The sentiment towards Somany Ceramics has improved due to other positives such as efforts to address corporate governance lapses and strong growth outlook
Shares of tile maker Somany Ceramics Ltd have risen 25% since it announced March-quarter earnings on 16 June. Among the key highlights was its robust 52% year-on-year (y-o-y) volume growth, which was aided by a low base and demand from smaller cities.
However, analysts say the sharp rally is not just about the earnings. Larger competitor Kajaria Ceramics Ltd also posted a decent performance in Q4FY21. In fact, on a two-year CAGR basis, both companies saw similar volume growth of over 5% each. CAGR is short for compounded annual growth rate.
The sentiment towards Somany Ceramics has improved due to other positives such as efforts to address corporate governance lapses and strong growth outlook.
An employee fraud and exposure to non-core financial services segment were among the concerns for investors in this stock. In a post-earnings conference call, the management said it has completely stopped treasury operations and will be using cash for better working capital management and deleveraging.
Somany Ceramics has eliminated inter-corporate deposits (ICDs) entirely and all outstanding ICDs as of March 2020 have been collected by March 2021. Further, the company expects to receive a major portion of claim from the employee who committed fraud. The company has recovered ₹7 crore out of the ₹16 crore claim and ₹4 crore is already accounted for in FY21 books, the management said.
Lastly, although Somany is still in a legal battle concerning the broker fraud issue, the management is hopeful of a positive outcome over the medium term. In September 2019, the company disclosed that a cheque of ₹26.2 crore issued in its favour by Mentor Financial Services Pvt. Ltd, a stockbroker of the firm, had bounced due to insufficient funds.
Despite near-term uncertainty on demand, the management has guided for a high teen y-o-y growth in the tiles segment. It expects to maintain operating margins at 12-13%. It should be noted that the company’s balance sheet witnessed significant improvement as net working capital fell to 64 days from 99 in March 2020. Net debt/equity reduced to 0.3 times from 0.7 times in March 2020 and is cash surplus at a standalone level as of Q4, the management said. The company has also announced capex of ₹180 crore across three projects for FY22.
All these factors not only bode well for the stock’s performance, but would help the company bridge the valuation gap with peers. “Somany is strengthening its distribution network while working on improving its cash-flow cycle and balance sheet. With more clarity on Mentor Financial Services and employee-related frauds, its valuation discount to Kajaria will narrow," analysts at PhillipCapital (India) Pvt. Ltd said in a report.
On a one-year forward price-to-earnings (PE) basis, shares of Somany Ceramics are trading at a multiple of around 20 times. This is a steep discount to the Kajaria stock, which is trading at a PE multiple of 33 times.
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