Tile manufacturers Q2 review – Margin recovery underway; like Asian Granito with long-term view

Taking into account the above factors, Kajaria’s volume growth came in strong at 11 percent. This was, however, aided by favourable base last year. Asian Granito’s 8 percent increase in volumes was primarily on account of a higher share from trading business. Somany Ceramics’ focus on improving receivables along with production issues on account of gas supplies disruption impacted the business performance.

Revenue growth for all the players lagged volume growth due to a drop in price realisations. Addition of new tile plants in the Morbi region in the recent past has resulted in increased supply amid subdued market demand and is putting constant pressure on realisations.

Gas prices impacting profitability

While the cost of raw materials remained largely stable, operating margins for all the players came in lower as the natural gas prices (linked to crude oil and rupee-dollar rate) have risen sharply. Natural gas has seen a steep rise in the past one year and this has been the primary reason for the significant dip in operating margins of all the industry players. The input costs are expected to remain high for the next 2 quarters as natural gas prices have seen a further revision of around 10 percent from October.

Gujarat-based tile manufactures enjoy a cost advantage as they receive state government subsidies for natural gas. During H1CY18, the industry was unable to undertake price hikes due to natural gas price disparity across states. However, in July 2018, it took a small price hike of 2-3 percent across categories, which gave support to the Q2 margin profile on a sequential basis. In October, it initiated another price hike of 2-3 percent to alleviate cost pressures. These price actions have been replicated by Morbi players as well.

Outlook and recommendation

The tiles industry has had a challenging operating environment over the past 12-15 months. The combination of high competitive intensity, subdued demand and elevated input costs have had a compounding effect on the profitability of the industry. The recent reversal in oil prices along with a strengthening rupee could prove positive as it would put a cap on the further revision of natural gas prices. The margins are also anticipated gradually recover due to the recent price hikes.

During Q1 and Q2, Kajaria displayed resilient operational performance which indicated superior execution capabilities in a tough market. We remain sanguine on the long-term prospects of all the three players but prefer Asian Granito considering the risk-reward ratio at current valuations.

The stock has seen a sharp correction post weak financial performance in the first half of this fiscal year. The same is expected to continue in the second half as well and the current valuations seem to factor in a majority of the negatives. We anticipate a steady pick-up in consumer demand and margin pressures to abate over the course of FY20 and therefore, recommend accumulation on dips as the company stands to benefit from the augmentation of dealer network along with expansion in its retail footprint.