Carborundum Universal Ltd Abrasives Ceramics Electrominerals ACE of Abrasives! We initiate coverage on Carborundum Universal Ltd (CUMI), a part of Rs42bn, Murugappa group with a Long Term Buy recommendation at Rs241. Market leadership, quality management, growth in end user-industries and economic revival coupled with attractive valuations makes this company a very good play on the overall growth in Indian economy. Analyst Ajay Shethiya+(91 22) 2685 0101 December 2003 ([email protected]) Dealing (+91 22)2685 0505 Sandeepa Arora 5540 9033 Biren Patel 5540 8601 It’s all about money, honey! Carborundum Universal Ltd: Ace of Abrasives! COMPANY RESEARCH Investment Rationale Overall growth in the economy leading to spurt in user-segment is likely to drive Recommendation demand growth for CUMI’s product profile. BUY Market leadership in Indian abrasive segment, which contributes 74% to its total CMP Rs 241 revenue. 52 week H/L Rs 245/100 Market Cap Rs 2.25bn Joint Venture with Wendt Gmbh, enabled CUMI to offer both conventional and super abrasive, leaving virtually a duopoly in the industry, with only competition from Grindwell Norton. Share Holding Pattern % Promoters 45.54 Institutional Investors 23.97 Being a part of Murugappa group, CUMI enjoy the group’s professional style of Other Investors 2.90 General Public 27.59 working, leadership status and its high standard of corporate governance. The stock is trading at 7.7 times FY05E EPS of Rs30.9 and 1.36 times its FY05E Book Value of Rs177. Share Price Chart Key Financials (Amt in Mn) FY01 FY02 FY03 FY04E FY05E Net Sales 2488.9 2479.8 2475.7 2723.2 3050.0 % yoy - (0.4) (0.2) 10.0 12.0 Net profit 232.0 215.2 365.5 242.7 288.9 % yoy - (7.3) 69.8 (33.6) 19.0 EPS 24.9 23.1 39.2 26.0 30.9 % yoy - (7.3) 69.8 (33.6) 19.0 Equity 93.4 93.4 93.4 93.4 93.4 Capital employed 2362.0 2383.6 2188.0 2091.8 2134.3 OPM (%) 19.2 17.9 13.6 13.9 14.2 RONW (%) 16.6 15.7 23.9 15.5 17.5 Debt-Equity (x) 0.7 0.7 0.4 0.3 0.3 Book NAV (Rs) 149.7 146.5 163.9 167.9 176.8 December 18, 2003 2 Carborundum Universal Ltd: Ace of Abrasives! Investment Rationale COMPANY RESEARCH Background CUMI, a flagship company of the Rs42bn, Murugappa Group was founded in 1954 as a tripartite collaboration between Ajax Products Ltd., India The Carborundum Co., USA and the Universal Grinding Wheel Co. Ltd., U.K. With technical assistance from its collaborators, CUMI undertook the ambitious project of manufacturing India’s first Coated and Bonded Abrasive products. Besides this, CUMI also pioneered the manufacture of Super Refractories, Electro-Cast Refractories, Electro-Minerals, Industrial Ceramics, Ceramic Fibres and Ceramic Colours in India.CUMI, a pioneer and market leader in the manufacture of abrasives in India has one of the widest ranges of bonded abrasives in the world Quality Management Being a part of Murugappa group, CUMI enjoys the group’s professional style of working and its leadership status. Mr. M V Murugappan, Chairman of CUMI is leading the top management. He has over 20years of managerial experience with Murugappa group and has been instrumental in CUMIs expansion and diversification plans. Mr. Ramesh Agarwal, President and Wholetime Director has been associated with the same Industry and has varied experience with top companies. We believe that CUMI has a well knit team. End user-segments to fuel growth Automobile The Indian Automobile sector grew at 16.53% in FY03 contributed by export growth of 65.35% and domestic growth of 14.80% as compared to FY02.Infrastructure has received a fillip in last 2 years through N-S-E-W corridor and Golden Quadrilateral projects. The transformation of road transport through these initiatives as well as higher economic growth would lead to higher demand for commercial vehicle industry. Passenger Cars continue to grow in double digit driven by rising aspirations and cheap and easy availability of finance. Within two wheelers, we expect motorcycle industry growth to continue on its growth path. After two bad years, the tractor industry is also likely to witness a turnaround with completion of inventory correction phase and good monsoons is likely to drive demand. Thus, we expect. Automobile and Auto Ancillary jointly accounts for 35% of the total demand for Abrasives and we expect all segment of automobile industry to report strong growth in the coming year in turn fuelling the growth for Abrasives. Auto-Ancillary India’s automotive components industry manufactures almost the entire range of parts required by the domestic automotive industry for various types of vehicles. The demand for automotive components is a function of the demand for automotives in India. With December 18, 2003 3 Carborundum Universal Ltd: Ace of Abrasives! COMPANY RESEARCH the automotive sector likely to show better growth, automotive component industry will witness a revival of fortunes. This apart, exports of automotive components from India hold promise for growth with India likely to become the sourcing hub for global automotive companies. Indian auto component industry, which grew by 17% in the last five years, the exports has risen by a robust 25% in the same period. The auto ancillary sector in India is likely to better this growth rate given its export competitiveness and outsourcing opportunities. General Engineering The engineering sector is the second largest user segment for Indian abrasives market accounting for 20% of abrasive sales. The manufacturing sector has grown at 6% in FY03 and capital goods have shown a robust growth of 10.5% in FY03. The Indian economy is expected to grow by 6.5-7% in FY03-04. The overall revival in industry and manufacturing will drive capital investments and spur growth in the engineering industry – the second largest customer for abrasive industry. Export potential and overall growth in the economy had lead to an encouraging environment for the engineering sector. With India’s competitive advantage in terms of skilled and technical manpower, low labor cost, local availability of raw materials, huge domestic demand is likely to spurt growth in the overall engineering sector. On April 29, 2003, RBI had projected a GDP growth of about 6.0% for the year 2003-04, based on the assumption of rainfall at around 96 per cent of its long period average. In busy season credit policy, this has been increased to 6.5-7% on the back of good monsoons and an overall growth in all sectors. With the overall economy in up swing and potential growth seen in user segments, we expect better growth for CUMI as all this factors augurs well for the growth of the Company. Exhibit 1: User-Segment Share Fabriction 10% Construction General 8% Engineering 20% Steel 8% Auto-Auto Ancillary Others 30% 24% Source: Company/ India Infoline Research December 18, 2003 4 Carborundum Universal Ltd: Ace of Abrasives! COMPANY RESEARCH Virtual duopoly with competition only from Grindwell Norton In India there are three main players in this Industry. Apart from CUMI, Grindwell Norton Ltd and Wendt India Ltd are the major players. In order to mitigate the competition risk, CUMI entered into a joint venture with Wendt India and holds 40% of its share capital. After the joint venture, it now offers full range of abrasives to its customer’s viz. conventional and super abrasives. Super abrasives are manufactured by Wendt India Ltd. at its plant located at Hosur in Tamil Nadu.CUMI is a market leader in Indian abrasive industry and enjoys a share of more than 45% followed by Grindwell Norton which has a share of 40% in the total Rs5bn abrasive market. Division wise performance CUMI operates in three segments viz Abrasives, Ceramics and Electrominerals.After the joint venture with Wendt India, it now offer conventional and super abrasives. We have discussed in details the business segments and their product offerings. Segmental Analysis Business Segment Product Offering Abrasives Bonded & coated abrasives and metal working fluids Ceramics Industrial ceramics and super refractories Electrominerals Brown fused alumina grains, white fused alumina grains and silicon carbide grains Abrasives Abrasives division contributes around 74% to the total sales of the company. Abrasives are products used for material removal, polishing and finishing. They are broadly of three types Bonded Coated and Super abrasives. Bonded and super abrasives are mostly in the form of wheels but also in other shapes such as segments, sticks etc. Coated abrasives are flexible abrasives and are in the form of sheets, belts and discs. CUMI is the market leader in the Indian Abrasive Industry. The sale of the CUMI in abrasive sector was affected in the fourth quarter due to introduction of VAT and ended up registering an overall growth of 10%. Enhanced basket of products, application of engineering support and innovative marketing initiative from CUMIs is likely to take advantage of recent growth seen in its user industry viz. automobile, auto ancillary and general engineering. December 18, 2003 5 Carborundum Universal Ltd: Ace of Abrasives! COMPANY RESEARCH Performance: Abrasives Capacity Production Utilization Quantity sold Sales value Realization/unit (Ton) (Ton) % (Ton) (Amt in Mn) Bonded FY2003 9,500 8,573 90.24% 8,010 1287.61 160,750.3 FY2002 9,500 7,591 79.91% 7,595 1160.5 152,797.9 FY2001 9,500 7,725 81.32% 7,438 1238.277 166,479.8 Coated (Ream) (Ream) FY2003 337,000 264,304 78.43% 259,813 816.95 3,144.4 FY2002 337,000 220,080 65.31% 219,392 785.39 3,579.8 FY2001 337,000 220,320 65.38% 219,578 761.266 3,467.0 Industrial Cloth(Metre) (Metre) FY2003 4500,000 1933,343 42.96% 57,400 3.75 65.3 FY2002 1800,000 1029,712 57.21% 336,265 38 113.0 FY2001 1800,000 1482,244 82.35% 518,825 46.97 90.5 Ceramics In this segment, CUMI offers two product lines Industrial ceramics Super refractories Industrial ceramics are high alumina ceramic products.