Lanka Walltile records 14% Ceylon Theatres Group

Lanka Walltile Limited yesterday released its third quarter results. Following is an Interim Update by Nuwan de Silva of Asia Wealth Management:

Lanka Walltile Limited (LWL) yesterday released its third quarter results, recording recorded a 14% growth to Rs. 6,444.3 m in the top line on the back of the increased demand by the local market.

The company noted that 60% of the top line was contributed by the tile segment followed by packaging materials which contributed circa 18% of the counter’s turnover. Going forward, with the construction sector boom together with strong investment inflow and higher activity levels in the country, the company pertains value as a potential growth stock.

The wall-tile giant encompasses Lanka Tiles PLC (54.5% ownership) and Uni-Dil Packaging (52.9%) whilst having a controlling interest in Horana Plantations PLC with a 27% effective holdings (through Ceytea Plantations). Furthermore, LWL has an associate interest of 34.6% on Parquet (Ceylon) PLC, which changed its core business to production of Grout and Mortar.

Going forward, with the construction sector boom together with strong investment inflow and higher activity levels in the country the ‘tile giant’ pertains value as a potential growth stock.

Company overview

LWL, a member of the Ceylon Theatres Group and a direct subsidiary of Lanka Ceramics recorded a 47% YoY gain on the back of the empowered construction run and capital investments flowing into the country with the economic uptrend.

The walltile giant encompasses Lanka Tiles PLC (54.5% ownership) and Uni-Dil Packaging (52.9%) whilst having a controlling interest in Horana Plantations PLC with a effective 27% holdings (LWL owns 52% of Ceytea Plantations whilst Ceytea Plantations own 51% of Horana Plantations).

Furthermore, LWL has an associate interest in Parquet (Ceylon) PLC, which was running with inefficiencies and out dated machinery over at the Balangoda plant and discontinued operations over the last few quarters. Albeit the closure of the factory, the company had to increase further costs related to a Voluntary Retirement Scheme (VRS) amounting to Rs. 216 m.

However, internally generated funds smoothen the transition period. The strategic change allowed LWL to divest from the loss making venture and to concentrate on high yielding opportunities in the sector.

With the expected construction boom and in anticipation to meet the growing international demand, the Meepe factory which has a current production capacity of circa 5,000Sqm per day is being expanded by a further 3,600Sqm per day to facilitate production of 9,000Sqm of tile by FY2012 with an investment of Rs. 558 m.

This growth momentum will be strengthened by the subsidiary’s (Lanka Tiles) expansion investment of Rs. 500 m to bring the floor tile capacity to 11,500Sqm by the start of FY2012. Further, to promote the export business a ‘Trim Tile’ line would be added to the Meepe plant which would expect to be in operation by 1QFY12.

The increased capacity and the divestment of the Balangoda factory together with the positive earnings from the plantation arm, the company was able to record a circa 30% growth in cumulative 3QFY11 PAT where a near 73% was contributed by the 3rd quarter results of Rs. 410.3mn.

A glance at 3QFY11 performance

Strong construction sector boom pilling turnover: LWL recorded a 14% incline to Rs. 6,444.3 m in the top line for the cumulative 3QFY11 on the back of the increased demand by the local market. 60% of the top line was contributed by the tile segment followed by packaging materials which contributed circa 18% of the counter’s turnover.

Uni Dil Packaging and Uni Dil Papersacks which comprises the packaging arm of LWL witnessed high sales level with gaining market recognition as a leading all-round packaging entity. The plantation sector which witnessed healthy turnover levels due to the strong commodity prices contributed 22% of the top-line. Further, the tile plant was running at a utilisation rate in the upper range of 90%.

Gross profit margin to strengthen with stabilised energy costs: The escalation of energy prices which constitutes LP Gas has a significant adverse impact on the cost of production as 40% of the cost of sales is attributable to the said segment.

The volatile gas prices and the impose of a Cess of Rs. 13.12 per kilo during September 2010 had a negative impact on the tile sector as the tile plant consumes nearly 1,000 metric tons of gas per month to light up the kilns. Yet, with Government initiation, the stabilised energy costs and the lowered labour costs brought about a strong Gross Profit Margin of 30% in 3QFY11 in comparison to margin of 27% the previous year.

Reaping income via dividends: The other income component which includes dividends from LWL’s subsidiaries witnessed a staggering growth of 123% YoY on the back of strong earnings. Further, the cumulative 3QFY11 recorded Rs. 123.5 m as other income which is a significant jump of 74% YoY.

Distribution inline amidst expansion: Distribution cost remained flat at Rs. 95.1 m in the 3rd quarter FY2011 even though the counter has increased its distribution network over the said period. Currently the showroom count tops 14 in number with 12 franchise operations.

Further, the distribution network is shouldered by the six Lanka Ceramic branches and three more franchise showrooms which are in the pipeline for the coming quarter. Lanka Walltile in collaboration with Lanka Floor Tile would be launching a common brand ‘Lanka Tile’ during the present quarter. The above brand investment is expected to drive the distribution cost higher over the following quarters.

Healthy operating margin: The operating margins of the counter settled at a healthy 22% for 3QFY11 in compassion to 19% the previous year. The strengthening of the operating margin could be attributable to the reduced administration cost of the Balangoda property together with the strong earnings through the plantation arm.

Declining burden on finances: The counter witnessed a decline in finance expenses to Rs. 48.8 m (dip of 17% YoY) for 3QFY11 with a majority of loan capital being paid off during the year. Further, a major component of finance expenses were derived from the plantation sector whereas the tile companies (walltile and floor-tile) remained in the positive cash territory during the quarter. Yet, for capacity expansion purposes LWL is said to go for a five year loan with a one year grace period.

Soaring profits despite anomalies: The cumulative Profit Before Tax recorded a strong LKR817.9 mn (31% YoY Gain) despite a non recurrent loss of over Rs. 216 m as the VRS and the closure of Balangoda factory. The 3rd quarter performance was up by an impressive 38% to Rs. 502.2 m on the back of the strong demand not only for the core tile products but for the packaging arm as well.

Further, the plantation sector had a significant impact on the bottom line with the rubber prices appreciating over the year. Even though the counter recorded a strong cumulative PAT figure the minority interest weighed down the equity holders portion of earnings.

The cumulative 3QFY11 net profits decline by 10% to Rs. 246.6 m whilst the quarterly earnings recorded a 44% incline to Rs. 226.9 m. However, the company earnings is in line to grow on the back of the accelerated investment rate and the high geared economy.

Future outlook

Lanka Walltile is poised to grow in the current economic outlook backed by its presence in the construction sector. The hike in the per capita income backed by the credit growth in the island is going to strengthen the future earnings of the counter.

Further, the rubber price appreciation over time and the demand for Sri Lankan plantation products would support the counter’s subsidiaries. The expected capacity expansion would shoulder the future revenue whilst the export oriented ‘Thin Tiles’ would gain additional income and add flavour in to the international markets.

With the change in business strategy (change from wood base flooring to production of grout and mortar) of Parquet Ceylon the counter is poised to gain from the untapped local market segment. With no Balangoda plant weighing down the counter’s performance, future earnings are expected to improve. Further, the capital gain from the disposal of property in Balangoda is expected to be accounted for in the near future.

The rebranding of the Lanka Walltile would uplift the image of the organisation with a strong recognition among the local and international clients. Further, the growing franchise network would add presence to this newly developed brand across the island.

Therefore, in the midst of rapid economic uptrend backed by the strong construction sector boom the company is poised to grow. The capacity increment together with the dismissal of the loss making counterpart would be reflected positively in the financials for Lanka Walltiles. With an umbrella of investments covering the construction sector togather with a touch of diversification via the plantation sector the counter is set to perform on a positive note going forward.

Valuations

In light of the recent performance measures and the potential opportunities in the Sri Lanka economy as well as the global market we strongly believe that LWL has a definite upside potential backed by its strong earnings.

In the current market context with high levels of activities we expect LWL to post a profit figure of Rs. 448.2 m in FY2011E dipping 6% YoY whilst in FY2012 to pertain an earnings figure of Rs. 689.9 m (54% growth). Share is priced at 20.0X trailing earnings with the counter reaching its highest prices of circa Rs. 164.00 (post capitalisation of 9.1 m shares) at present.

Following a steep price hike LWL has gained over 151% in the current period on the back of positive earnings sentiments associated with the counter. At current price levels the counter is trading at a projected earnings potential of 20.0X for FY11E whilst for FY12E the expected Price Earnings is valued at 13.0X.

Based on an analysis of a historic one year price movement, we derived a price volatility of +/-23.80 on a mean of LKR102.20 hence the flux is circa +/-23.3%. Furthermore, if it is assumed that the same upside momentum is witnessed pushing the price to Rs. 203.00 (from the current level of LKR164.00), the forward PE multiples would increase to a figure of 24.7X and 16.1X for FY11E and FY12E respectively.

Further, on an adjustment of LWL’s return to its risk (deviation of the share price), the derived Sharpe ratio of the counter is at 2.3 whilst the Tile Sector (deviation from the cumulative index of RCL, TILE, LWL & PARQ ) and the market records a Sharpe ratio of 1.7 and 4.0 respectively which is below the market threshold.

LWL’s volatile adjusted risk is moderate due to the counters deviation of returns has been 25.7% as opposed 10.5% of the market. Hence LWL display a moderate risk adjusted return when compared to the Tile sector and the market.

Going forward with the construction sector boom together with strong investment inflow and higher activity levels in the country the tile giant pertain value as a potential growth stock.