Initiate at Buy: The jewel in the ceramic crown

Disclosures & Disclaimer This report must be read with the disclosures and the analyst certifications in the Disclosure appendix, and with the Disclaimer, which forms part of it. Issuer of report: HSBC Securities and Capital Markets (India) Private Limited View HSBC Global Research at: https://www.research.hsbc.com  Market leader commands a brand premium, while demonstrating superior financial performance over peers  An attractive entry level as the stock has corrected 28% from its peak; set to benefit from market share gains, residential completions, government initiatives, and low gas prices  Initiate at Buy rating with a target price of INR615 Top tile manufacturer. Kajaria Ceramics is India’s largest tile manufacturer, with a 10% market share in a highly fragmented industry. The company has improved its product mix and commands a 5-6% brand premium over its closest rivals, which it outperforms on a number of metrics. The share price has corrected 28% since 18 October due to disappointing volumes in 2Q FY17 and the government’s recent demonetisation initiative. Despite a slow FY17, we see this as a buying opportunity as the long-term outlook is bright and we expect earnings to rise at a CAGR of 26% over FY17-FY19e. Impressive performer. Kajaria has a network of 1,100 dealers which cater to around 4,000 associates, giving the company a truly pan-India footprint. Its operating margins are double those of its peers; Kajaria also has an enviable returns ratio. We expect ROE of 24-25% over FY17-FY19e. Its net debt-to-equity ratio has fallen from 1.26x in FY11 to only 0.3x in FY16, strengthening its balance sheet. Its increasing use of joint ventures lowers capex and keeps the balance sheet asset light. Catalysts. The introduction of the goods and services tax (GST) next year is likely to squeeze smaller operators, leading to market share gains. An increase in the number of residential property projects approaching completion and government-led housing and hygiene programmes should drive volume growth, while low gas prices and a richer product mix should support margins. The likely imposition of an anti-dumping duty (ADD) on imports from China should create opportunities for market share gains, while structural drivers such as urbanisation and rising disposable income should favour the company’s growth outlook. Valuation and risks. We initiate coverage with a Buy rating because we forecast 26% earnings growth over FY17-FY19e given the number of catalysts that are in sight. Our target price is derived from a DCF-based valuation as at end-FY17, which we then discount to arrive at our fair value target price of INR615 based on FY18e EPS of INR19.4, leading to an implied PE of 32x. The stock trades at 27x FY18e PE, higher than its close peers, but we believe its market leadership, superior returns ratio, and high EPS growth during FY18-FY19 justify its premium valuation. Our FY17e and FY18e EPS estimates are 8% and 10% below consensus as we are more bearish about the impact of demonetisation on sales in the rest of FY17e and early FY18e. Downside risks: A spike in gas prices, delays in residential completions, delays in ADD on China, and slippages in government housing schemes. 7 December 2016 INITIATE AT BUY TARGET PRICE (INR) PREVIOUS TARGET (INR) 615.00 - SHARE PRICE (INR) UPSIDE/DOWNSIDE 532.00 +15.6% (as of 05 Dec 2016) MARKET DATA Market cap (INRm) 84,555 Free float 49% Market cap (USDm) 1,241 BBG KJC IN 3m ADTV (USDm) 2.2 RIC KAJR.BO FINANCIALS AND RATIOS (INR) Year to 03/2016a 03/2017e 03/2018e 03/2019e HSBC EPS 14.45 15.44 19.41 24.55 HSBC EPS (prev) - - - - Change (%) - - - - Consensus EPS 14.29 17.85 21.59 26.41 PE (x) 36.8 34.4 27.4 21.7 Dividend yield (%) 0.5 0.5 0.6 0.8 EV/EBITDA (x) 18.8 17.6 15.0 12.2 ROE (%) 27.6 24.0 24.7 25.3 52-WEEK PRICE (INR) Source: Thomson Reuters IBES, HSBC estimates Saurabh Jain* Analyst HSBC Securities and Capital Markets (India) Private Limited saurabh2jain@hsbc.co.in +9122 6164 0691 Puneet Gulati*, CFA Analyst HSBC Securities and Capital Markets (India) Private Limited puneetgulati@hsbc.co.in +9122 2268 1235 *Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/qualified pursuant to FINRA regulations. Kajaria Ceramics (KJC IN) EQUITIES CONSTRUCTION MATERIALS India 390.00585.00780.0012/1506/1612/16Target price: 615.00High: 734.80 Low: 432.52 Current: 532.00Initiate at Buy: The jewel in the ceramic crown  EQUITIES ● CONSTRUCTION MATERIALS 7 December 2016 2 Investment summary 7 We initiate coverage with a Buy rating 7 Valuation and risks 9 Key downside risks to our view 11 Why buy Kajaria? 12 Key catalysts 12 Other structural drivers to support long-term growth 15 Why we like Kajaria 18 Key concerns 19 Peer comparison 21 A clear leader 21 Kajaria in charts: An attractive consumer stock 26 Financial analysis 27 Revenue growth to improve from FY18 27 Margins: Improving product mix helps 28 Balance sheet to r