Carborundum Universal: Buy

Investors with a three-four year perspective can consider buying the stock of Carborundum Universal (CUMI), a leading player in the abrasives and industrial ceramics space. CUMI's capacity expansion, growing focus on export market and its venture into new businesses are likely to help it scale up future revenues.

However, given the company's plan to partly fund its acquisitions and capital expansion through debt, earnings over the next couple of years may witness some pressure.

It could take over two-three years for CUMI to enjoy the full benefit of its acquisitions and capex, thus underscoring the importance of a long-term perspective on the stock.

At current market price of Rs 163, the stock trades at about 14 times its likely FY09 per share earnings. Investors may accumulate the stock in lots given the volatility in the broad markets.

Expanding capacities and markets

CUMI's prospects appear promising in view of the buoyant demand trends in its user industries such as fabrication, construction, auto, auto components and OEMs (original equipment manufacturers).

Besides, factors such as increased focus by government on infrastructure and a likely increase in outsourcing to Indian component manufacturers could also keep the demand for refractories/abrasives upbeat.

CUMI, with its planned expansion in capacities, appears well-placed to meet such an increase in demand. It has lined up a capital investment of about Rs 120-130 crore to expand capacity in its super refractories, abrasives and ceramics division.

Further, contributions may also flow in from its joint venture in China, which has capacity to produce about 3,000 tonnes bonded abrasives and is expected to commence commercial production from the third quarter of FY08.

Capacity of the industrial ceramics division is also set to increase to 5,200 tonnes from the current 3,000 tonnes. Nevertheless, it may be noted that effective contributions from the increased capacities are likely from financial year 2008-09 only.

Leveraging on the advantage of a low-cost manufacturing base in India and China, CUMI plans to set up marketing presence in Europe, the US and South-East Asia through subsidiaries or strategic partners.

This appears tactical given the increasing demand for abrasives and ceramics in the target markets, where CUMI's cost advantage could help give it a competitive edge over local players.

The management expects renewed focus on these markets to improve export revenue contribution from the current levels of about 22 per cent to about 40 per cent in two-three years.

New initiatives

CUMI recently announced its plan to enter the power tools business. This venture holds significant potential, considering the industry estimates, which peg the worldwide power tools market at about $12 billion and the Indian market at about Rs 400 crore. Besides, with companies such as Bosch growing more than 70 per cent in the last two years, this foray could add significantly to CUMI's markets.

Additionally, since CUMI already supplies consumables to the power tool industry (30 per cent of the power tool price), it will make the transition to an integrated player in the sector.

CUMI's presence in Silicon Carbide powder and bio ceramics space also holds promise. Notably, with the recent acquisition of VAW, a Russian manufacturer of silicon carbide (SiC) grain and bonded abrasive, CUMI has become the second largest producer of SiC.

This is significant since SiC is used in manufacturing abrasives and in powdered form is used for cutting polysilicon into thin wafers, a critical step for manufacturing photovoltaic cells. With only a few manufacturers of high quality SiC powder, this could help CUMI vault into the big league.

Financials

For the quarter ended June 2007, CUMI reported a 23 per cent growth in revenues. However, lower margins, higher interest cost and depreciation led to a 12 per cent drop in earnings.

Operating margins dipped by about 1.4 percentage points to 17.3 per cent on the back of increased raw material costs.

Going forward, this pressure could ease in the light of the shift in focus to products enjoying higher margin and on export markets, over a two-three year time frame.

On a segmental basis, abrasives contributed to about 64 per cent of the total revenues, while ceramics (19 per cent) and electrominerals (17 per cent) contributed the rest. This apart, any slowdown in capex and an unexpected rupee fluctuation could affect CUMI's earnings.

Besides, increase in sourcing of abrasives from the Indian counterparts of its competitors could also pose a risk to CUMI.