Business Valuation of RAK Ceramics BD a Choice of Smart Investors Target Price: Tk

Business Valuation of RAK Ceramics BD A Choice of Smart Investors Target Price: Tk. 65

Market Price: Tk. 58

Grab a 11% Return on Investment (ROI)

Akramul Alam, Senior Research Analyst 15 Jan 2018 RIL- Business Valuation

Valuation Particulars

Company Name: RAK Ceramics Ltd. Date of First Report Release: 15 January, 2018 Last Date of Updates: Principal Analyst and Contact: Akramul Alam, Royal Capital Ltd

Dates Company Visited Visit No. Date Factory/Head Office 1. 19 December, 2017 Head Office

Company Officials Consulted: Name Designation Frequency Md. Shahidul Islam, FCS. Company Secretary 1

RIL Team: Akramul Alam, Senior Research Analyst Isfaqur Rahman, Research Analyst Rakibul Hossen, Research Assistant

Report Available at: 1. 1 R.K. Mission Road, Manik Mia Foundation, Motijheel, Dhaka 1203, Bangladesh 2. www.rclbd.co

Information and Query on this Report: [email protected] , [email protected]

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Bangladesh Economy: At a Glance

The macroeconomic outlook of Bangladesh defines the country as stable & growth potential which can be validated by the historic macroeconomic figures. In the recent decade Bangladesh placed as lower middle income country from lower income country. According to Bloomberg economic growth prospect, Bangladesh is on the track to log in the 2nd best economic growth figure this year out of 93 countries. Bloomberg forecasted that Bangladesh’s economy will grow at 6.6% in 2016, a joint 2nd rank with Vietnam. The rate was 2nd fastest pace after India, which was expected to clock in 7.4% growth. In reality, Bangladesh achieved 7.11% growth in FY2016 that is much higher than that of Bloomberg predicted.

Variables 2012 2013 2014 2015 2016 2017-Oct GDP- Mkt Price (Tk. Crore) 1,055,200 1,198,920 1,343,670 1,515,802 1,732,864 1,956,060 GDP Growth Rate 6.52% 6.01% 6.06% 6.55% 7.11% 7.24% Per Capita GDP ($) 880 976 1,110 1,236 1,385 1,528 Private Investment (% of GDP) 22.50% 21.70% 22.00% 22.10% 21.80% 23.00% Industrial Growth (% of GDP) 9.96% 10.31% 8.77% 10.31% 10.30% 10.96% Agricultural Growth (% of GDP) 2.41% 1.47% 3.81% 2.45% 1.53% 2.51% FDI Inflow (mn $) 1191 1726 1432 1700 2001 1,706 Domestic Credit (Tk. Crore) 514,973 571,737 637,906 701,526 800,011 890,670 Reserve Money (Tk. Crore) 97,803 112,489 129,876 148,482 193,201 185,004 Inflation Rate (Weighted Avg.) 10.62% 6.78% 7.35% 6.40% 5.92% 5.44% Balance of Trade (mn $) -12,683 -10,262 -10,429 -13,981 -8,664 (12,158) FOREX Reserve (mn $) 10,364 15,315 21,507 25,025 30,168 33,407 Source: DSE Monthly Review- October 2017

The economy of Bangladesh experienced a consistent growth over the last five years with an average 6.45% GDP growth. In addition, the Per Capita GDP stood $1,528 from $880 in the last five years nine months signifies robust growth despite facing political debacle & global financial crisis in the last few years. The economy of Bangladesh is majorly fueled by Agricultural Products, Ready Made Garment & Service Sector which are supported by young population & Skilled and Un-Skilled labor force. Despite ability to access cheap finance, the SME sector of Bangladesh is growing at a faster pace which contributes to the national economy and generates employment of human resources and income to the middle and lower class citizens. Besides, Bangladesh got capable of controlling inflationary pressure in the last decade. Inflation rate came down to 5.44% in October 2017 from 10.62% in 2012 which is remarkable indeed. Domestic Credit in 2016 is 1.73 times higher than that of 2012 along with 10.96% Industrial Growth rate in October 2017. FOREX reserve stood triple in the last five years ten months which is mainly derived from remittance from Bangladeshi nationals working abroad. Foreign Direct Investment became almost double in the last five years due to the attractiveness & prospect of businesses in Bangladesh.

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GDP & Industrial Growth 15.00% GDP Growth Trend 10.00%

5.00% Industrial Growth 0.00% 2014 2015 2016 2017-Oct

GDP Growth Rate Industrial Growth Rate (% of GDP)

FDI INFLOW (MN $) Foreign Direct 1726

1700 Investment became

1432 almost DOUBLE in last 1191 5 years due to perceived

775 growth potential of Bangladesh by the foreign institutions 2011 2012 2013 2014 2015

Besides the prospects, Bangladesh has major challenges in the area of political stability, good governance, corruption control, adequate & uninterrupted power and gas supply, enhancement of human capital, infrastructure development etc. to capture opportunities in the future. After the financial crisis in 2007 & oil price slump in 2015 global economic activities are shifting from west to east to some extent. In that case Bangladesh has very good growth potential. To capture the growth Bangladesh requires transparency, political stability, effective policy support & measures.

It’s expected that the GDP of Bangladesh will grow at above 6.5% rate along with inflation cut in the next few years. The service sector contribution would be increased and FDI inflow would also be increased in the future. But if the risks facing by the country as mentioned above would occur, there might be great challenge to maintain the growth & stability and the country might be sentenced to severe penalty.

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Industry Stance: Ceramic Industry of Bangladesh in brief

Bangladesh, being a high-quality producer of ceramics and having skilled manpower, low labor cost and supply of sulphur-free natural gas, is a natural choice for ceramic production. In line with these competitive advantages, the 15-20 percent country’s ceramic industry has experienced 200 percent growth in production increase in in the last five years and the industry has increased its presence in the global global export market, capturing only 0.14 percent, by 15 to 20 percent after catering to more than 80 percent of the local demand of ceramic products. Still there is presence ample opportunity for the entrepreneurs to explore and invest in the emerging ceramic industry of Bangladesh.

WORLD MANUFACTURING AREAS - TILES Asia manufacturers 69% of global ceramic production with high level of competencies

69% Western world produces less than other regions as they don’t concentrate to the ceramic 10% 10% 5% 3% 3% ASIA C E N T R A L OTHERS O T H E R AFRICA N O R T H production for less feasibility of raw S O U T H E U R O P E A M E R I C A AMERICA ( T U R K Y ( M E X I C O materials & lower domestic demand INCLUDED) INCLUDED)

WORLD CONSUMPTION AREAS- TILES Asia consumes 66% of global ceramic consumption represents the largest market around the world

66% Western world consumes less than other regions as they possess strong 11% 8% 6% 5% 4% ASIA S O U T H E U R O P E A N AFRICA O T H E R N O R T H substitute of ceramic for their AMERICA U N I O N E U R O P E AMERICA ( 2 7 ) ( T U R K Y household INCLUDED)

Source: Ceramic Industry Magazine

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History

The ceramic industry is not quite a new one in Bangladesh. The industry started its Journey journey in 1958 with the establishment of a small manufacturing plant for porcelain started in tableware by Tajma Ceramic Industries in Bagura. But it began to flourish from late 1958 and 1990’s, when all the manufacturing set-ups were focusing towards export market. flourished According to Bangladesh Ceramic Ware Manufacturers Association (BCWMA), there from late are 62 ceramic manufacturers operating in this industry producing tableware, tiles and 1990’s sanitary ware. Another 20 ceramic manufacturers will hit the market by June 2018.

Present Scenario

Local & Direct & Initial Number of Industry Production Value Foreign Indirect Investment Companies Growth Growth Addition Investments Manpower Requirement

BDT. 100 US$ 1 52 200% 0.5 million million billion (20 in 12-15% (in last 5 65% (40% female (for a medium (more than) pipeline) years) workers) scale plant)

Major Local Main Sources Global Export Competitors Major Foreign Market Export of Raw Market Share Destination in Global Investments Share Materials Market

US$ 42 50+ countries million China, India, 80% 0.14% (Europe, (in 2016-17) China, Turkey, Germany, Chain, The America, India, New Zealand, Middle East (in 2016-17) (in 2016) (4.39% Australia, Asia growth in Thailand Indonesia, States Regions) July-October Italy 2017-18)

LAST 5 YEARS EXPORT (US$ MILLION)

Total Tableware Tiles Sanitaryware

47.58

45.53

42.92

41.82

39.77

37.69 37.69

35.57

35.32

35.14

6.25

2.36

1.6

1.55

1.52

1.06

1.03

0.99

0.01 0

2016- 17 2015- 16 2014- 15 2013- 14 2012- 13

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MARKET SIZE (US$ MILLION) Sanitaryware Tiles Tableware

38.03

259.11

60.05

Source: Bangladesh Ceramic Manufacturers & Exporters Association (BCMEA) & Trade Map

Global ceramic tiles industry

The worldwide ceramic tiles market is spread across Latin America, North America, Asia Pacific, Europe and the Middle East and Africa. Currently, the highest consumption of ceramic tiles is being reported in Asia Pacific. In 2017, the region accounted for a share of 69% of the overall demand for these tiles in the world. The rapid urbanization has given significant rise to construction activities in emerging Asian economies over the last few years. The world tile consumption increased by 0.66 percent to 12,175 sqm mn in 2015 from 12,095 sqm mn in 2014. The consumption of tile was shortage of 180 sqm mn in 2015 against the production.

An upswing in construction activities, owing to the increasing urbanization, is boosting the demand for ceramic tiles significantly across the world. The global tile market is expected to double its value by 2018 (from five years ago) to just over $102 billion, while the global sanitary ware value will expand by one- third to $33 billion, all of these meaning the growing need for production in low-wage countries like Bangladesh. Asian countries produce over two-thirds of global production with China (37%), Brazil (7%), India (6%), Iran (4%), and Italy (4%) and consumes two- thirds of the global supply.

Local Ceramic Tiles Industry

Ceramic Tiles Number of companies : 26 Yearly production capacity : 120 million sq. mt. Market consumption : US$ 259.11 million Market share of local products with : Local: 72.29%; Import: 27.71% imported Export in 2016-17 : US$ 6.25 million (Market Share: 14.95%) Main export destination : India, Nepal, Bhutan

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Turnover Sharing Position ANNUAL PRODUCTION CAPACITY (CRORE SQ. MT.) Monalisa 1% Mirpur 1%

Khadim 1% 1.60

1.50

1.30 1.30 AB 1% 1.25 Sun Power 2%

Hua Thai 2% BANGLADESH DBL AKIJ G R E A T W A L L R.A.K. Dhaka Shanghai 2% HARDLAND

Bangladesh Taiwan 2% ATI 2% INVESTMENT / PROJECT VALUE Madhumati 3% (CRORE TAKA) X Ceramics 4% Fu-wang 4%

China-Bangla

350 350 5% 350 Mir 11% Akij 13%

R.A.K. 14%

320 320 Star 16% Great Wall 16% AKIJ G R E A T W A L L R.A.K. BANGLADESH MIR HARDLAND

Source: Bangladesh Ceramic Manufacturers & Exporters Association (BCMEA) & Trade Map

EXPORT & IMPORT ( U S $ ' 0 0 0 )

Export Import

59,226 59,226

41,308 41,308

38,535 38,535

30,855 30,855

798 798

734 734

168 168 45 45

2016 2015 2013 2012

Ceramic Sanitaryware Number of companies : 16 Yearly production capacity : 7.5 million pieces Market consumption : US$ 38.03 million Market share of local products with : Local: 83.43%; Import: 16.57% imported Export in 2016-17 : No Export Main export destination : The Middle East States (especially, The UAE)

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Turnover Sharing Position ANNUAL PRODUCTION CAPACITY (LAKH PIECES) Glory 2%

Dacca 2%

14.00 14.00

Solar 3% 12.00 3.00 Apple 3% 4.80

Euro Bangla 4% CHARU R.A.K A B U L STAR E U R O KHAIR BANGLA

Sanita 5%

BISF 6% INVESTMENT / PROJECT VALUE (CRORE TAKA) Exellent 7%

Star 9% 350

Others 9% 250

Abul Khair 22% 170

80 70 R.A.K 28% CHARU A B U L R.A.K EXELLENT STAR KHAIR

Source: Bangladesh Ceramic Manufacturers & Exporters Association (BCMEA) & Trade Map

EXPORT & IMPORT ( U S $ ' 0 0 0 )

Export Import

8,012

48 48

22 22

3 3

2,279 1,785 2,274

2016 2015 2013 2012

Ceramic Industry Life Cycle

The ceramic industry has been playing a vital role in Bangladesh economy by earning and saving foreign exchange through export of ceramic products after meeting more than 80 percent of the local demand. As overseas demand is going up, the country’s major manufacturers are now pumping 80 percent of the production into the international market. However, the industry needs to import 100 percent raw materials and machineries. Some of the suppliers like India now become a powerful rival in global export market. Hence, weak backward linkage is a key threat to growth potential of the industry.

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Bangladesh ceramic industry is in Expansion Stage with Mature Industry Growth.

At this stage of the life cycle, an industry is improving its products and perhaps lowering its price. The industry is more stable and solid, and at this stage it often attracts considerable investment funds. The industry continues to grow and to prosper, but the growth is more moderate than that of in the early expansion stage.

Ceramic Industry Structure and Profitability

Ceramic Industry Environment Analysis

Competitive Parameter Condition Effect Force

Competitive - Primary investment Medium Rivalry within - Market growth: Export High the industry Degree of Actual - Market growth: Domestic Medium and Potential - Probability of competing rivals Competition High making fresh moves Medium - Existing product diversity / Medium differentiation

- Possibility of production capacity development by competitors Medium

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Threat of New - Pool of new entrants High Entrants - New entrants immediate access to industry’s required technology Low and technical knowledge Medium High - New entrants immediate access to suppliers - Probability that new entrants Medium would earn attractive profits Medium - Primary Investment

Threat of - Switching cost of end users Low Substitutes - Availability of substitutes High High - Attractiveness of substitutes price Medium

- Probability of end-users growing more comfortable with substitutes Medium

Bargaining - Number of potential customers High Power of Buyers - Number of actual customers Medium - Imposed cost for switching to an alternative product Low High - Probability of potential customers using another company’s product High - Company’s financial dependency Bargaining Power on selling to customers in Input and High Output Markets Bargaining - Number of key suppliers Medium Power of - Suppliers ability to bargain for Suppliers prices and favorable terms Medium - Switching cost from one supplier Medium Moderate to another Medium - Suppliers power on product quality

The high intensity of competition indicates that the potential for creating abnormal The collective profits by the companies in the ceramic industry is very low. In the same way, it is impact of the five difficult to retain the potential profits by the industry since the relative bargaining competitive power of the companies in the industry over their customers and suppliers is not in forces is that level to influence them. As the collective impact of the five competitive forces is moderate to high. moderate to high, the ceramic industry is considered to be not so much competitively attractive.

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The profitability of an industry is influenced not only by its structure but also by the The industry strategic choices it makes in positioning itself in the global competitive market. To should move from build a sustainable competitive advantage, besides following cost leadership low-end to high- strategy, the companies in the ceramic industry should chase strategy of product end products. differentiation, moving towards high-end products, to supply unique design and quality products at a cost lower than the price premium customers usually pay.

Problems to Overcome

Natural gas is not only the key energy source for the industry but also crucial for maintaining quality of the products as the local natural gas does not contain any Inadequate sulphur which makes locally produced ceramic products look brighter and shiny. The government has addressed the problem and given assurance to resolve the crisis by Supply of July 2018 when liquefied natural gas (LNG) will come into operation. Moreover, some Natural Gas of the entrepreneurs have planned to set-up ceramic factories in Bhola due to availability of gas there. However, ever increasing tariff on gas fetches the industry’s competitive advantage.

The industry is 100% dependent on import of raw material from overseas even some close competing countries like China, India. Hence, the government should take steps to find deposits of superior quality clay for ceramic in the coalmine region of north Bengal. Likewise, the industry ought to realize that, many tools and machineries those are currently being imported can be manufactured in the country. Moreover, Weak Backward the port and communication facilities should have been up to the mark to fast-track Linkage import of raw materials and delivery of finished products. However, the industry faces high import duty on certain ceramic raw materials from 5 percent to 25 percent and pays high Value Added Tax (VAT) of 15 percent on produced goods. Eventually, these payments to the government increases price of ceramic products and reduces cost competitiveness.

Higher interest on working capital and on the credit for the procurement of capital Double-digit machineries forces the local producers to loss the competitiveness in local and Interest Rate, international markets. Similarly, The entrepreneurs seem to be highly concerned on the effect of under-invoicing, Tax evasion and illegal import of ceramic products. Corruptions & Furthermore, at present the ceramic industry is enjoying protection but if Supplementary supplementary duty, now 50 percent for finished goods, is withdrawn from Duty importable ceramic products at a time, the manufactures may face uneven competition with the imported products.

Traditionally, ceramic industry is a labor-intensive sector and companies in developed countries such as Italy and Spain experience difficulties in remaining competitive due to rising labor cost which have forced them towards high-end with more remunerative priced ceramic products. In terms of quality, Bangladesh can easily compete with Chinese, Turkish and Indian products which are building strong position in the global ceramic market. To recapitulate, the effective measures against hindering factors on the growth track of the industry and the collective impact of the competitive forces will lead the ceramic industry to be one of the top foreign exchange earners of the country.

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RAK Ceramics vs. Peer Companies: Industry Potentials & Competitiveness

HerfindahI-Hirschman Index The Herfindahl-Hirschman index (HHI) is a widely accepted measure of market concentration. It is Tiles Producers Market Share Square calculated by squaring the market share of each Great Wall 16 256 firm competing in a market, and then summing Star 16 256 the resulting numbers, and can range from close R.A.K 14 196 to zero to 10,000. The US Department of Justice Akij 13 169 uses the HHI for evaluating potential mergers Mir 11 121 issues. The closer a market is to being China-Bangla 5 25 a monopoly, the higher the market's Fu-wang 4 16 concentration (and the lower its competition). X Ceramics 4 16 Modhumoti 3 9 The table illustrates the HHI for Tiles Producers in ATI 2 4 Bangladesh where the index value is only 1088 BD Taiwan 2 4 signifying saturation of the ceramic tiles market Dhaka Shanghai 2 4 with little possibility of abnormal profitability. The Hua Thai 2 4 US Department of Justice considers a market with Sun Power 2 4 an HHI of less than 1,500 to be a competitive AB 1 1 marketplace, an HHI of 1,500 to 2,500 to be a Khadim 1 1 moderately concentrated marketplace, and an Mirpur 1 1 HHI of 2,500 or greater to be a highly Monalisa 1 1 concentrated marketplace. Index Value 1088 Pareto Analysis introduced by Italian economist Vilfredo Pareto in 1906, is a technique used for Pareto analysis business decision making based on the 80/20 rule. Tiles Producers Market Share Cum. Mkt Share It is a decision-making technique that statistically Great Wall 16% 16% separates a limited number of input factors as Star 16% 32% having the greatest impact on an outcome. R.A.K 14% 46% According to the theory 80% wealth or market in Akij 13% 59% the world is captured by only 20% entities. With Mir 11% 70% reference to the statement, almost 40% China-Bangla 5% 75% companies in the tiles segment of the ceramic Fu-wang 4% 79% X Ceramics 4% 83% industry holds 80% market share referring that Modhumoti 3% 86% few number of companies are controlling the ATI 2% 88% majority of the market. In this case the Pareto rule BD Taiwan 2% 90% applies by 80/40 rule as a means by moderately Dhaka Shanghai 2% 92% saturation of the market. But if there would be Hua Thai 2% 94% found 80/20 rule for the given scenario, there Sun Power 2% 96% would have the possibility Price Leadership and AB 1% 97% thus abnormal profitability. Khadim 1% 98% The analyses tell, RAK Ceramic Ltd. will generate Mirpur 1% 99% organic growth while maintaining its market Monalisa 1% 100% position instead of hyper growth in the future.

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Return Comparison – RAK Ceramics vs. Peers

EARNINGS PER SHARE RAK Peer Companies The Earnings per Share of the

company was pretty higher 3.25 3.25

2.72 2.72 than the peer companies

2.03 2.03

1.99 1.99 1.67 1.67 Hence, investors assume more

1.07 relative value of the company in

0.55 0.51

0.30 comparison to the peers 0.17

2012 2013 2014 2015 2016

GROSS MARGIN RAK Peer Companies The Higher Gross Margin of

the company than the peer

42.74%

42.56%

39.30% 39.14% 39.10% companies, mainly attributed

32.87% from premium pricing policy

26.06%

23.71% 22.29% 21.90% of the company in comparison to others

2012 2013 2014 2015 2016

OPERATING MARGIN RAK Peer Companies The Higher Operating Margin of the company than the peer

companies represents higher

28.78%

25.09% 23.86%

23.80% operating efficiency of RAK

20.95% 18.55%

17.93% Ceramics which is driven by

13.11% 12.12% 10.76% better risk management & cost efficiency

2012 2013 2014 2015 2016

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NET MARGIN RAK Ceramics has been RAK Peer Companies contributing between 10% &

22% Net Profit out of its 21.63%

Revenue to the shareholders

16.39% 16.17%

12.87% since past 5 years that is 10.19%

7.44% considerably higher than its

3.97% 0.11%

- peer companies representing

1.66% 1.48% higher profitability 2012 2013 2014 2015 2016

RETURN ON ASSETS RAK Ceramics has been RAK Peer Companies generating more profit as percentage of assets than its

10.18% peer companies over the past

8.62% 8.20%

6.86% 5 years denoting prudent 6.06% asset utilization as a means

2.37% of operational excellence by

0.03%

0.89%

- 0.45% 0.43% the management 2012 2013 2014 2015 2016

RETURN ON EQUITY The company has been RAK Peer Companies generating considerably more Shareholders Returns than its

18.12% peer companies over the past

14.98% 13.26%

11.09% 5 years 8.84%

ROE of the company for past 5

3.59%

0.05%

1.32% 0.67% 0.63% years is worth more than its opportunity cost of equity capital 2012 2013 2014 2015 2016

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RAK Ceramics- Business & Insights

RAK Ceramics (Bangladesh) Ltd. is the country’s largest and most respected tiles and sanitary ware brand. It was incorporated in Bangladesh on 26 November, 1998 as a private limited company under the Companies Act, 1994 as a UAE-Bangladesh joint venture project. It has started its commercial production on 12 November 2000. It has converted into public limited company on 10 June 2008 and listed in the stock exchanges of Bangladesh on 13 June 2010. The Company has anchored this position on the basis of its market-leading capacities, world-class manufacturing assets, high production utilization, optimized cost structures, vibrant sales and distribution network and robust customer engagement programs.

Nature of Business: The core business of RAK Ceramics (BD) Ltd. is to manufacture and sell of ceramics and gres porcellanato (Porcelain/ fully vitrified) tiles, bathroom sets and all types of sanitary ware. The Company has over 2,500 models active in the ceramic and porcelain tile business and regularly adds several new designs to the product portfolio. The Company manufactures tiles in a very wide range of tiles in the sizes from 20 cm X 30 cm up to 60 cm X 60 cm in Bangladesh location. The Company has over 30 models an exclusive range of sanitary ware to offer with a very wide choice. In sanitary ware various models are produced in wash basins (mounted as well as pedestal), water closets, accessories and marble sets. Besides, the product mix is geared to produce mostly value added products. This paired with the other advantages will ensure a shrunken payback cycle. Production is mostly consumed in local market. The company’s annual production capacity is 11.68 mn sqm of tiles and 1.45 mn pieces of sanitary ware. In the year 2016 actual capacity utilization of 68% at our tiles plant and 100% at our sanitary ware facility. The current market for the Company includes construction developers, government institutions and local consumers. The Company has a strong market reputation in Bangladesh with a firm network of 92 dealers nationwide and receives strong support from RAK Ceramics PJSC, UAE in terms of technological know- how, management and marketing support. The Company emerged as the first Bangladeshi Company in its industry to be awarded the prestigious ISO 9001: 2008 certification.

The ownership of RAK Ceramics (Bangladesh) Limited comprises with 75.59% held by the sponsors (71.67% by RAK Ceramics PJSC, UAE and 3.92% by local investor Mr. S.A.K. Ekramuzzaman) and remaining 24.41% is holding by general public including institutional investors as on December 31, 2016. With an annual turnover of over BDT 5,661.41 million in 2016, within the short span of 16 years RAK has firmly established itself as one of the leading manufacturer of high quality ceramic wall, floor tiles, gres porcellanato and sanitary wares products in Bangladesh.

Historic Sales (mn Tk.) 2012 2013 2014 2015 2016 CAGR Local Sales 5,793 5,854 6,255 6,303 7,086 5.17% Export Sales 18 26 27 27 15 -5.17% Gross Sales 5,812 5,880 6,281 6,330 7,101 5.14%

Growth Strategy: The Company seeks above-market growth rates by extending its market leading product positions to newer customers in newer geographies, transferring its core marketing, sales and supply chain capabilities to provide full-fledged home and office improvement solutions, continuing to seek low- risk business opportunities that enable high customer value-addition, focusing on organic growth through debottlenecking and strategic capacity expansion.

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Product wise Revenue Profile (mn Tk.)- Local Portion 2012 2013 2014 2015 2016 CAGR Tiles 3,785 3,683 3,923 3,914 4,380 3.72% Sanitary Ware 1,891 2,067 2,232 2,266 2,522 7.46% Décor/Border 116 104 100 75 76 -10.03%

Product wise Revenue (mn Tk.)- Local Portion RAK Ceramics generated

4,380 revenue by selling three 3,923 3,914 3,785 3,683 products as Tiles, Sanitary

2,522 Ware & Décor 2,232 2,266 1,891 2,067 Out of those Tiles & Sanitary Ware grew moderately at CAGR 116 104 100 75 76 of 4% & 7% respectively and 2012 2013 2014 2015 2016 Décor fails to maintain its growth

Tiles Sanitary Ware Décor/Border since FY2015

Revenue Mix 2012 2013 2014 2015 2016 Avg. Tiles 65% 63% 63% 63% 63% 63% Sanitary Ware 33% 35% 36% 36% 36% 35% Décor/Border 2% 2% 2% 1% 1% 2%

Tiles segment of the company has been contributing significantly on its total sales which accounts 63% of total revenue between FY2012-16. Sanitary Ware has been contributing 35% out of total sales between FY2016-12.

Capacity Utilization-Tiles The Capacity Utilization of 2021-F 76% Tiles segment of the company 2020-F 75% remained volatile over the past 2019-F 74% 5 years mainly induced by old 2018-F 73% machineries & spare parts 2017-F 72% 2016 68% The future Capacity would be 2015 75% utilized steadily as the company 2014 63% installed new machineries & 2013 68% spare parts to streamline of its 2012 83% production in FY2015-16

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Business Finance Insights

Financial Performance (mn Tk.) 2011 2012 2013 2014 2015 CAGR Revenue 4,908 4,725 5,047 5,059 5,661 3.6% Gross profit 1,929 1,847 1,975 2,162 2,409 5.7% Operating Profit 911 1,125 1,057 1,456 1,351 10.4% Net Profit After Tax 500 775 650 1,094 915 16.3% Total Assets 8,256 8,987 9,477 10,753 11,158 7.8% Total Equity 5,660 5,842 5,860 6,039 6,112 1.9% Working Capital 4,908 4,725 5,047 5,059 5,661 3.6% Source: Annual Reports of the company

HISTORICAL PROFITS RAK Ceramics generated Gross profit Operating Profit Net Profit After Tax good Profits from high quality

product sales & robust cost

2,409 2,162

1,975 optimization

1,929 1,847

1,456

1,351

1,125

1,094

1,057 915

911 16% NPAT growth along with

775 650

500 4% Sales growth represents its robust supply chain & cost

2012 2013 2014 2015 2016 efficiency

ASSETS & EQUITY Total Assets Total Equity 2% Equity Growth is very

insignificant in comparison to 11,158

10,753 alternative safe investment

9,477 8,987

8,256 opportunities

6,112

6,039

5,860

5,842 5,660 Assets growth was more than equity growth refers the liability had increased over last 5 years

2012 2013 2014 2015 2016

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Company Metrics Metrics 2012 2013 2014 2015 2016 Liquidity & Solvency Current Ratio 2.00 1.97 2.01 1.60 1.63 Quick Ratio 1.28 1.31 1.49 1.07 1.04 Cash Conversion Cycle (Days) 240 260 218 248 257 Debt to Equity Ratio 0.33% 0.32% 0.00% 6.97% 9.73% Cash Ratio 26% 30% 17% 22% 26% Debt Service Coverage Ratio 2.23 2.33 3.27 1.22 1.16 Profitability Gross Margin 39% 39% 39% 43% 43% Operating Margin 19% 24% 21% 29% 24% Net Margin 10% 16% 13% 22% 16% EBITDA Margin 26% 31% 26% 34% 31% Cash to Sales 13% 19% 12% 18% 19% Asset Utilization Basic Earning Power 11% 13% 11% 14% 12% Asset Utilization 59% 53% 53% 47% 51% EBITDA to Total Assets 15% 16% 14% 16% 16% OCF to Total Assets 8% 10% 7% 9% 10% Investment Valuation Return on Assets 6% 9% 7% 10% 8% Return of Equity 9% 13% 11% 18% 15% Return on Invested Capital 9% 13% 11% 17% 14% Cash to Invested Capital 11% 15% 11% 14% 16% Free Cash Flow per Share 0.04 2.58 0.66 (2.63) 1.54 Market Capitalilzation (Tk. mn) 15,811 16,324 19,436 22,522 20,831 Earnings Yield 3.50% 3.81% 2.89% 4.86% 4.39% Dividend Payout 75.38% 73.89% 149.70% 76.95% 73.61% Dividend Yield 2.64% 2.81% 4.33% 3.74% 3.23% Price Earning Multiple (Restated 28 Nov) 28.54 26.26 34.55 20.58 22.76 Earnings Per Share (Restated) 1.99 2.03 1.67 3.25 2.72 Net Assets Value Per Share (Restated) 18.13 17.27 17.57 17.93 18.14 Advanced Valuation multiples EV/EBITDA multiple (0.19) 0.01 (0.09) 0.19 0.08 EV/Invested Capital (0.04) 0.00 (0.02) 0.05 0.02 EV/Shareholders Equity (0.04) 0.00 (0.02) 0.05 0.02 Price to Sales 3.22 3.45 3.85 4.45 3.68 Price to Cash Flows 24.32 18.21 31.43 24.53 18.88

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PROFIT MARGINS Gross & Operating Margin Gross Margin Operating Margin Net Margin EBITDA Margin

increased to 43% & 24% from 43%

43% 39% & 19% respectively in

39%

39% 39%

34% last 5 years due to premium

31%

29% 26%

26% pricing of products & cost

24%

22% 21%

19% efficiency

16%

16% 13% 10% Net Margin & EBITDA Margin also increased to 16% & 31%

2012 2013 2014 2015 2016 from 10% & 26% respectively

PROFITABILITY Return on Equity increased Return on Assets Return of Equity Return on Invested Capital to 15% from 9% between

18% FY2012-16 ensuring good 17%

15% shareholders’ returns

14%

13%

11% 11%

10% ROIC increased to 14% from 9%

9% 8%

7% between FY2012-16 ensures 6% good returns for Shareholders & Creditors though it is mostly financed by equity 2012 2013 2014 2015 2016

YIELD METRICS Earnings Yield Dividend Yield Dividend Yield of RAK Ceramics is only 3.23% in

FY2016 which is unattractive

4.86% 4.39%

4.33% for investors as it is less than

3.81%

3.74% 3.50%

3.23% the opportunity cost i.e. T-

2.89%

2.81% 2.64% bill, Bank Deposits etc.

Earnings Yield soared to 4.39% from 3.50% in past 5 years 2012 2013 2014 2015 2016

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PER SHARE The company has generated Free Cash Flow per Share Earnings Per Share (Restated) Tk. 1.54 Free Cash Flow per

3.25 share to distribute to banks &

2.72

2.58 2.03

1.99 shareholders although there 1.67

1.54 was negative figure in 0.66

0.04 FY2015 induced by capital

2012 2013 2014 2015 2016 investment for expansion The EPS was Tk. 1.99 to Tk.

(2.63) 2.72 between FY2012-16

EV MULTIPLES The company has generated EV/EBITDA multiple EV/Invested Capital immaterial Economic Value

0.19 by employing debt & equity capital between FY2014-16

0.08 Only 0.08 EV/EBITDA multiple 0.05

0.02 in FY2016 refers hardness to generate satisfactory level of

2014 2015 2016 Economic Profit (0.02) (0.09)

PRICE MULTIPLES Price to Sales Price to Cash Flows The Price to Sales ratio between FY2014-16 shows a

declining trend

31.43 24.53

24.32 The Price to Cash Flows has 18.88 18.21 been maintaining stable outlook along with market price

between FY2012-2016 tells,

4.45

3.85

3.68 3.45 3.22 investors had focus on the cash performance of the company 2012 2013 2014 2015 2016 rather than

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Management Capacity & Shareholdings

Key Management Information:

Name Position Experience Education Affiliation Business Mr. Abdallah Massaad Chairman Same Industry UAE Administration Managing Bangladesh & Mr. S.A.K. Ekramuzzaman Same Industry Not Mentioned Director UAE Mr. Khaled Abdulla Yousef Director Same Industry Not Mentioned UAE Abdulla Aal Abdulla Chartered Mr. Pramod Kumar Chand Director Same Industry UAE Accountant Independent Local Legal Mr. Rafique-ul Huq Legal Industry Barrister-at-Law Director Affairs Independent Local Legal Mr. Faheemul Huq Legal Industry Barrister-at-Law Director Affairs Independent International MBA from the Mr. Wassim Moukahhal UAE Director Private Equity Wharton School Source: Annual Report 2016 of the company.

Board Composition:

Category No. of Personnel % out of Total Chairman 1 14.28% Executive Directors (excluding Chair) 3 42.86% Non-Executive/Independent Directors 3 42.86%

There is a good balance between ED & NEDs in the board which enhances better board composition to stimulate good corporate governance. The Remuneration, Nomination & Audit Committees complied the BSEC Corporate Governance Guideline accordingly.

SHAREHOLDING-% AS ON DEC 28, 2017 72% (Majority) Shareholdings is Public, 13.12% held by the Board of Directors out of which 71% is held by the parent Foreign, 0.05% company based on UAE as they have high interest in the company

Institute, 14.78% Institutional Investors held 15% Shares of the company which is Sponsors, significant in terms of holdings 72.05%

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Insights from Meeting with Senior Management

After experiencing a meeting with the company secretary of RAK Ceramics Bangladesh Ltd. the following quotations are derived in brief which can be taken into account while making any long term investment decision in the shares of the company.

Long-Term Debt: Although the company is cash rich, it has taken floating rate debt from the London Sterling Market at the rate of LIBOR+3% to expand its production capacity in plant-4. According to its balance sheet, the company has long term loan liability of Tk. 594 mn in the FY2016 which was issued by the foreign bank as foreign currency loan. The plant-4 started its commercial operation in July 2017 successfully. The Pay-back period of the project is less than 5 years. As the company borrowed at cheap to expand the existing capacity, the plant would contribute significant profit for its stakeholders.

Capacity Utilization: According to the management, RAK Ceramics is the number one tiles producer across the globe. Since tiles is the major revenue driver of the company, the company puts its concentration more on that. The production capacity utilization of tiles segment would be enhanced in the upcoming years as the company pursued process re-engineering in its factory layout and made capital investments for the replacement of old machineries. Their tiles products are priced at premium with high level of quality which is basically marketed for the urban area of the country where consumers has more purchase power and modern buying behavior. As the country’s rural economy is experiencing rapid urbanization with higher financial inclusion, the company has greater potential in the future. Now the concentration of the tiles segment of the company belongs to private customers whoever are house owners & city dwellers. As per the management there is no specific plan to maximize the existing production capacity of the sanitary segment despite its running at full capacity with good sales growth trend. But there might have some investments for the sanitary segment in future for its credibility to drive significant revenue although the management didn’t disclose anything about it in the meeting.

Competitiveness: RAK Ceramics Bangladesh Ltd is the leading producer of ceramics products locally & internationally. For business potentiality in the local market some giants are investing now a days in this sector which eventually creates threat to the existing companies. The management of RAK Ceramics expressed their opinion regarding the matter as manageable as the potential competitors may face huge barriers because of the nature of production and market of ceramic products in Bangladesh. The production oriented investments i.e. fixed assets & machineries are costly with long production run style leads the company an advantage over their competitors. Despite of that if there appears any high competition in the future that drives the prospect of the company down, it will go for Mergers & Acquisitions in the later future to minimize such risks.

Business Prospect: Despite not having any boom in the real estate sector in the country, RAK Ceramics business will generate organic growth by its strategic expansion while maintaining superior quality. As only 5% people out of 160 mn people use tiles products, there is ample scope to expand in the future.

Message to Shareholders: RAK Ceramics is maintaining its transparency and governance at high level of ethical standards with rational growth trajectory. Therefore, long term investment in the shares is more feasible for the investors than any speculation to get handsome return at minimum level of risks.

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RAK Ceramics Bangladesh Ltd. – Business Valuation

Diligence: Extensive research & analyses have been taken to value the business of RAK Ceramics Bangladesh Ltd. under the model of Discounted Cash Flows, Residual Earnings & Relative Valuation. Under the valuation approach relevant valuation assumptions are made as per actively taken research output as well as passively taken information from recognized institutional sources. Prospective analyses in the form of growth forecast & risks associated to the business of the company triggered the value of the company mostly. Historic Financial Statements of the company considered as last five years which has been utilized to project Income & Cash Flows rationally. Under the valuation process, highest care & ethical standard have been maintained to present the analysis stand-out and to protect shareholders interest into the company.

Growth Assumptions; Three-Stage Growth Model: The growth rates for valuing the business of the company is followed by the three-stage growth model out of which 1st stage stands for FY2017-18 and 2nd stage stands for FY2019-21 sales & production growth and another stands for the growth in perpetuity. After applying several estimates on the past numbers, future market share of the company considering industry growth & competitive outlook has been taken to forecast the financial statements of RAK Ceramics which evidenced approximately 6% sales & production growth per annum for the FY2017-18 and 4% growth for the FY2019-21 followed by a small drop in market share-% from FY2019 due to industry competition. The perpetual growth is estimated by the potential nominal GDP growth rate of Bangladesh for the next 50 years timeline i.e. approximately 8% terminal growth.

Growth Assumptions 2017-F 2018-F 2019-F 2020-F 2021-F Capacity Utilization 72% 73% 74% 75% 76% Mkt Share 14% 14% 13% 12% 12% Market Size (mn Tk.) 22173 23060 23982 24941 25939 Contribution-Local Sales Tiles 16630 17987 19186 20701 22048 RAK Sales- Tiles 4,656 5,036 4,988 4,968 5,292 RAK Sales- Total 5,820 6,295 6,235 6,210 6,614 Future Sales Mix- Tiles : Sanitary 80 : 20 CAGR basis RAK Sales- Total 5,867 6,080 6,301 6,530 6,768 Capacity Utilization basis RAK Sales- Total 8,326 5,994 6,078 6,161 6,244

The table illustrates the output of three statistical methods applied to estimate growth of the company in terms of production & sales; out of which industry growth with competitiveness has been taken for valuing the company although several other techniques i.e. Compounded Annual Growth rate, Logarithm Growth etc. have applied.

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Statement of Financial Position Forecast Assets 2015 2016 2017-F 2018-F 2019-F 2020-F 2021-F Fixed Assets 2,312 4,005 4,161 4,329 4,496 4,662 4,838 Total non-current assets 4,012 4,115 4,522 4,705 4,887 5,067 5,259 Inventories 2,240 2,528 2,289 2,433 2,366 2,357 2,465 Trade receivables 638 619 582 630 624 621 661 Total current assets 6,742 7,043 7,508 8,266 9,099 10,012 10,999 Total assets 10,753 11,158 12,030 12,971 13,985 15,079 16,258 Equity - - - - - Share capital 3,369 3,369 3,537 3,537 3,537 3,537 3,537 Share premium 1,473 1,474 1,474 1,474 1,474 1,474 1,474 Retained earnings 1,196 1,270 1,489 1,674 1,723 1,812 1,863 Total equity 6,039 6,112 6,500 6,685 6,734 6,822 6,873 Liabilities Borrowings 421 595 571 548 526 505 485 Deferred tax liability 76 128 100 100 100 100 100 Total non-current liabilities 496 723 671 648 626 605 585 Borrowings 771 568 545 523 502 482 463 Trade payables 641 589 664 705 686 683 714 Total current liabilities 4,218 4,323 4,859 5,638 6,625 7,651 8,800 Total liabilities 4,715 5,046 5,530 6,286 7,252 8,257 9,385 Equity and liabilities 10,753 11,158 12,030 12,971 13,985 15,079 16,258

Statement of Profit or Loss Forecast 2015 2016 2017-F 2018-F 2019-F 2020-F 2021-F Sales 5,059 5,661 5,820 6,295 6,235 6,210 6,614 Cost of sales 2,897 3,252 3,318 3,525 3,429 3,416 3,572 Gross profit 2,162 2,409 2,503 2,770 2,806 2,795 3,043 Operating Profit 1,456 1,351 1,513 1,700 1,746 1,801 1,984 PBT 1,479 1,271 1,416 1,594 1,638 1,690 1,865 Net Profit 1,094 915 1,062 1,195 1,228 1,268 1,398 EPS 3.25 2.72 3.15 3.55 3.65 3.76 4.15

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Discounted Cash Flow based Valuation Summary

Valuation Toolkit T-Bond rate 8.00% Under this valuation model assumptions are made as Risk Premium 4.00% per prudent research. T-Bond rate assumed as risk free Cost of Equity 12.00% rate as it carries lowest default risk. Equity risk premium Cost of Debt 4.00% is estimated by excess return of market over risk-free rate. Cost of Fund is derived from weighted average Cost Tax Rate 25.00% of Equity & Cost of Debt Capital which is used as Post Tax Cost of Debt 10.20% discount rate. The company avails only 10.56% discount Total Debt to Equity 19.02% rate as it borrows from the London Sterling Market at WACC 10.56% LIBOR+3% which is cheaper than local loans. The LIBOR rate varies from 25 to 50 basis points over past few Terminal Growth 8.00% years. Terminal Growth rate came from Long Term GDP LT Real GDP Growth 4.50% Growth rate & Inflation rate of Bangladesh. LT Inflation 3.50%

Equity Valuation- Discounted Cash Flow 2017F 2018F 2019F 2020F 2021F EBIT 1,513,293,600 1,699,731,372 1,745,896,915 1,801,017,375 1,984,336,551 Taxes 378,323,400 424,932,843 436,474,229 450,254,344 496,084,138 NOPAT 1,134,970,200 1,274,798,529 1,309,422,686 1,350,763,031 1,488,252,413 Depreciation 407,425,200 440,671,096 436,474,229 434,728,332 463,011,862 Operating WC Changes (349,261,028) 149,298,287 (53,000,442) (9,215,842) 116,885,803 Operating Cash Flows 1,891,656,428 1,566,171,338 1,798,897,357 1,794,707,204 1,834,378,472 Capital Expenditure 563,001,704 608,942,643 603,143,190 600,730,617 639,814,296 Free Cash Flows (FCF) 1,328,654,724 957,228,694 1,195,754,167 1,193,976,588 1,194,564,176 Discounted FCF 1201733066 783082393 884768248 799059854 723084184 Terminal Value 18,453,930,751 Enterprise Value 22,845,658,496 Target Price (Tk.) 64.59 Market Price (15-1-2018) 58 Return Potential 11% Status Undervalued

Sensitivity Analysis Cost of Funds Target Price 64.59 9% 11% 11% 12% 13% 5% 50.37 35.79 33.10 28.29 24.75 6% 63.33 41.19 37.50 31.19 26.76

7% 89.25 49.62 44.10 35.25 29.43 8% 167.00 64.63 55.10 41.34 33.18

TerminalG. 9% 400.26 80.99 66.10 46.71 36.25

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According to the sensitivity analysis it’s observable that the highest value can be found under 9% terminal growth at 9% discount rate. The lowest value can be found under 5% terminal growth rate at 13% discount rate. The highlighted values in the table are the above average values of the entire value stream.

Residual Income based Valuation Summary Residual Income based Valuation 2017-F 2018-F 2019-F 2020-F 2021-F NOPAT 1,134,970,200 1,274,798,529 1,309,422,686 1,350,763,031 1,488,252,413 Capital Charge 746,824,611 763,911,936 766,790,230 773,919,528 777,179,257 Residual Income 388,145,589 510,886,593 542,632,456 576,843,503 711,073,156 Discounted RI 351,067,422 417,942,230 401,507,250 386,048,177 430,421,206 Terminal Value 10,984,838,692 Enterprise Value 12,971,824,978 Target Price (Tk.) 36.68 Market Price (15-1-2018) 58 Return Potential -37% Status Overvalued

The valuation assumptions of Residual Income Approach are the same as Discounted Cash Flows Model.

Sensitivity Analysis Cost of Funds Target Price 36.68 9% 11% 11% 12% 13% 5% 33.01 19.53 17.05 12.60 9.31 6% 41.97 22.75 19.55 14.07 10.21

7% 59.89 27.77 23.30 16.13 11.40 8% 113.65 36.70 29.55 19.22 13.07

TerminalG. 9% 274.94 46.45 35.80 21.94 14.43

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Relative based Valuation Summary

Relative Valuation

EPS-Q3 of RAK Ceramics 2.14 Under Relative Valuation Approach, Confidence Factor 90% Price Multiple Model is used to find the value of the company. Adjusted EPS-Q3 1.93 Projected Earnings per Share (EPS) Annualized EPS 2.57 of the company has been Ceramics Sector P/E 23.61 considered with the peer companies P/E Multiple to value the Relative Value 60.63 company. This model reflects the Market Price (14/1/2018) 58 combination of fundamentals & Return Potential 5% market sentiment Status Undervalued

Analysts Judgment: Out of the models analyzed finding the intrinsic value of RAK Ceramics Bangladesh Ltd, Discounted Cash Flows model can be prioritized over the Residual Income based model & Relative Valuation model on the basis of the worth of the model to have better understanding regarding the value of business of the company. The Residual Income based model comprised by accrual basis of accounting which eventually fails to generate appropriate idea of cash flows to the business of the company. Relative Valuation model is not full-fledged fundamental reflection of the company as it carries high degree of fair market value of the quoted peer companies. Besides, Discounted Cash Flows model tells about the Free Cash Flow of the company that can be used for managing the cost of fund of the business in the form of dividends to the shareholders & interest to the lenders. In addition, according to many study of corporate finance cash flow measure has prioritized than income of the company as cash flow tells the true performance of any business entity.

Disclaimer: This publication is produced by Research and Innovation Lab at Royal Capital Limited RCL) solely for the information of Clients of RCL. Clients are expected to make their own investment decisions using any information contained herein. The contained info in the report do not be interpreted as an offer to sell, or a solicitation of any offer to buy any investment. Projections of potential risk is based on published information but does not guarantee of any actual risk or return to be materialized.

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