Management Speak: Carborundum Universal (Outperformer) - Focus on high value add products to drive margins

We visited CUMI’s ceramic plant (Metz and wear Ceramics; 22% of revenues and 29% of EBIT in FY18) in Hosur, Tamil Nadu. Key highlights:

Ceramics - focus on high margin products: The ceramics segment consists of industrial ceramics and refractories. The overall global market for industrial ceramics is estimated to be at US$7bn. CUMI has focussed on high margin products within industrial ceramics (~Rs3.5bn revenues in FY19E) such as Metallized Cylinders (Metz; Rs1.2bn revenues) and Engineered Ceramics (EC; ~Rs1.2bn revenues). On the other hand, wear ceramics (Rs1.1bn revenues) are largely standardised products such as lined equipment, wear resistant tiles, etc., used as consumables for bulk material handling, ceramics tiles, coal based thermal power, etc. With the strong growth in specialised segments such as Metz and EC and benefits of rupee depreciation (~70% exports), the ceramics segment has seen margins expansion from 15.6% in FY17 to 19.2% in 9MFY19.

Metz – high-margin, fast growing product: CUMI has emerged as the 2^nd largest global player in the market for Metz with a capacity of 1.7mn cylinders/year. Metz is an integral part of Vacuum Interrupters used in Vacuum Circuit Breakers (VCBs), which in turn are used in medium voltage switchgears and power distribution lines. Around 70% of the business caters to all major power T&D players in the export markets.  CUMI is de-bottlenecking its Metz capacity by 0.5mn cylinders, as capacity is likely to reach complete utilisation in FY20. Accordingly, it expects the growth trajectory to remain strong over the next few years.

Wendt – super abrasives player: Super abrasives is a US$6.5bn industry (India mkt ~US$100m). CUMI’s offerings of super abrasives is via its Wendt JV (40% stake). Wendt’s super abrasives are used to grind and shape tough materials that have end usage in industries such as autos, steel, textiles, glass, etc. The business has wide product offerings, with exports comprising ~70% of its Rs1.5bn revenues. Wendt has seen sharp margin expansion in 9M19 (+390bps yoy to 21%) led by better product mix.

Valuation and view

CUMI’s performance has improved on higher volumes, improved revenue mix towards specialities and ramp up of new capacities. Even though near-term margins are under pressure due to higher input costs, particularly power, we believe the improving supply-demand dynamics across segments would result in gradual price hikes and drive earnings. At 24x FY20E earnings, the stock looks attractive in view of strong earnings outlook (19% earnings CAGR over FY18-20E) and improvement in return ratios. We reiterate Outperformer rating on the stock.