Carborundum Universal- Integrated industrial materials firm:: UBS

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UBS Investment Research
Carborundum Universal
Integrated industrial materials firm

􀂄 Market leader in abrasives/industrial ceramics
We initiate coverage of Carborundum Universal (CUMI) with a Buy rating. CUMI
is a producer of industrial products (abrasives and ceramics) for the automotive,
industrial, construction and infrastructure sectors. The abrasives market is almost
an oligopoly in India. There are also no other large companies with a similar
product range as CUMI in India’s industrial ceramics market.


􀂄 Electro minerals (EMD)—future strategic driver
EMD (the raw materials for abrasives and ceramics) are strategic minerals used in
high-end applications. They are also scarce commodities. CUMI’s EMD business
made up 36%/50% of its revenue/EBIT in FY10. Its EMD business has high
margins (22% EBIT margin in FY10 compared to 9%/19% for abrasives/ceramics)
and return on capital employed (ROCE) (39% in FY10 compared to 13%/18% for
abrasives/ceramics). CUMI’s EMD capacity already significantly exceeds its
captive requirements. The company has four new projects to expand its EMD
capacity.

􀂄 Strong earnings growth, boosting ROCE
We forecast a 36% profit after tax (PAT) CAGR over FY10-12, driven by a 24%
revenue CAGR and higher margins. Higher capacity utilisation should increase
ROCE to 25%+ (we forecast an FY12 ROCE of 23%). CUMI’s ROCE was
adversely impacted by a major capacity expansion over the past three years.

􀂄 Valuation: initiate coverage with Buy rating, Rs296.00 price target
We value CUMI on a PE basis, using comparable multiples for listed industrial
materials/mineral companies in India. We base our price target on 14x FY12E PE,
supported by our FY10-12 forecasts of a 39% earnings CAGR and 19%-24% ROE.
Our price target is 21% above the current share price.


We initiate coverage of CUMI with a Buy rating and a Rs296.00 price target—
21% above its current share price. We think its current share price is attractive
as we expect it to trade at 14x FY12E PE and forecast 36% earnings CAGR
over FY10-12.
CUMI, part of the reputable Murugappa Group, is an industrial
products/minerals producer (abrasives and ceramics) catering to the
automotive, industrial, construction, fabrication and infrastructure sectors. It is
a market leader in many of its businesses. The abrasives market is almost an
oligopoly in India (CUMI and Saint Gobain’s subsidiary Grindwell Norton
control almost two-thirds of the market). Meanwhile, industrial ceramics is a
technology- and capital-intensive product and there are no other established
and large players like CUMI in India.
CUMI’s strategy is underpinned by an increased focus on EMD (36%/50% of
revenue/EBIT in FY10). EMD are the raw materials for its abrasives and
ceramics businesses. The company aims to evolve into a large player in the
specialty minerals and technology-intensive industrial products segments. EMD
is characterised by its short supply (zircon sand is only available in South Africa
and Australia), and are also strategic minerals given their use in high-end
applications. The EMD business has high margins (22% EBIT margin in FY10
compared to 9%/19% for abrasives/ceramics) and ROCE (39% EBIT ROCE in
FY10 compared to 13%/18% for abrasives/ceramics). CUMI’s EMD capacities
already significantly exceed its captive requirement and the company is
undertaking four key projects for capacity expansion/new capacities.
We forecast a 36% CAGR for PAT over FY10-12, driven by a 24% revenue
CAGR and higher margins. Despite significant capex plans, leverage is likely
to remain stable at 0.7x. Higher capacity utilisation in its abrasives and
ceramics businesses should boost ROCE back to 25%+ (we forecast an FY12
ROCE of 23%). CUMI’s ROCE was adversely impacted by a major capacity
expansion over the past three years.
We value CUMI on a PE basis, using comparable multiples for listed
industrial materials/mineral companies in India—Grindwell Norton and AIA
Engineering (AIA). We base our price target on 14x FY12E PE, supported by
our FY10-12 forecasts of a 39% earnings CAGR and 19%-24% ROE. Our
price target implies 9.1x FY12E EV/EBITDA.


Key catalysts
Strong earnings growth. CUMI has a diversified revenue stream from abrasives,
ceramics and EMD. We expect the company to continue to benefit from our
positive outlook on the materials, automotive, infrastructure and construction
sectors. We forecast earnings growth of 57% YoY in FY11 and 24% YoY in
FY12 (84% growth YoY in H1 FY11). This should be driven by greater volume
and higher margins as capacity utilisation ramps up (refer to Table 9).
Gujarat Mineral Development Corporation (GMDC) JV. CUMI has plans
for a brown-fused alumina JV with GMDC (CUMI has proposed a 74% stake).
We believe this will be a key catalyst for CUMI’s share price given it would
secure the supply of this mineral.


New products/markets. CUMI is focused on introducing new products that
meet its customers’ changing requirements and can capture different markets.
This should boost growth.
Coal India’s usage of ceramics. Coal India—the largest coal mining company
in the world and in India—does not use ceramics for its coal washeries.
Ceramics have higher costs, but a longer life. Should Coal India move towards
using ceramics, it could mean a significant market opportunity for CUMI,
especially given Coal India’s aggressive washery expansion plans.

Risks
Forex. Volatile forex movements can impact CUMI’s reported earnings given
45% of its FY10 revenue came from overseas. CUMI has major operations in
Russia, South Africa, China and Australia. As its products face international
competition, FX moves could impact its competitiveness and margins.
Competition. CUMI is exposed to competitive pressures from global companies
in both its abrasives and ceramics businesses.
Cyclical risk. While CUMI commands a leading position in its businesses, it is
also significantly exposed to the automotive, industrials, steel and infrastructure
sectors, which in turn makes it vulnerable to demand cyclicality.
Macroeconomic slowdown. CUMI’s businesses are affected by GDP growth.
Thus, any economic slowdown will impact its growth and earnings. This is true
in both India and developed markets such as the EU and the US.

Valuation and basis for our price target
We value CUMI on a PE basis, using comparable multiples for listed industrial
materials/mineral companies in India— Grindwell Norton and AIA. We believe
CUMI is well-positioned compared to these peers given its diversified and
integrated model as well as the structural long-term benefits of EMD. These
factors should lead to steady and secular growth in its earnings over the medium
term as well as strong return ratios.
CUMI is trading at a discount to AIA based on the data in Table 2, possibly as
AIA is a leader in industrial grinding media/mill internals—an oligopolistic
industry globally—according to Bloomberg, the street forecasts an FY10-12
EPS CAGR of 19% for AIA.
CUMI is trading at a discount to Grindwell Norton based on the data in Table 2,
which we think is unjustified given CUMI’s broader product mix (Grindwell is
mainly into abrasives) and higher FY10-12E EPS CAGR (we forecast 39%
compared to a street forecast of 23% for Grindwell).
We base our Rs296.00 price target on 14x FY12E PE, supported by our FY10-
12 forecasts of a 39% earnings CAGR and 19%-24% ROE. Our price target is
21% above its current share price and implies 9.1x FY12E EV/EBITDA.