The Hindu Business Line : Euro Ceramics: Invest at cut-off

Euro Ceramics is a high-risk option for those looking for businesses that capitalise on the real-estate boom. High profit margins, plans to expand into the sanitary ware business and reasonable valuations augur well for the growth prospects of this tile manufacturer. However, garnering market share in a highly unorganised sector and the threat from cheap imports are major industry risks. The company is also a relatively new player (incorporated in 2002) and faces tough competition from well-established branded players.

Investors can consider exposure with a two-year perspective. At the price band of Rs 150-180, the share is being offered at eight-ten times its earnings for FY-06. On an expanded equity base and after commencement of commercial production, the price-earnings multiple for FY-08 is likely to remain in the above range. While this valuation appears to be at a slight premium to Murudeshwar Ceramics, Euro Ceramics' business mix will undergo a change with its entry into the sanitary ware business, which commands higher valuations.

Business: Euro Ceramics is a maker of vitrified ceramic tiles and aluminium extrusion sections used in construction. It was in the jewellery business for a short while in 2005 and exited the same due to poor margins. The business now appears more focussed on building materials. For the half-year ended September 2006, vitrified tiles accounted for 88 per cent of the revenues. The company plans to raise Rs 85-100 crore through this offer.

It plans to deploy the funds for setting up manufacturing facilities in Gujarat for sanitary ware. This will mark the company's entry into this line of business.

Quick expansion

Euro Ceramics has more than doubled its vitrified tile capacity to the current 79,971 tonnes per annum over 2003-2005, which is clearly reflected in the topline.

The operating profit margin, which was in line with the industry average, rose to a high 32 per cent in the half-year ended September 2006, driven mostly by higher capacity utilisation, post-December 2005 expansion. Given the current real-estate boom and about 60 per cent of the company's clients being institutions, Euro Ceramics is likely to witness robust demand for its product over the next couple of years. We view Euro Ceramics' entry into the sanitary ware segment as an extension of its existing business. The new facility, with an installed capacity of 11,000 tonnes is likely to be operational by October 2007. While the sanitary ware business is unlikely to command OPMs enjoyed by the vitrified tile segment, it carries potential to bring in robust volumes. That peers such as Hindustan Sanitaryware and Cera Sanitaryware are operating at near-full capacity indicates the robust demand for the product. However, being a new entrant, Euro Ceramics' success may well depend on its competitiveness in pricing to capture markets initially.

The company is also in the process of setting up a calcareous tile manufacturing facility, which is a substitute for marble and natural granite and caters to the upper end of the tile market. Local players have so far largely imported this kind of tile. This unit is expected to be operational in June 2007. We have, however, not considered revenues from this stream given the uncertainty in demand for this premium product.

This product, however, holds potential to prop the profit margins.

Further, the company is now enjoying certain tax and duty exemptions available for its factory in the Kutch district. This is likely to support the bottomline for the next couple of years and is likely to be extended to its new businesses, which is also located in the same region.

Risks

The quick expansion and new facility for calcarious tile has increased the debt component of the company's capital. The post-offer debt equity ratio of about 1.5:1 however appears comfortable.

The adequate interest coverage also adds comfort. The company is awaiting conversion certificate (from agriculture to industrial use) of a part of procured and registered land for the proposed project. Any delay in the same can affect earnings growth. However, the company has already received approval for a part of the land in the same area and has not so far witnessed any delays.

Euro Ceramics now has a captive lignite-based power plant. Although the cost per unit is lower than procuring from the State electricity board, lignite is not as efficient a source as natural gas, the latter being used by some of the peers.

Any steep increase in lignite could dent the operating profits. Investors averse to the above risks can consider setting a moderate target return for the stock and exit if the target is met shortly after listing.

Offer details: The IPO is open from February 07-13. UTI Securities is the book running lead manager.

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