Description
· Business Description
o Leading manufacturer of engineered quartz surfaces, primarily used as countertops in residential kitchens
o The company produces a range of colors, finishes, textures, thicknesses and other physical properties, allowing them to fit different functions and price points
o Products are currently sold in over 50 countries through a combination of direct sales and indirectly through third-party distributors
o They had revenues of approximately $360mm in 2013 (35% from US, 25% from Australia, 14% from Canada, 12% from Israel, 6% from Europe, and 8% from the rest of the world)and EBITDA of ~$90mm
o Caesarstone was founded in 1987 and went public in March 2012 under the ticker CSTE
o The company operates five production lines across two manufacturing facilities in Israel- two at its plant in Kibbutz Sdot-Yam and three at its Bar-Lev facility
o A limited number of slabs are acquired from independent third parties
o In the process of building a US Facility in Georgia (once completed company expects to meet demand needs internally)
· Company trades at ~22x EBITDA and 40x P/E clearly implying massive increases in market penetration for quartz
· Even at a premium multiple of 10x to comps (~8.5x for Fortune Brands, PlyGem, Beacon Roofing) and assuming a through-the-cycle EBITDA of $130mm company is worth $1.3bn versus a current market cap of $2.2bn for ~41% downside
Main Points
1. Bull case is that Kitchens are increasingly becoming focal point of American home, quartz rapidly taking share of Kitchen countertops in US because better quality than granite and cheaper
2. Bull case is wrong
a. Not Cheaper
b. Not only not better quality, but worse quality- sun staining
c. Extremely limited competitive advantage- no patents, all companies use the same equipment to produce, not a differentiated product, Caesarstone puts shiny chemicals in their slabs to “differentiate themselves”, when they were founded in 1980 the Company was the only one producing quartz, now they’re the third largest (behind Silestone, Cambria)
i. There’s a reason there is no granite countertop manufacturer with significant market share
d. Company trades at 24x EBITDA and 40x EPS- sell-side makes extremely aggressive assumptions to get there- US market share for quartz growing from 6% to 17%, Caesarstone share in US growing from 15% to 25%
i. $360mm LTM revenue and $90mm LTM EBITDA, sell-side estimates ~$800mm revenue and $200mm EBITDA by 2017, applies an 11x multiple
e. Not only does this seem unlikely given lack of barriers to entry, sell side doesn’t consider the ramifications on the company’s input costs if this were true
i. Quartz primarily used for kitchen countertops- other uses are phones and watches, which is quartz crystal (different manufacturing process and limited quantity)
ii. Current global demand for quartz is 8%*$74bn=~$6bn. Sell side is projecting US demand to grow from 6%*17bn=$1bn to 17%*$17bn=$2.89bn, which translates to global demand growing 31.5%
iii. Caesarstone management has already said that pricing is rising from existing suppliers
3. Pricing is the same for Quartz and Granite
a. Both natural and engineered stone requires a fabricator for proper installation
4. Quartz has significant quality concerns
a. Installation is difficult- manufacturers of engineered stone often offer training to certify installers in order to guarantee it is done properly
b. With granite countertop suppliers are very fragmented and localized. Most homeowners/remodelers can actually see the exact slab that they will be purchasing. With Caesarstone slabs you never actually see the slab until it shows up at your doorstep.
c. Customers say that Caesarstone has terrible customer service, inconsistent quality, and a tendency for staining
i. “I have had the black Caesarstone installed 6 years ago. It has chipped in 3 places no impact either. It has one scratch in it. It has dulled out. I would never buy this product again. Customer service is horrible… after 2 weeks their rep still hasn’t returned my phone call”
ii. “I work at a marble shop. Caesar stone have problems on slabs from time to time. I say 10-20% of the time. Their customer service is non-exist. it is almost impossible for them to replace anything for you. Sometime we have to pay for a second slab to finish a job.”
iii. “The fabricator took several hours of training from Caesarstone to learn their buffing-out procedure. He worked on my countertop with various polishing pads and solutions for 2 1/2 hours, which only spread the dull spot. It also chipped on the edge two weeks after install from no apparent abuse. I didn't want Caesarstone again because of the lack of quality control.The counter didn't look anything like the sample. One slab was fine, but the other had white thumb-print sized resin blotches all over it. It was not covered under warranty, so I would have been stuck with that ugly slab.”
5. Caesarstone does not have sustainable competitive advantages
a. The countertop industry is comprised of numerous options across price points with materials having varying attributes. As such, competition between them tends to be a matter of the pros and cons and consumers make their decisions based on their needs, budget and aesthetics
b. At the higher end of the market, competition is more localized and less focused on price given the unique nature of the products
c. All participants in the engineered stone market use the same equipment for manufacturing. The equipment is purchased from Breton, an Italian company that originally developed engineered stone surfaces
d. 4 significant players Cosentino (31%), Cambria (24%), Caesarstone (15%) and LG Hausys (8%), 22% other companies
e. Pricing power is limited to the manufacturer’s ability to develop and market new products
f. Limited intellectual property protection reflected by the fact that most quartz manufacturers utilize similar production equipment and techniques
6. The business is highly cyclical and growth in quartz share in the US as well as Caesarstone margins are a reflection of housing construction and remodel being in a stage toward the peak of its cycle
a. 2007 home remodel spending was ~$340bn, reached a trough of ~$270bn in 2011 and is expected to reach ~$350bn in 2015
b. “Deferred kitchen remodels” from financial crisis creating pent up demand in 2014 and 2015
7. Bulls don’t understand the economic ramifications of Quartz growing to ~23% market share by 2018
a. Caesarstone’s engineered quartz is comprised of 90% quartz by volume and 10% polymers, pigments and other materials (by $ amount: 30% quartz, 43% polymers, 27% pigments)
b. Over the past few years rising global demand for quartz has led to upward pressures in pricing – the company has said that they are already experiencing uptick in quartz pricing
c. Total US countertop demand was $17.9bn in 2012
d. Quartz input costs are currently ~8.7% of total costs and ~15.0% of COGS. In a situation where Quartz countertop demand grew to 17% of the total market in the US we wouldn’t be surprised to see the Quartz input costs grow to 22.0% of COGS leading to 7.0% margin compression
8. Caesarstone is already having trouble meeting demand
a. Two manufacturing facilities- one in Kibbutz Sdot-Yam and one in Bar-Lev
9. Caesarstone has significant supply chain concerns
a. Sources more than 70% of its quartz from 4 suppliers in Turkey, with one supplier Mikroman responsible for the majority
b. Company has significant risk in that primary suppliers are in Turkey- geopolitical conflict between Israel and Turkey
10. Valuation
a. Comps (Beacon Roofing, Fortune Brands, Ply Gem)
b. They all trade at 8x
c. Even if you give company 10x (EBITDA of $120mm) at premium to comps company worth $1.2bn which is about 50% of current market cap
I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise do not hold a material investment in the issuer's securities.
Catalyst
1. Market reassessment of potential market penetration for quartz