Sanghavi Priyank J. Cera Sanitaryware Ltd.

Cera Sanitaryware Ltd. (NSE: Cera; BSE: 532443; ISIN: INE739E01017)

May 2, 2011. Current Market Price Rs. 186. Buy for duration of at least 3 to 5 years.

Margin of Safety is 42%.

Investment Summary: A business that converts abundant and therefore inexpensive raw
materials like Sand, Sandstone and Clay into branded products.

In the Berkshire Chairman’s letter to Shareholders, 2007, Warren Buffet writes: “Charlie and I
look for companies that have a) a business we understand; b) favorable long-term economics;
c) able and trustworthy management; and d) a sensible price tag”.

Analysis of Cera with respect to the above four filters:

a) Simple Business

Sanitaryware is a relatively slow changing business that does not require cutting edge R&D.
Sanitaryware includes Wash Basins, Water Closets (WCs i.e. Commodes), Cisterns, Urinals
etc. Cera also manufactures Shower Cubicles, Shower Panels, Bathroom fittings etc.
Humans have been using some of these products since centuries and shall continue to use
them in the future – so there is no risk of the products getting obsolete or of a threat of
replacement. Cera is not into manufacturing of tiles, which, according to me, does not have
a good moat.

Sanitaryware Industry

In India, Sanitaryware industry is 50-50 divided between the branded and the unorganized
sector. Three major branded manufacturers are Hindware (HSIL), Parryware (owned by
Roca - a Spanish company) and Cera. Other brands are Ess Ess, Kohler and Duravit - the
last two are multinationals. Hindware, Parryware and Cera have market share of
approximately 40%, 40% and 20% respectively. Ess Ess is relatively small while Kohler and
Duravit are into ultra-luxury segments and into exports. While only HSIL and Cera are listed,
HSIL has a high debt/equity of 1.0 relative to Cera’s conservative 0.3.

Moat

Moat for all three branded manufacturers is the pan India distribution network. Economies of
scale as well as rapport with the distributors and dealers cannot be quickly replicated by an
unorganized manufacturer. There is also a shortage of skilled labor for the industry giving
the established manufacturer an advantage over new competition. Knowledge about and
access to quality raw material leading to durable end products also works as a moat to a
certain extent. The moat enjoyed by Cera is seen in its increasing ROCE from 21 to 28 and
RONW from 20 to 22 between Mar’06 and Mar’10. Also, I believe that the returns are high

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but not extra ordinary high for a big industrial house with deep pockets to setup scale and
distribution network from scratch.

b) Long Term Economics – Demand Side

Demand for Sanitaryware products shall increase in tandem with that of the residential and
commercial real estate industry. As the current middle class progresses economically, they
shall start paying equal attention to their bathroom interiors as they do their room interiors.

India also has a large, young and educated population in smaller towns who are willing to
migrate to bigger cities for white collar job opportunities. Eventually they marry but most
often it is not feasible for their parents to follow them into the cities. This results in the
creation of a new household. Increasing trend of nuclear families also results into creation of
new households.

Long Term Economics – Supply Side

While these are favorable long term demand economics for Cera’s products, there is not
much concern on the supply side as well since the raw material is abundant and hence
inexpensive. Study of the past ten years’ books of Cera shows that there has never been an
acute margin squeeze due to uncontrolled increase in raw material prices.

c) Able Management

Unlike HSIL’s, Cera’s management never went overboard with promised growth prospects
resulting in higher leverage. At the same time, they have been prudent enough to use little
leverage. Cera had been the first Sanitaryware Company to use natural gas resulting in
lower cost of production relative to its competitors. The twin-flush model launched in India by
Cera for the first time, reduces the water needs of households considerably. WCs designed
to flush in just 4 litres of water is another notable innovation by Cera.

Trustworthy Management

While there is no evidence of honesty of Cera management, there is no evidence of

dishonesty either. Management pay is reasonable. Directors have been regularly attending
the board meetings. One of the independent directors has a 1.94% stake in the company as
on Dec 31, 2010. This ensures that the director is not just interested in sitting fees but also
has sufficient incentive to see that the company is well run.

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Sanghavi Priyank J. Cera Sanitaryware Ltd.

d) Valuing a business is a very subjective matter.

Calculating Owner Earnings:

Average Net Profit from Mar ’07 to Mar ’11 is Rs. 15.8 Cr.

Since this is not a capital intensive business, it is safe to assume that the depreciation costs
equals the capital expenditures required to maintain the same level of business.

Estimating growth rate:

Top line CAGR from Mar ’07 to Mar ’11 is 23%.

Operating profit CAGR from Mar ’07 to Mar ’11 is 23%.

Net Profit CAGR from Mar ’07 to Mar ’11 is 32%.

To be conservative, assume Net Profit CAGR of 12% for the next ten years and terminal
growth rate of 3%.

Estimating Discount rate:

Since this is a simple, non-changing business with a good track record, it is safe to assume
that investing in this business is relatively risk free. Hence use the discount rate as 10% i.e.
slightly higher than the ten year G-sec rate.

Calculating Intrinsic Value:

DCF using the above values gives intrinsic value of Rs. 450 Cr.

Enterprise Value (EV) of the business is Rs. 260 Cr.

Margin of Safety is 42%.

At the Current Market Price of Rs. 186, PE (ttm) is 8.5 for a business that has four years Net
Profit CAGR of 32%. PEG is 0.27.

EV/Sales is 1.07.

Note: I own shares of Cera Sanitaryware Limited. My average purchase price is Rs.
165.

Over long periods, stock price follow the performance of the business.

Do not buy to trade in this stock since this is a low volume stock.

For any queries, feel free to contact me.

Priyank J. Sanghavi; priyankjs1@gmail.com; +91 96381 04733

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