Morbi takes shutdowns; market share gains for bigger players
Tile players manufacturing Polished vitrified (PVT), double-charged (DC) and wall tiles in Morbi (c.50-60% capacity) have decided to take shutdowns in phases for a month each during Aug-Sept’21 as a) export orders being deferred due to sharp rise in freight rates and container availability issues and b) domestic industry is still on the recovery path and thus, entire production cannot be diverted to domestic markets, especially when they are trying to take price hikes to pass on higher costs (Gas price, packaging material prices have gone up). This production shutdowns, industry hopes, will lead to supply shortage creating a favourable scenario for such price hikes.
Healthy tile exports momentum (+26% 2yr CAGR in AprMay’21) seemed to have seen some moderation from June’21 due to shipment challenges/deferral by customers, though order book continues to remain strong. We expect large players like Kajaria/Somany to be least impacted as their outsourcing volumes are c.22- 25% (JVs are unaffacted; they may face challenges on the DC/PVT/wall tile outsourced volume to some extent), though this will be more than offset by favorable pricing scenario.
Players with high outsourcing mix may be severely impacted due to these supply issues and price hikes. We maintain BUY on Somany Ceramics (SOMC) on account of its balance sheet improvement, receding governance concerns and attractive valuation (22.5x FY23E EPS) while we have HOLD on Kajaria Ceramics (KJC) given rich valuations (40.8x FY23E EPS). We do not change our estimates and watch out sustainability of this shutdown.
* Morbi players take shutdowns for a month for each category of tiles (excluding GVT): Morbi players usually take a week long production shutdown during Janmashtami festival, while in the current season players involved in manufacturing of Polished vitrified tiles (PVT), double-charged (DC) and wall tiles (c.50-60% capacity in Morbi region) have decided take a month long shutdown during Aug-Sept’21 as a) export orders being deferred due to sharp rise in freight rates and container availability issues (buyers asking deferral of shipments; most export orders are on FOB basis) and b) domestic industry is still on the recovery path and thus, entire production cannot be absorbed by domestic market. Given recent gas price hike (c.12%), higher transport cost and packaging material costs, Morbi players need to hike tile prices in the range of c.5-10%. This shutdown will aid in creating supply shortage and hence enable in hiking the prices.
* GVT tile plants continue to operate: Polished vitrified tiles (PVT), double-charged (DC) and wall tiles segment of the tiles industry, generally face pricing issues as they are mainly used in projects segment and are mass category products, while the pricing scenario in Glazed Vitrified Tiles (GVT) is significantly better as it is a value-added product which is also used in the retail segment. Thus, GVT tile plants continue to operate as a) it is relatively smaller segment of the industry (c.20-30% of the capacity), b) pricing scenario is relatively better and c) demand scenario is healthy in domestic markets. Albeit, we do not rule out the possibility of GVT plants taking shutdowns in the near term.
* Export momentum to get impacted; order book healthy: Morbi, which constitute 65-70% of the country’s tile manufacturing capacity has been witnessing strong exports momentum in recent months as a) various countries imposed anti-dumping duty on Chinese tiles and anti-China sentiment owing to Covid-19 and b) traders have been increasing import share towards India to hedge purchases. Tile exports were up 20% YoY in FY21 despite the washout in Apr-May’20 due to Covid-19 lockdown while it is 26% 2yr CAGR in Apr-May’21). Export momentum has estimated to have seen some moderation from June’21 as international clients have deferred the delivery of materials due to sharp rise in ocean freight and container availability issues (exports are largely on Free-on-Board (FOB) basis). Though, our channel checks suggest that export order book continues to be strong.
* Large organised players like Kajaria/Somany to be least impacted: Large tile players like Kajaria/Somany are likely to be least impacted as their own manufacturing and Joint Ventures are not likely to face any production shutdowns, while they may face supply issues from their outsourcing partners. Kajaria/Somany had outsourcing volumes mix of c.25%/22% respectively in FY21, though they may possibly face challenges on the DC/PVT/wall tile outsourced volume to some extent. Organised players who are mainly dependent on outsourcing model are likely to face supply issues over near term till the production cuts last.
* KJC/SOMC in a sweet spot to gain market share: Production cuts taken by Morbi players augur well for the tile industry as it will help in creating demand-supply equilibrium and pricing discipline, which will eventually benefit the organised players. Even Morbi based players are willing to partner with larger companies with a distribution network and brand as it is incrementally getting challenging for them (especially post covid) to sell in domestic markets. We believe large tile players like Kajaria and Somany are in a sweet spot to gain market share in the near to medium term as they will be well placed to partially fill the supply vaccum created by production shutdowns by the Morbi players and also increase their channel depth (dealers will incrementally prefer organised players due to supply security).
* We maintain BUY on Somany Ceramics (SOMC) on account of its balance sheet improvement, receding governance concerns and attractive valuation (22.5x FY23E EPS) while we have HOLD on Kajaria Ceramics (KJC) given rich valuations (40.8x FY23E EPS).
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