Kajaria Ceramics' Q2FY19 results (Outperformer) - Volume growth surprise; bottoming out…

Q2FY19 results highlights

• KJC’s tiles volume registered a surprise 10.5% yoy growth to ~19.5 mn sq. m. (IDFCe: +1.2%). Despite the base being relatively soft (~6% yoy in Q2FY18 aided by GST restocking), the performance is commendable given that the quarter had issues like the Trucking Strike (July) and Kerala Floods (in August; 12-13% of rev.).
• Blended tiles realization declined 3.3% yoy, but has improved by 1.3% on a sequential basis. KJC had taken a price hike of 1-2% in ceramic products in July’18 and recently has taken a 2-3% hike in GVT as well.
• Tiles revenue grew 6.8% yoy to ~Rs6.8bn while Sanitaryware/Faucet revenue continued its healthy upmove, registering a growth of 31.5% yoy to ~Rs435m. Cons. revenue grew 8.1% yoy to ~Rs7.3bn (11% beat).
• Higher in-house production sales led to gross margins expanding ~650 bps yoy to 63.0%. However, continued pressure on fuel prices (+35% yoy) led to EBITDA margins declining ~320 bps yoy to 15% (IDFCe: 14%). Cons. EBITDA, as a result, fell 10.7% yoy to ~Rs1.1bn (19% beat due to better volumes).
• Cons. PAT at ~Rs536m fell 15.8% yoy (23% beat). This was cushioned by higher other income (4x yoy) and lower interest (fell ~29.3% yoy).
• KJC has also achieved a reduction of its NWC cycle by 1 day to 59 days, despite the 11% volume growth. This is commendable as well, and is reflected in the company becoming net-cash as of Q2 end (~Rs380m net cash vs ~Rs880m net debt as of March 2018).

Key positives: Strong volume growth / NWC cycle reduced by 1 day.

Key negatives: High fuel costs.

Impact on financials: ~1% cut in FY19E/20E EPS.

Valuation & view   

While it is possible that KJC would be in a position to build on its Q2 performance in H2FY19E, persistent high fuel prices would continue to eat into margins while the macro issues in terms of real estate sluggishness and high competition continue to plague the industry in the near-term. We have marginally tweaked our estimates (increased revenue by 1%, but cut earnings by 1% due to higher fuel prices). We further revise our multiple lower to 25x (vs 27.5x earlier) due to the current macro issues, thus revising our target price to Rs442. Maintain Outperformer as KJC is the best tile franchise to own; finally available  at attractive valuations, and it should be the biggest beneficiary of any uptick in demand. A fall in gas prices remains a key trigger.