Lanka Tiles poised for growth

Lanka Tiles (TILE) is a 51.5% subsidiary of Lanka Walltiles Ltd which is a subsidiary of Lanka Ceramics whose parent company is Ceylon Theatres Limited.

TILE has the capacity to produce 2.2 mn square metres of tiles annually. The company manufactures glazed ceramic tiles and has a network of 30 dealers and 35 distributors who service 450 sub dealers. Its market is presently in short supply enabling it to sell its entire production.

Efforts made to increase capacity by a target 40 per cent in the 3rd quarter through a 30 per cent increase in factory capacity and a 10 per cent increase in machine utilisation led to three shifts being operated at the plant. This led to inefficiency due to machine fatigue resulting in frequent breakdowns which caused a higher per centage of damages.

This is evident in the Q3 FY04/05 results which depict a 12 per cent increase in net sales with a concurrent increase of Cost of Sales by 35 per cent. TILE is likely to revert to a two shift operation in the near future. The company is expanding capacity to 2.4 mn square metres at a cost of Rs. 160 mn. The additional capacity is expected to be on stream in May 2005 when it will have a total production capacity of 7,500 square metres a day.

In the medium-term the company plans to expand capacity to 10,000 square metres per day at an estimated cost of SLRs 100 mn. The management perceive this to be the limit to capacity expansion in Sri Lanka due to the scarcity of raw materials such as ball clay and restrictions on mining it.

TILE is also planning to expand its production capacity with a plant overseas and is evaluating the feasibility of locating the plant in Bangladesh. The proposed plant requiring an investment of approximately SL Rs. 600 mn will have a capacity of 4,000 square metres per day.

The company presently has 460 employees and three unions with which it has entered into a collective bargaining agreement which will be operative till December 2006. The average wage bill amounts to 10 to 12 % of the cost of production.

Electricity and LP gas are the main sources of energy and account for 28 per cent of the Cost of Sales.

The on-going capacity expansion is funded by Rs. 100mn of debt and Rs. 60 mn internally generated funds. The average cost of borrowing for the company is around 10 per cent.

The venture into Bangladesh is expected to be funded through 50 per cent debt and the management is presently evaluating options to bridge the balance financing.

TILE is dependent on a single supplier for the supply of 60 per cent of its ball clay requirement and this leaves the company susceptible to arbitrary changes in price. The balance requirement is supplied by Lanka Ceramics.

Competition cheap

Imports from countries such as China, India and Thailand remain cheap due to economies of scale in production enjoyed by these suppliers. A 20 per cent cess on imports introduced through the November budget is unlikely to level the playing field.

Export sales constitute 15 per cent of turnover but revenue growth is being realised mainly in the domestic market which accounts for 85 per cent of turnover, and not in the export market. Its main export market is Australia and it also exports to Singapore, Italy, Maldives, Japan and Canada. TILE recently launched its brand in the USA and is on the verge of launching it in Germany.

Future performance

Revenue is expected to increase 31% YOY during the current financial year to SLRs.1,361 mn in line with capacity expansion which the market is able to sustain as it is in short supply. Cost of Sales increased disproportionately by 35 % to SLRs. 238.5 mn in Q3 2004/05 while sales in the same quarter increased 12% to SLRs. 329.8 mn due excessive processing damages.

The company plans to revert to a two shift operation and shed inefficiencies of Q3 to incur Cost of Sales in line with sales to end the year on an improved note. However increased finance cost due to borrowing is likely to keep Profit After Tax flat at SLRs. 140.3 mn for the FY 2004/05. We expect the Net profit After Tax to increase to SLRs. 233.6 mn in the FY 2005/06 as a result of the increased turnover due to the impact of the capacity expansion.

The forward PE multiples on forecast earnings are 9.31 times and 5.59 times for FY 2004/05 and FY 2005/06 respectively. With ambitious expansion plans on the horizon the company appears to be poised for growth and we are of the opinion that the stock suitable as a medium to long-term investment.

Courtesy: Lanka Orix Securities (Pvt) Ltd