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Our dealer checks and industry discussions suggest a) modest demand as construction activity and demand for home improvement have gone up in Feb-Mar’23 from Oct-Dec’22 (Q3FY23), b) demand in tier 2 and below cities is better than that in metros and tier 1 cities, c) competitive intensity in the tile industry has intensified due expansion of the distribution footprint by regional players, coupled with higher spending on branding and new launches. Tile exports from India remains robust despite slowdown in global demand as Indian exporters have become more cost competitive because European exporters face cost inflation and gas availability issues. Brent crude declined 8% QoQ in 4QFY23 (-18% YoY) resulting in an 8% QoQ fall in RasGas price (spot gas declined 43% QoQ) while Gujarat Gas price fell 23% QoQ (-17% YoY) as the company cut prices sharply due to lower demand from Morbi players (as many players switched to alternative fuels such as LPG/propane). Given this modest demand scenario coupled with increasing competitive intensity, we expect leading tile players such as Kajaria and Somany to pass on the fall in gas cost. We have a BUY rating on Kajaria and Somany and a HOLD rating on Cera. There is no change in estimates/TP.

* Gas prices soften (Asia spot LNG down 43% QoQ/ 36% YoY): Gas prices, which remained elevated during most of CY22, have softened since Nov’22. We estimate that RasGas price will decline 8% QoQ in 4QFY23 to INR 48.2/scm. Gujarat Gas price has declined 23% QoQ in 4QFY23 as Morbi players have switched to alternative fuels such as LPG/propane. Asia Spot LNG prices slumped by 43% QoQ (-36% YoY) to INR 60.1/scm in 4QFY23. Leading tile manufacturers have switched their consumption partly to alternative fuels such as biofuel, LPG and propane, which are 10-20% cheaper than gas. As a result, Kajaria / Somany saw a marginal expansion in gross margin (post P&F) of 50bps /110bps QoQ in 3QFY23. The Kajaria management indicated that its fuel cost would reduce to INR 46-47/scm in 4QFY23 from INR 53/scm in 3QFY23 following a switch to alternative fuels (35% of the total fuel mix).

* Tiles channel checks suggests modest demand improvement: Our interaction with tiles channel partners suggests modest demand during Jan-Feb’23 as construction and home improvement activity improved from weak scenario witnessed in Q3FY23. In Mar’23, demand has improved further, largely led by tier 2 and below cities. Demand for premium tiles and vitrified large size tiles is robust and is outperforming other categories. The number of brands and SKUs in the premium tiles segment is also aiding robust growth. Demand for sanitaryware and faucets remains healthy. Organised players continue to gain market share from unorganised players as they strengthen their distribution network.

* Increasing competitive intensity as smaller players increase their footprint: Tile players are witnessing an increase in competitive intensity as many regional brands are expanding their footprint to become a national player. Besides widening their footprint, regional brands have also expanded their focus from project business to mid-premium and premium end of the retail segment. Aided by higher spending on branding and advertisements, these players are aggressively expanding their presence in tier 2 and 3 cities across the country.

* Tile companies to pass on gas cost reduction: We expect the reduction in gas prices to be mostly passed on to customers as a) the demand scenario has been subdued in the last few quarters, and b) competitive intensity is rising in the industry with the advent of regional players aspiring to become national players.

* Tile exports regains momentum despite global slowdown: Monthly tile exports, which had dropped to INR 7.5bn in Sept’22 and INR 10.8bn from the monthly average of INR 13bn (during Apr-Aug’22) on account of the 1-month shutdown by Morbi tile manufacturers, rebounded in Nov’22-Jan’23 to INR 14-15bn per month with the reopening of manufacturing units. Export momentum remains robust on the back of a) higher electricity cost and gas cost in other exporting countries – Italy, Spain and China 

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