It's no walkover for tile makers staring at competition, gas prices

Shaky Ground: Price hikes, too, may imperil demand

Tile manufacturers in India had a strong April-June quarter (first quarter, or Q1), aided by robust volume growth and higher realisations. Although demand trends for the rest of 2022-23 (FY23) are expected to be healthy, there are multiple headwinds that could offset these gains in the near term.
 

While higher competitive intensity from Morbi-based tile makers could exert pressure on realisations, the bigger worry for leading listed players in the tile and bathware segment is a sharp rise in input costs.
 

Given these headwinds, some stocks in the tile and bathware (faucets and sanitaryware) sector have been feeling the squeeze.
 

Kajaria Ceramics — the largest listed player — is down 1.3 per cent, while Somany Ceramics has shed 1.7 per cent over the past month. 
 

Cera Sanitaryware, Hindware Home Innovation, and Prism Johnson (H&R Johnson division) are up between 6 per cent and 17 per cent. Tile makers have faced greater pricing pressures than the bathware segment.
 

Say analysts Akhil Parekh and Kevin Shah of Centrum Institutional Research, “Unlike faucets and sanitaryware, tiles have witnessed pricing pressure. Morbi-based players exporting to Europe and the US during the pandemic have started to dump inventory in domestic markets. With impending recession in Europe and the US, export offtake for Morbi players has reduced.
They have started to sell aggressively in the domestic markets. This has created pricing pressure for domestic branded players.”

 

Some tile makers have either reduced the thickness of tiles or rolled back price hikes as a countermeasure.
 

While there could be near-term pressures, Jefferies India in a recent report has a contrary viewpoint. The brokerage believes there are multiple triggers for exports in the medium term that could benefit market leaders like Kajaria. 
 

Quoting a former head of the Morbi Ceramics Associations, Sonali Salgaonkar of the brokerage says the catalysts for exports include easing competition as European exporters — Spain and Italy in particular — are impacted by a spike in energy costs.

The two countries account for about 5 per cent of the global ceramic tile production. Russia could also emerge as an alternative export market, helping it to treble exports this year from the current levels. Higher export focus by Morbi players could ease competition in the domestic market, sustaining pricing stability, says Jefferies.
 

The Street will focus on revenue growth (volumes, realisations) and margin trajectory. Revenue growth for the top players (Kajaria, Cera, and Somany) in Q1FY23 grew over 60 per cent year-on-year (YoY) on a low base, aided by volume growth of 40 per cent and realisation gains of over 15 per cent.
 

Kajaria and Somany have had a robust three-year revenue growth of 12 per cent and expect demand to be strong this year, led by tier II and III cities, says ICICI Securities.
 

While Kajaria expects 15-20 per cent growth for FY23 and 15 per cent-plus growth next year onwards, Somany expects 20 per cent growth. Cera expects revenue to double in the next three and a half years. While Kajaria has refrained from giving guidance on margins, given the volatility in gas prices, Somany and Cera are hopeful about expansion. Gross margins for the three companies were down 319-569 basis points YoY in Q1.
 

Natural gas prices are soaring after cuts in Russian gas supplies. These could aggravate the costs for tile players as power and fuel account for 20 per cent of their net sales.
 

A 10 per cent hike in energy cost requires a 2 per cent price hike in tiles, observes Jeffries. While a pronounced gap between natural gas and propane has prompted some tile makers in Morbi to switch to the latter in a graded manner, not all tile makers have made the switch, with key players, including market leader Kajaria, continuing to run their plants on natural gas. This will mean more pain for the sector in the near term and price hikes may not recompense the sudden spike.
 

For most brokerages, Kajaria Ceramics remains a top pick in the sector. Jefferies believes the company is a robust play on housing revival/home furnishing and expects the market leader to outperform with 17 per cent and 22 per cent net profit growth annually over the 2021-22 through 2024-25 period. 
  

Besides Kajaria, ICICI Securities also likes Cera in the building material space due to its comprehensive product portfolio, strong brand, wide distribution reach, and significant presence in tier II, III and below cities, allowing it to benefit from the uptick in the housing market.
 

Investors could consider these stocks on sharp corrections.