Things have improved remarkably at Somany Ceramics in recent years, but it lacks what the market values.
The stock of Somany Ceramics trades at ₹435 per share today, barely unchanged over the past ten years. Additionally, the stock was highly volatile during the period. It traded at ₹900 per share in January 2018 but declined by 88 per cent in two years, towards ₹100 per share by April 2020. The stock soon made a sharp recovery from those troughs towards ₹900 per share (again) by January 2022 but failed to sustain those levels.
Low revenue growth and volatile earnings characterised Somany Ceramics’ business over the past decade, during which its revenue compounded at 5.9 per cent; operating profit compounded at 9.3 per cent; net profit at 8.9 per cent; earnings-per-share at 7.5 per cent; and dividend at 4.6 per cent. Poor revenue growth, volatile earnings, and declining operating profitability were seemingly responsible for the stock’s underperformance over the last decade. However, its cash flow has a different and hopeful story to tell.
Somany Ceramics’ cash flow significantly improved during the second half of the last decade compared to the first half. During the first half of the decade, between FY15 and FY19, Somany Ceramics did a cumulative capital expenditure of ₹535 crores. Its operating cash flow after interest expenses totalled ₹228 crores during the period. It had to raise outside capital – debt and equity – of ₹340 crores during the period, as operating cash flow could finance only half of the capital expenditures.
During the second half of the decade, between FY20 and FY24, the company did a cumulative capital expenditure (capex) of ₹697 crores – 30 per cent higher than the first half. However, the operating cash flow after interest expenses during this period was ₹1,021 crores, more than four times that from the decade’s first half. This was more than enough to meet the CapEx of the period. The surplus cash (after CapEx) was utilised to buy back shares worth ₹130 crores and repay debt worth ₹204 crores.
The total outstanding debt, which increased from ₹192 crores to ₹614 crores during the first half of the past decade, has declined to ₹402 crores today. The total outstanding equity shares, which increased from 38.85 lakh to 42.38 lakh shares in the first half of the decade, have declined to 41.00 lakh shares today.
Better working capital management contributed to the significant improvement in Somany Ceramics’ cash flow. Five years ago, working capital assets constituted 34 per cent of the stock’s net operating assets – the rest being fixed capital assets. By FY24, the share of net working capital assets in net operating assets has declined to 6 per cent. The improved cash flow has enabled the company to finance its higher CapEx of recent years entirely through internal accruals. Despite the higher capex, the firm generated large free cash flow over the past three years, which was utilised for share buybacks, debt repayments, and increased dividends. These initiatives have catapulted Somany Ceramics’ capital allocation from below-average before FY24 to above-average now.
The gross profit margin is the most straightforward measure to evaluate a firm’s competitive position. A stable and expanding gross profit margin indicates a good competitive position. In this light, the increase in Somany Ceramics’ gross profit margin from an average of 40 per cent ten years ago to 56.1 per cent today is a significant, encouraging feat. If we consider the last three years, however, the measure has declined from 57.9 per cent in FY22 to 56.1 per cent in FY24. Somany Ceramics’ gross profit margin today is above average and stable but has slightly shrunk over the past two years. The gross profit margin profile seems favourable to the stock’s investment prospect.
The improvement in gross profit margin, working capital management, cash flow, and capital allocation in recent years augurs well for Somany Ceramics’ future investment prospects. However, it is disappointing that these improvements have failed to revive its lingering stock price. During the ongoing market correction of the past five – six months, the stock has declined from ₹700 per share to ₹435 per share, a decline of 38 per cent.
The principal drivers of a stock’s price are its earnings growth and profitability. Somany Ceramics’ earnings and profitability have remained tepid and volatile for the past decade, and there have been no signs of improvement in recent quarters. Revenue increased 5.3 per cent year-on-year in the most recent quarter that ended 31 December 2024; faster growth in expenses saw its gross profit increase by a lesser 3.9 per cent and operating profit decline by 24 per cent.
Somany Ceramics derived 87 per cent of its FY24 revenue from tiles; sanitaryware and bath fittings constituted the rest; exports constituted less than 5 per cent of the revenue. It manufactures three categories of tiles: ceramic tiles, polished vitrified tiles, and glazed vitrified tiles. In FY24, they contributed 32.1 per cent, 25.3 per cent, and 29.7 per cent to total revenue. Over the last 8 years, the share of ceramic and polished vitrified tiles in total revenue has declined, while that of glazed vitrified tiles has increased.
With a combined tile manufacturing capacity of 61.57 million square meters (MSM), Somany Ceramics claims to be India’s second largest tile company. Kajaria Ceramics, the largest tile company in India, has a tile manufacturing capacity of 86.47 MSM, 40 per cent higher than Somany Ceramics. But Kajaria’s tile sales of ₹4,100 crores were 76 per cent higher than Somany Ceramics’ tile sales of ₹2,332 crores in FY24. The gap between their market capitalisations is much starker: Kajaria Ceramics’ market capitalisation (₹12,610 crores) is 7.5 times higher than Somany Ceramics’ (₹1,686 crores). There is wide divergence in how the market values them. Kajaria is richly valued at 4.69 times its book value and 37 times its earnings, while Somany is valued moderately at 2.20 times its book value and 24 times its earnings.
However, a temporal view of the gross profit margins of these two leading Indian tiles manufacturers reveals that, over the past eight years, Somany Ceramics has significantly strengthened its competitive position, particularly relative to its larger competitor. Eight years ago, in FY16, Kajaria Ceramics’ gross profit margin (GPM) stood at 55.2 per cent. It peaked at 61.9 per cent three years later, in FY19, but gradually declined to 58 per cent by FY24. Meanwhile, for Somany Ceramics, the GPM was much lower, at 40.7 per cent, in FY16. However, the GPM made fast progress over the next six years and peaked at 57.9 per cent in FY22. After declining slightly over the next two years, the figure stood at 56.1 per cent in FY24.
A comparison of major expense ratios indicates Somany Ceramics not to be disadvantaged competitive-wise, though it has not surpassed Kajaria Ceramics on any of the ratios, either. Generally, the lower the expense ratios, the better competitively placed the firm is. Notable expenses for tile manufacturers are ‘power and fuel,’ ‘packaging, freight, and forwarding,’ and ‘advertisement, publicity, and promotions.’ Regarding the first two expenses, the lower the expense ratio (the expense as a share of revenue), the better competitively placed the firm is. It is ambiguous regarding ‘advertisement, publicity, and promotions.’ Being able to achieve objectives at a lower cost is a competitive advantage. However, some companies occupy leadership positions in their respective industries with higher marketing expense ratios than their competitors. Somany Ceramics’ ‘power and fuel’ expense ratio stood at 22 per cent compared to 20 per cent for Kajaria; ‘packaging, freight, and forwarding’ expense ratio at 1.7 per cent compared to 1.6 per cent for Kajaria; ‘advertisement, publicity, and promotions’ expense ratio at 2.2 per cent compared to 2.5 per cent for Kajaria.
An RNOA (return on net operating assets) of 13.45 per cent is discounted into the current market price of ₹435 per share. Somany Ceramics’ 5-year median and FY24 RNOA stood at 7.8 per cent and 9.9 per cent, respectively. On an absolute basis, the discounted RNOA suggest a reasonable, or even an attractive, valuation. However, the discounted RNOA’s premium to trailing RNOAs adds uncertainty.
The significant improvement in Somany Ceramics’ fundamentals over the past three to five years, whether working capital, cash flow, or capital allocation, is commendable. These are the platforms on which high earnings growth and profitability are made. However, Somany Ceramics has poor earnings growth and declining margins and profitability. Against this backdrop, from an investment perspective, it seems appropriate to wait until convincing evidence of revival in earnings and profitability are visible before making an investment commitment.
Superior investment return happens when robust fundamentals, a positive trend in earnings and profitability, and reasonable valuation come together. Somany Ceramics has strong fundamentals and a reasonable valuation. But the market values only what it lacks – the earnings trend. Signs of a sustainable earnings recovery are essential to reinvigorate the stock.
Disclosure
This post is not a piece of investment advice to buy or sell stocks. We are neither registered investment advisors nor research analysts. This analysis is prepared for our internal investment decision-making. The purpose of sharing it is purely informational.
Investment in the stock market is subjected to various risks and can result in capital losses. It is advisable to do your own research and/or consult your investment advisor before making your investment decisions.
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