CFA Institute Research Challenge Hosted by CFA Society of Thailand Thammasat University Industry: Property Construction Thammasat University Student Research Sector: Construction Material This report is published for educational purposes only by students competing on the CFA Institute Research Challenge. DYNASTY CERAMIC PCL Date: 21/12/2014 Current Price: THB 55.75 Target Price: THB 41.50 Ticker: DCC (SET) USD 1.00: THB 32.85 Recommendation: SELL (25.6% Downside) Company Overview Investment Highlights Founded in 1989, Dynasty Ceramic PCL We place a “SELL” recommendation. Despite the high Return on Equity (“ROE”) and solid financial (“DCC” or the “Company”) is one of the position, the absence of future growth opportunities as well as the intensifying competition largest tile manufacturers and distributors implies that past stellar performance is unlikely to repeat again. With our valuation using of ceramic tiles in Thailand. Listed on the Stock Exchange of Thailand in 1992. As of Dividend Discount Model (“DDM”) and Free Cash Flow to Firm (“FCFF”) model, the one-year December 2014, DCC operates 195 outlets target price is THB 41.50, which leads to our final recommendation. nationwide targeting low-to middle-income Limited ability to drive sales through store expansion leads to greater reliance on same store customer segments mainly in provincial areas. sales growth: With 195 stores covering almost all 77 provinces throughout Thailand, the Company is likely to experience difficulties in expanding its branch network. The declining trend DCC Relative to SET Index in the number of new stores opened annually from 10 stores in 2012 to only 4 stores in 2013 15% indicates deteriorating expansion opportunity. In fact, in year-to-date 2014, 1 store was closed 10% 5% while no stores were opened. This reflects management’s failure to meet the initially set 5 new 0% stores. Even in the scenario in which the company successfully achieves the expansion target, the -5% -10% impact on top line would be immaterial because of the current large store network. Going -15% forward, DCC is unlikely to achieve substantial growth of its existing business purely through -20% opening new stores as it used to experience in the past. Jul-14 Jan-14 Jun-14 Oct-13 Oct-14 Sep-13 Sep-14 Feb-14 Dec-13 Apr-14 Aug-13 Aug-14 Nov-13 Nov-14 Mar-14 May-14 Weak economic outlook implies low potential to boost same store sales: DCC’s main target DCC SET market is in upcountry areas, where the demand is closely tied to the agricultural products. With Source: Bloomberg the continuous declining in both farm income and agricultural price index by -7.7% YoY and -7.2% YoY in 3Q2014, the recovery of sales growth appears difficult. In addition, the level of DCC VS. SET Holding Period Return household debt has reached the record high of 84% of Thailand’s GDP, as of June 30, 2014. This Time horizon SET DCC can potentially slowdown house renovation market which is DCC’s key market. Combining these 1-year 26.63% 21.23% unfavorable macroeconomic indicators, the turnaround of same store sales growth is unlikely to 3-year 71.08% 9.36% take place in the near future. 5-year 160.02% 145.57% Intensifying competition adds risk to future growth prospect: The lower cost of imported tiles, Source: Bloomberg especially from China and Vietnam, has incentivized both local tile manufacturers and other home improvement retailers to outsource the production activities. It allows importers to sell their High ROE is offset by high P/BV products at 10-15% below market Average Selling Price (“ASP”). As a result, tiles imported value ROE has been increasing with the CAGR of 28% during 2009 to 2013. In addition, other competing (%) DCC TB 50.00 Average home improvement retailers, namely Global House and Thai Watsadu, have aggressively expanded their stores in both urban and provincial areas with number of stores increasing from 40.00 12 to 66 stores within last 5 years. The competitive advantage of DCC as being a low-cost 30.00 manufacturer and having the extensive store network is now being threatened. This changing SCC TB competitive landscape reflects in a gradual decrease in DCC market share from 24% in 2009 to 20.00 TTC VN Average 21% in 2013. DCC’s sales volume continues declining from -4.9% in 2013 and -5.2% in 2014. TGCI TB 10.00 GLOBAL TB Future plan to grow remains questionable: After domestic sales saturates, the clarity of the 0.00 next growth strategies is crucial to drive DCC forward. At the moment, international expansion 0.00 2.00 4.00 6.00 8.00 10.00 seems to be very attractive. However, the management has decided to put the expansion strategy P/BV (Times) Note: The label represents Bloomberg ticker on hold due to many uncertainties and risks involved. Therefore, the international expansion is Source: Bloomberg expected not to happen in the near future. An absence of the next growth engine makes DCC become less attractive. Relative Peers Relative Valuations also indicate overprice for no growth company: The indicative valuation DCC Multiples Average multiples obtained from the relative valuation, covering both local and regional comparable P/E 18.90 14.51 companies further confirms that DCC’s stock price is not justified by its growth outlook. Although PEG 7.43 3.00 DCC’s P/E ratio of 18.9x is considered in line with peers’ average P/E ratio at 14.5x, when the P/B 8.58 2.30 Company’s growth is incorporated into multiple analysis, DCC’s PEG ratio of over 7.4x is, in fact, EV/EBITDA 13.68 10.17 significantly higher than peers’, which is only 3.0x. With the expected growth rate of 2-3% per Source: Bloomberg and Team’s Estimates annum, the results from all valuation methods confirm that the current price of THB 55.75 per share is overvalued. Market Profile 52 weeks price range Key Financial Ratios 2012 2013 2014F 2015F 2016F 2017F 2018F 2019F (THB/share) 48-61 Sales Growth 5.5% -0.7% -4.4% 2.4% 2.8% 2.4% 2.4% 2.3% Average daily volume (Shares) 306,100 Beta 0.57 Earning per Share Growth 1.8% 2.6% -7.9% 3.6% -2.8% -8.9% 21.5% 22.6% Dividend yield 5.76% Gross Profit Margin 39.2% 41.1% 40.5% 40.5% 40.5% 40.5% 40.4% 40.3% Market capitalization (Mn THB) 23,358 Net Profit Margin 16.7% 17.2% 16.6% 16.6% 16.5% 16.4% 16.3% 16.2% Share outstanding (Mn Shares) 408 Free float 36.07% Return on Equity 45.8% 46.8% 43.1% 43.5% 44.4% 45.0% 45.7% 46.3% Foreign limit 35.00% Debt-to-Equity Ratio 0.30 0.43 0.47 0.54 0.61 0.63 0.65 0.65 Source: Bloomberg Earning per Share (THB) 3.08 3.18 2.93 2.99 3.06 3.12 3.18 3.23 1 Figure 1: Sales by distribution channels Business Description Export Franchise 2% Real Estate 3% Founded in 1989, Dynasty Ceramic Public Company Limited (“DCC” or the “Company”) is one Developers 10% of the largest ceramic tile manufacturers in Thailand. The Company manufactures and sells a great variety of ceramic wall/floor tiles as well as other tile-related products under its own brands (Appendix 1 & 2). DCC targets low to lower-middle income customer segments mainly in Home Improvemen provincial areas. The Company distributes its products through various sales channels; however, t Centers Outlet Stores 67% the main sales channel is DCC’s own outlet stores (Figure 1). As of December 2014, DCC has 195 18% outlet stores located nationwide and 2 factories in Saraburi with total annual production capacity of 69 Mn sq.m. In June 2014, DCC has conducted a group restructuring by Entire Business Transfer of three of the Source: Company Data and Team’s Estimates, Company’s subsidiaries, with an intention to reduce interrelated work process and general and Average 9M2014 administrative expenses, leaving Tile Top Industry Public Co., Ltd as DCC’s only subsidiary company with 97% controlling stake (Appendix 3). Product Types Description Low-price 16x16” tiles and smaller Company Strategies products High-price Hybrid and rectified products 16x16” tiles and larger Product line extension: Aiming to capture the higher market segment, DCC has recently launched the high-price products, i.e. Digital and larger-sized tiles. And to further ensure the success of new Figure 2: Average selling price and market penetration, DCC has been renovating its outlet stores hand-in-hand with the launch of sales contribution by product types new products. THB/Sq.m 225 88% 12% Distribution channel expansion: DCC has been continuously expanding through its new outlet 200 stores. This allows the Company to further reduce its reliance on other distributors. However, after the slowdown in sales from outlet stores, it also aims to expand the distribution channels by 187.7 175 focusing on other markets such as; new home market, wholesale, and construction projects in 150 Overall ASP order to expand its customer base. Nevertheless, this might still be questionable whether it is 136.9 125 going to benefit DCC enough because it may lead to the decrease in margin and increase in 128.2 accounts receivable days. 100 Low-price products High-price products Cost reduction: In order to achieve gross margin target of 43% in 2014, DCC has been trying to ASP Sales Contribution reduce the cost of production.