An­thony Clark: Dec­o­rate your port­fo­lio with Italtile

It will be on ev­ery profit path, thanks to the deal with Ce­ramic — and ex­cel­lent man­age­ment

Financial Mail - Investors Monthly - - Front Page - AN­THONY CLARK

Ihave cov­ered Italtile for 16 years and can say, tongue in cheek, that the counter was al­ways seen as a cash-“flush” prop­erty com­pany that hap­pened to sell tiles and san­i­tary­ware.

How times have changed, The R6.2bn rev­enue busi­ness has a net­work of 162 stores in three main brands — the lower-end Top T, the mid­dle-range CTM and the up­per Italtile. There are also man­u­fac­tur­ing in­ter­ests via a 21% stake in Ce­ramic In­dus­tries, prop­erty and sup­ply chain di­vi­sions

I wrote about three years ago — after a change of man­age­ment di­rec­tion and strat­egy that had started de­liv­er­ing im­proved earn­ings to share­hold­ers — that the CEO had seem­ingly taken “re­tail Vi­a­gra”.

The past few sets of re­sults have shown Italtile sharp­en­ing its re­tail pen­cil, dra­mat­i­cally im­prov­ing oper­a­tional ef­fi­ciency and earn­ings.

Ex­pan­sion into the af­ford­able lower end of the sec­tor via Top T, com­pet­ing against the of­fer­ings of Cash­build and the like, has grown Top T dra­mat­i­cally.

In re­cent re­sults, the low­erend seg­ment was the fastest­grow­ing unit, beat­ing the iconic CTM and Italtile stable of brands. Top T didn’t even ex­ist a few years ago and now con­sists of 64 na­tion­ally rep­re­sented stores.

An­other strate­gic turn has been made re­cently. The com­pe­ti­tion tri­bunal, after a baby-ele­phant pe­riod of ges­ta­tion and de­lib­er­a­tion, has given the nod to Italtile’s buy­out of 74% of Ce­ramic In­dus­tries. Ce­ramic is a lead­ing do­mes­tic man­u­fac­turer of tiles and san­i­tary­ware.

Italtile made an of­fer to ac­quire the mi­nori­ties of Ce­ramic In­dus­tries, a busi­ness it has known for decades. The of­fer val­ues Ce­ramic at R3.6bn payable in cash, debt fund­ing and shares. A rights of­fer to raise R1.2bn from share­hold­ers at a ra­tio of 22 new shares for ev­ery 100 held at 1,157c/share will also be un­der­taken.

While this seems like a large chunk of debt, Italtile’s prodi­gious cash flow and strong bal­ance sheet, backed by cash of R511m and prop­erty val­ued at R2.6bn, will re­duce debt sharply after three years.

The Ce­ramic deal will ce­ment Italtile’s po­si­tion and en­able it to con­tinue its growth vec­tor for years to come.

In ac­quir­ing Ce­ramic, Italtile gains ver­ti­cal in­te­gra­tion, thus trap­ping mar­gin along each turn, rather than giv­ing much of it away to mid­dle­men. From mak­ing tiles and toi­lets to dis­tribut­ing them to sell­ing them (mostly) in their own stores to sell­ing you the ad­he­sive to stick the prod­uct to your walls, Italtile will be on ev­ery profit path.

While wait­ing for the Ce­ramic ap­provals, Italtile was launch­ing new units, like sup­ply­ing its own shower en­clo­sures (a lu­cra­tive cat­e­gory) and re­fin­ing its sup­ply chain, dis­tri­bu­tion and lo­gis­tics ca­pac­ity.

Italtile’s 2017 re­sults to June were a tale of two halves. H1 2017 had a sound per­for­mance. Then, as do­mes­tic con­sumer and eco­nomic con­fi­dence weak­ened thanks to gov­ern­ment scan­dals and poor pol­icy, the econ­omy buck­led in the sec­ond half from De­cem­ber to June 2017. Earn­ings for the year had a 7% first-half rise re­verse by 7.4% in the sec­ond half as rev­enue fell by 9% in that pe­riod. Earn­ings for the year of 85.7c/share fell 1.4% y/y.

To cope with a weak­en­ing sit­u­a­tion, Italtile cut in­ven­tory by 28%, hoarded cash to R511m and cut over­heads by 7%.

Italtile, like its com­peti­tors, showed weak­ness in the past six months and in­di­ca­tions are that the com­ing De­cem­ber in­terim re­sults pe­riod will again be chal­leng­ing.

Con­di­tions may be chal­leng­ing, but Italtile is in ro­bust shape and the Ce­ramic deal adds a new growth vec­tor. At the time of writ­ing Italtile, at 1,286c, is on a p:e of 14.6, hav­ing come off by 6% this year.

Hold­ers of Italtile should cer­tainly follow their rights. Po­ten­tial new in­vestors should watch the counter. Given its in­her­ent strong qual­i­ties, I’d use any weak­ness to buy the stock for the long term.

In­di­ca­tions are that the com­ing De­cem­ber in­terim re­sults pe­riod will again be chal­leng­ing

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