. During FY14 its topline remained at Rs. 1,858.20 crore while its net profit remained at Rs.  33.98 crore on a consolidated basis, despite posting loss of Rs. 66 crore on account of its glass business - impacting its EPS in a big way. In fact the company has posted a five-year CAGR of over 25 per cent in terms of topline and the profi tability of its BPD business remained at all-time high through the years. During FY14 the company earned revenue of Rs.  863 crore from its BPD business, while it earned EBITDA of Rs.  182 crore which gives it a margin of 20.75 per cent while other players in the business earn around 16-17 per cent margin. This is due to the niche that its brand has created in the market.

The company claims that it has the highest profit margin in the world in the sanitary ware segment. HSIL has huge capex plans for future in the BPD segment and will invest Rs.  200 crore by FY17 in its Bibinagar, Bahadurgarh and Gujarat facilities, which it will finance via internal accrual. Currently the biggest problem for the company is a debt of Rs.  980 crore, out of which Rs.  350 is of working capital requirement. As such, the company is now seriously looking at curtailing this debt so that the interest burden can be reduced.

WHAT SHOULD BE YOUR CHOICE?

Considering the business proposition and potential that India would be having in the sanitation space, HSIL is placed quite well in the market as a market leader. Also, it has a vast network of 2,900 dealers and retailers in the country to make use of its increased capacity and meet the future demands of the market.

Currently India has an organised sanitary ware market of Rs.  3,000 crore, which is growing at a pace of 10-12 per cent. In addition to this, the new demand that will come from the government’s cleanliness drive will easily increase the demand by another 20-30 per cent. The company’s focus on high-end products gives it a good margin in the BPD segment. The only drag factor is its glass business and as the management seems to be set to segregate the two businesses, it will certainly prove beneficial for investors.

On the positive front, its domestic institutional investors have continuously increased their stake in the company since December 2013 and currently hold 17.61 per cent in the company, while FIIs have 14.10 per cent stake. Currently it is trading at a PE multiple of 64.74x and its EPS is at just Rs.  5.14 but if company is somehow able to manage its loss in the glass business during the current year, its net profi t will automatically reach around Rs.  100 crore, pushing its EPS northward. Considering this, investors can put their money into HSIL on a long-term horizon as companies comparable to HSIL are deriving better valuation on the bourses.