The market does not pay an investor for the company’s past. It pays for the future. Many would pass on Pokarna for its messy past. Like many other companies it over leveraged its Balance sheet and got into trouble. The company is now shifting gears and showing signs of turnaround. Having paid off its FCCBs, Pokarna is on the highway of fast expansion in the growing natural and engineered stones market.
Set up in 1991, Pokarna Ltd. is into three divisions-
1.Granite – This accounts for 45% of the revenues. Pokarna is the largest exporter of finished granite in India. It sources 80% of its materials from its own quarries and processes them in its state-of-the-art manufacturing facilities in Andhra Pradesh and Telangana. Finished granite by the company finds primary application in flooring and kitchen countertops. It is also used for gravestone segment.
Exports account for approximately 75% share in this segment while USA alone accounts for 31%. The company has a capacity of around 6 lakh square feet per annum and was operating at 70% utilization in FY 2015. This division has grown at a CAGR of 12%. Some of the projects that the company has supplied to are: Reliant NFL Stadium, Houston, USA, Radisson Hotel, Flint, Michigan, USA; Buckhead Village, Atlanta, Georgia, USA, Tidel Park, Chennai, India and Amaravathi Buddhist Museum, Guntur, India.
2. Quartz- What led to the mess is now the shining knight in the company. Operated under the wholly owned subsidiary Pokarna Engineered Stone Limited (PESL), the company entered into manufacturing quartz in 2006. In order to set up the manufacturing plant, the company issued FCCBs worth USD 12 million in 2007 which were to be redeemed on March 29 March 2012. The FCCBs were convertible at the price of Rs.294. Quartz, like Granite finds primary application in kitchen countertops and is also used for bathroom countertops, bar, floor and exterior walls and so on. The fate of this segment is dependent on the housing market and since US accounts for more than 70% of export revenues, the company suffered in the downturn after the financial crisis and defaulted on its payment.
The company started selling quartz under the brand name ‘Quantra’ and it took a while for the company to enter the US market which was dominated by Caesarstone and Cambria. Owing to its quality products, problems faced by its main competitor-Caesarstone and turnaround in the US housing market, this division started gaining fast traction and acceptance in the US market. The quartz segment has grown at a 5 year CAGR of 70% and is showing no signs of stopping. The company redeemed all its FCCBs in 2015 and reduced its debt burden. This segment now accounts for 51% revenues of the company (as per the latest quarterly numbers Q3FY16). The company has a capacity of 6 lakh square feet/annum and was operating at around 50% utilization in FY 2015.
PESL is the only company in India using patented Bretonstone Technology from Italy to manufacture quartz surfaces. This technology is a testament to quality and is considered as an important parameter by the buyers of the product. Breton is the world leader in the stone industry for its technology and has patents globally. There are only a few manufacturers globally with this technology. The company sells its products to dealers who sell it to fabricators some of which are on an exclusive basis. As per the director of Breton, Mr. Dario Toncelli, ”Among the many brands in quartz, Quantra is one of the best quality brands”.
Some of the projects the company has supplied to are: Mumbai International Airport (T2), Continental Hospitals – Hyderabad, Dew Flower, Sobha Developers – Bengaluru, Arlington Downs – USA, Marriott Irvine – USA Amli Ballard – USA, Amway Specialty Suites – USA.
3. Apparel – Although it accounts for only 4% of the revenues, this division is a drain on the company’s resources. Pokarna sells apparels in the brand name ‘Stanza’. It has been continuously making losses and sooner or later I expect the management to be wiser and get rid of this division. Last year the apparel segment did sales of 7 cr with EBIT of -10 cr.
To know more about the business and please watch this video- http://www.quantra.in/seeourfilm.html
Industry :Tailwind in the construction and renovation market supplemented by high demand for stones especially quartz is driving growth for ‘Quantra’ and granite slabs by Pokarna
As the disposable income of consumers increases, so does their appetite for luxury consumption. We have seen how the likes of Cera and Kajaria have performed over the past few years due to the same reason. Granite and quartz take aesthetics a notch higher. Although the trend is yet to pick up in residential market in India, it is growing rapidly in the developed markets especially US which is one of the major market that Pokarna caters to. In India, the demand is mostly from non-residential market.
Since Pokarna’s products are primarily used for flooring and countertops, the fate of the company is closely linked to the construction activities in its target market. The demand is dependent on new construction and renovation projects. Construction is US has been picking up since 2014 after 5 years of stagnation. This year construction is expected to increase by 6.5% mostly led by the residential market according to Contruction Market Data’s (CMD) latest forecast.
By 2018, demand for floor coverings will be the fastest in North America led by recovery in the housing sector in US. The housing sector in US is expected to grow at 6.2%. Although granite flooring currently accounts for a small portion in residential flooring, it is picking up pace and is expected to grow most rapidly in US overtaking porcelain and is expected to be the second largest type in area demand terms by 2017.
Second use of Pokarna’s products is for countertops which is growing faster than flooring. The global market for countertops is estimated at USD 81b. Until recently, natural stone was mainly used in luxury homes in US. However, with cheaper imports the availability has been extended to the mass market.
Currently in US, Laminates account for a high portion of countertops market. However, natural stone and engineered stoned (Quartz) are rapidly eating into the market share as can be seen below.
The share of engineered stones has doubled in a matter of 5 years. As per a study of countertops by the Freedonia Group by 2017, “the annual installations of natural-stone tops will hit 130 million ft²”. Demand for natural-stone countertops will increase at 7.6% annually- the highest among standard materials. It is will be closely followed by quartz surfaces at 7.4%.
While the usage of natural stones like granite, marble, soapstone for countertops were dominant in the past, there has been a visible shift in favor of quartz over the past decade. The migration has resulted in the product becoming the fastest growing material to be used in the countertop industry, gradually eating into the share of other materials, such as granite, manufactured solid surfaces and laminate.
As compared to 4.4% 15 years CAGR growth in countertop market globally, quartz alone has grown at a CAGR of 16% over the same period. The use of quartz as a countertop still has a long runway for growth in the US market where the penetration is just 8%
‘Quantra’ is known for its quality and price and hence is showing high growth. Pokarna’s exports are facing stiff competition from Brazil in the granite segment. As per the CS, Brazil has an upper hand in terms of colours and currency depreciation.
A deeper look into revenue distribution in terms of geography reveals more insights. The distribution of granite is varied across geographies with US accounting for the highest share closely followed by India. India accounts for 20% of the world resources in granite and exports more than 200 varieties. Although, around 80% of granite in India is used for exports, the demand is increasing in India due to uptick in non-residential construction and renovation like malls, hotel and airports. The demand for countertop is the highest in Asia Pacific and hence a lot of company’s granite is also exported there.
Most of the company’s manufactured quartz is being exported to US and is highly dependent on the fortunes of the US construction market. The company is slowly but surely expanding its geographical distribution by targeting Europe. Last year, it entered into an exclusive contract with Dekker Zevenhuizen B V in Netherlands to sell its products under the brand name ‘Quantra’.
Since my investment thesis is based on the Quartz segment, I will mainly focus on it in this report.
Quartz imports to US is growing at a scorching pace. It has been setting records consistently since the past year due to high demand by fabricators who in turn sell it to eventual consumers. The growth rate of imports from India have shown a YOY increase of 219%.
As per the latest monthly data available (November 2015), India again showed high growth rate of above 250%. In October, imports from India witnessed a growth of 478% YOY.
Financials : Pokarna is showing turnaround in its numbers aided by fast growth and repayment of debt
As mentioned, the company had a torrid time pre 2014. The housing market in US started picking up in 2014 and it also led to a revival in the company. Quartz segment picked up majorly in FY 2015 with 120% increase in revenue YOY. Due to operating leverage coming into play the company also improved its operating margin from 2% in 2010 to 19% in 2015.
The company redeemed all its outstanding FCCBs in mid-2014 and therefore improved its net profit margins too. Since the company procures its own raw materials from quarries, it has high gross margins. The total revenue (incl. scrap/other income) has grown at a CAGR of 18 % over the past 5 years.
The growth in the quartz segment continues in FY 16. The consolidated 9 months revenues are up 31% while the PAT has increased by 3 times over the same period in FY 15. The granite division has witnessed a marginal decline due to competition but that has been compensated by 75% increase in quartz surfaces in 9M FY 16. The EBIT margins of the company has improved to 30.4% during the same time. The ROCE on the Quartz segment stands at 30% while it amounts to 35% in the granite division.
Due to this transformation, the ROE of the company is close to 50%. Since the company has been reducing debt, the increase in ROE is mainly on account of increasing net profit margin and asset turnover.
The company also declared a dividend of Rs.3/share in FY 2015. The company needs to stop reinvesting in its apparel division and I am hoping sanity will prevail. That said, the company is slowly shifting its focus away from the apparel segment and has not increased the capital employed on the division. Quartz now accounts for more than 50% of the revenues (9mFY16). It accounted for 31% in FY 15.
With FCCBs out of the way, the company intends to use its cash to pay down the debt. The D/E ratio of the company is still very high. However, the ratio is also higher due to equity erosion in the past. In HY16 the company’s equity has already increased to 78 cr and the LT debt to equity has come down to 2.5.
Out of the 200 cr long term debt, 110cr amounts to loan taken from banks while the remaining amount is the loan given by the promoters. Below is the debt maturity profile of the term loans-
The company has consistently generated positive CFO except in 2014 when the receivables increased. Pokarna generated good free cash flows last year and since it does not have major capex planned, we can expect the company to generate FCF going forward too. As per the CS, the company may incur capex in the quartz division, however the amount will not be high since the company already has a provision for a second line in its Vizag plant.
Given the strong cash flow generation, low capex planned in future and strong bottom line growth, it is reasonable to assume that the company should not have much problems in paying down the debt.
Competition : Although the company faces stiff competition from across the globe, it is making a mark in the market as a result of its relationships with the dealers and adverse situation of one of its major competitors in US.
Pokarna Ltd. has been exporting finished and processed granite which is facing stiff competition from Brazilian manufacturers who have better colours and their currency has depreciated recently which enables them to sell cheaper.
As per the National Kitchen and Bath Association (US), “While both quartz and granite countertops were specified by more than 80% of respondents in 2014, only quartz is expected to increase, while NKBA designers expect fewer granite countertops in 2015”. US has also witnessed decline in granite imports recently from India. Hence, the real differentiator is ‘Quantra’ which is renowned for its quality. The company does not face any competition from India due to its use of patented Breton technology. There are players like Asian Granito which have inferior products in terms of mix(marble + quartz) and no access to Breton technology. Breton is an important technology for countertops as the manufacturing process is “Eco-friendly” and the finished product is free from micro porosities.
Pokarna’s main competitors in US are Caesarstone (Israel), Cambria (Minnesota), Silestone (Spain) and Dupoint (Canada). They all use Breton for manufacturing. All quartz manufacturers use the 93/7 formula (93% quartz and 7% polymer). Cambria is the only company that manufactures in USA. Caesarstone as per their latest AR have also set up a manufacturing plant in US. There are Chinese imports too but they use a lot of chemicals and hence their colours fade easily.
Pokarna Ltd. sells its products to third party dealers who in turn sell it to fabricators. The fabricators then sell products to contractors, developers and customers. Caesarstone is the only company in US which has both direct and indirect sales channels. It spends 60% of it expenses on advertising.
The market is very competitive and the main determinant for the brands would be the tie ups with the dealers.
Caesarstone has exclusive tie-ups with IKEA US and Canada, Silestone sells exclusively through Home Depot, DuPoint sells through Lowes and Pokarna sells exclusively to Daltile, Oregon Tile and Marble and IGM.
Caesarstone claims to have 19% market share in US. However, a recent ‘short’ report by Spruce Point Capital(http://www.sprucepointcap.com/cste-ltd/ ) not only questions these claims but also questions the quality of the product. As per their lab tests, Caesarstone had only 88% quartz and 12% polymer as compared to industry benchmark of 93% quartz and 7% polymer. The feedback of customers on http://countertopinvestigator.com/caesarstone-countertops/ and http://www.yelp.com/biz/caesarstone-san-leandro is not very encouraging and people have been complaining about stains and warranty on the product. Due to these reasons, Caesarstone has just shown 11% increase in revenues last year as compared to its previous 5 years average of 25%. The decrease is also due to stiff competition from cheaper imports as mentioned in the report and also by Caesarstone in their 2014 AR-
“We face competition in all of our key markets, primarily from manufacturers located in the Asia-Pacific region and in Europe that market quartz surface products at lower price points, including quartz surface products which imitate our products and designs. Manufacturers in China, Vietnam and other countries in the Asia-Pacific region frequently benefit from labor and energy costs that are significantly lower than our costs and enable them to price their products lower than our products. Under these circumstances, we can face direct competition that significantly undercuts the prices that we are able to charge and that we seek to charge our customers, as well as the prices that our distributors and fabricators are able to charge consumers. Even if we seek to lower the prices that we charge for our products in certain markets, we may be unable to achieve the same labor and energy costs in order to maintain current margins on our products”
As per the CS, Daltile- a big retailer of wall and flooring products which used to sell Caesarstone’s products, cancelled its contract with them recently and is now selling Pokarna’s quartz surfaces on an exclusive basis under the brand name One Quartz.
Caesarstone mentions labour being a primary reason for cheaper imports from Asia Pacific. Recent wage hikes in China has increased the labour cost by as much as 5 times (incl. social security costs) as compared to India. Labor accounts for 20% of the operating costs for Pokarna. This gives another opportunity to Pokarna Ltd. to increase its share in the US market.
To increase market its market presence, Pokarna has been displaying its products at various exhibitions and its marketing team is closing relationships with the dealers in the target market. Although there are many competitors, the market is large enough to accommodate all.
Voice of the dealers
I called up a few dealers of Quantra to understand the product, competition and what influences a customer’s decisions. Pokarna Ltd. is currently a B2B business. I spoke to dealers in US since that is the main market that Pokarna caters to.
Bedrosian, which used to exclusively sell Quantra until recently has discontinued the product. Instead they have started selling their own brand (Sequel Quartz) seeing the growth in the market. While one of the dealers cited quality as an issue, others said that there was no particular reason for them to discontinue the product. Most Bedrosian dealers mentioned that the management saw more potential in their own brand.
Oregon Marble and Tile has 5 dealers and sell Quantra only. They spoke highly of the quality of the product and said that they have been getting good feedback from the customers. There are two things that stood out for Quantra- range of exclusive colours and price. Average price for Quantra is around $25/sqf for 3 cm thickness as compared to $28-30 for Cambria. Caesarstone sells its product at an average price of $30-35/sqf since it has positioned itself as a premium brand. While only one dealer gave me a quote for the slabs, all others mentioned that the price depends mainly on the fabricators that are selling the product which includes the cost of installation.
Daltile, another dealer who buys exclusively from Pokarna sells its products under the brand- One Quartz. Again the feedback was good from dealers. They told me that Chinese quartz does not find application in kitchen countertops due to their inferior quality. They also told me that they are witnessing an increasing demand for quartz and have been increasing their inventory.
In terms of quality, all dealers said that the brands are on par with each other as long as they use Breton technology. The main criteria for decision making for the consumers are the fabricators and colours. As per a fabricator, “For a consumer- a quartz is a quartz” and hence brand does not play a significant role. The fabricators quote prices including their cost of installation which plays a major factor. In some cases cost of installation goes beyond the price of the slab itself. Some fabricators quoted as high as $70/sqf. The consumers have faced problems with installation in the past and hence they need to be wary of the skill level of the fabricator.
One of the fabricators also mentioned that the likes of Caesarstone and Silestone are giving high discounts on their products due to availability of cheaper products with the same quality. In some cases the discounts are as high as 40%. This will impact the margins of these companies and it will be interesting to see for how long they can maintain it.
I learnt from the conversations that every brand is on a level playing field. The real differentiator would be exclusivity with the dealers and the fabricators who in turn sell it to the eventual consumers. The market is very competitive and I believe that expecting a 50% growth YoY is unreasonable. As the base effect narrows and more competition enters the market, the growth rate would be more realistic. As per Daltile, it is reasonable to assume 20% growth rate for the next few years.
Valuation: Pokarna Ltd. is trading cheap on relative valuation and DCF based on conservative estimates
The closest listed comparable for Pokarna Ltd. is Caesarstone in US. Caesarstone’s stock took a beating recently after the report. Even though Pokarna has far better growth prospects than Caesarstone, it still looks cheap on a relative basis.
Based on conservative growth estimates, the company is trading at a discount to its PV of cash flows.
The company has very low institutional holding and is yet to be fully discovered by the market. It has no analyst following.
Why Pokarna Ltd.?
- Tailwinds– Pickup in both residential and non-residential construction market in US along with high demand for granite and quartz is a big positive for this company. The construction market witnessed it best growth in almost a decade in 2015 led by residential market. It is expected to grow 3.1% annually in real terms from current 1.7%.
Quartz is expected to be the fastest growing stone in the market. Residential market in US performed better than commercial last year and it accounts for 80% of the quartz countertop demand. Quartz penetration in US is increasing at a fast rate. Quartz growth has outperformed the industry growth in the past and is expected to continue on the same trajectory
Despite, increasing usage, Quartz accounts for just 8% of all countertops in America, resulting in one of the least penetrated developed markets in the world. The figure pales when compared with Australia and Europe wherein the share of the product ranges from 30% to 50%.
Quartz seems to be following the same growth story that granite countertops witnessed in the 90s in US when there was so much demand that the companies couldn’t even cater to it. As per NKBA, Quartz is the next big thing. The reason for the same is its uniform appearance, higher hardness rating as compared to other materials and its non-porous nature. Natural granite on the other hand needs to be sealed twice a year and its shine wears over time. The demand for quartz is high in both remodelling and new construction market.
Added to this, fed rate hike and interest rate cuts in India are dollar bullish which should benefit the company since it earns 70% of its revenues from exports.
Polymer which is expensive and comprises of 7% of slab material is dependent on the price of crude. Falling crude should further help company to expand margins.
- Growth- Pokarna Ltd. has a long runway for growth. ‘Quantra’ has just started picking up in US and is slowly entering other markets. It recently entered Netherlands through an exclusive tie up with Dekker Zevenhuizen which will sell its products under the brand name EQ by Quantra. Pokarna also entered Greece and Middle East. The company is making efforts on marketing and distribution. It showcased its ‘Ganges collection’ range by Quantra at Marmomacc event in Italy which is considered the biggest annual event in the stone industry. This was the biggest product launch in company’s history. The company was also awarded Kosher certification for its products. Kosher means proper or acceptable by Jewish traditions. This confirms that the product adheres to the highest quality of Kashrut(Jewish dietary laws) and allows the Kosher consumers to use Quantra in their kitchens. As per Mr. Gautam Chand, “This certification besides enabling us to expand our market presence will also help us meet the growing demand for products conforming with Kashrus principles. Equally important, it will help us strengthen the trust for our products in the Jewish market”. Caesarstone is the only other competitor with the same certification.
Pokarna has also made a mark in the domestic market by executing lucrative projects in the non-residential market like Taj hotel, Mumbai Airport etc. With disposable income rising, consumers will gradually shift to granite and quartz in the residential market too.
The company upgraded its plant to manufacture jumbo slabs this year due to their high demand in the US market.
As mentioned, maintaining and developing relationships with the dealers is key. In the construction market they would also need to work on creating awareness amongst the developers. In renovation market, I believe fabricators will play a major role in influencing a customer’s decisions. Since Pokarna enjoys better margins than its competitors, they can give more dealer commissions thereby penetrating the market. Caesarstone, in particular has been witnessing margin compression due to supply problems and also discounting being given to fabricators as a result of competition from cheaper imports.
- Improving financials – Pokarna ltd. is showing improvement in its numbers with increasing margins and ROE. The company is paying down debt and increasing top line which is always a good sign. As per the CS, the company intends to use excess cash flows for repayment of debt and will be wary of capacity expansion in case it puts more strain on the balance sheet. The company reported net profit margin of 20% in Q3FY16. Since it’s a capex heavy business, operating leverage will come into play with increasing sales which will further enhance the margins. Quartz division EBITDA increased by 228% YoY in 9mFY16. The company is also available at a good valuation with protected downside.
- Competitive edge – Pokarna is the only company in India with Breton technology. Bretonstone System follows an eco-friendly friendly manufacturing process and the final product guarantees an optimum “indoor life quality”. It also has an advantage of cheap labour when compared to its global peers. It takes about 2 years to set up a plant using this technology.
When it comes to granite, Pokarna Ltd. has its own quarries for raw materials. Getting a license for the quarry is a very difficult process and takes at least 2-3 years. There is abundant supply of raw materials in Andhra and Telangana where the company is located. Pokarna Ltd. has a head start in the market and has an opportunity to establish solid dealer networks before more competition enters the market.
- Supply of quartz– As per the CS, Pokarna Ltd. has been sourcing quartz from quarry owned by the Chettinad family. The company has applied for licenses but is yet to be granted one. The management is optimistic about getting it soon. They only have verbal agreement with the supplier. A quick look at the Government data for quartz mining lease shows that Pokarna has 20 hectares which is not operational(expires on March 2018) while Chettinad has another 20 hectares. There is lack of transparency in the deal between the two entities and the CS was not willing to answer the question.
- Slowdown in the construction market– Any slowdown in the construction market will impact the demand for Pokarna’s products.
- Apparel segment – The management has been destroying value on this segment. Although the company is shifting its focus away from this division, it still remains a drain on Pokarna’s profitability
- Inability to pay debt– If the company fails to generate cash flows due to slowdown in the sector or intense competition, the company may default on its debt.
- Corporate Governance– The company has material related party transactions and an investor needs to be cognizant of these transactions and the risks that come with them. Also the promoter took more salary in 2009 than what is permitted.