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Optimism on recovery continues

In 4QFY23, leading ceramic companies (Kajaria/ Somany) registered improvement in volume (+8%/9% YoY and 10%/9% QoQ) as demand for home improvement and construction activity rose in Feb-Mar’23 after a weak Oct-Nov’22. Blended gas prices fell 15-21% QoQ to INR 45.9/48.6 per scm for Kajaria/ Somany respectively, hence gross margin (post P&F) expanded by 160bps/ 110bps QoQ during the quarter. Natural gas prices have dipped further during 1QFY24 (Asia spot LNG/ Gujarat Gas price is down 42%/13% since Mar’23, as on 12th Jun’23). As per the management, gas cost savings will be passed on to the channel (Kajaria estimates INR 1.5bn in savings overall from reduction in fuel cost). Export momentum has remained robust since Dec’22 with a monthly run rate of INR 15-17bn on the back of increasing cost competitiveness. Our interaction with industry players and channel partners suggest a) subdued demand scenario, and b) still-high competitive intensity among domestic players; some large players are pushing volume with discounts/schemes (given savings in fuel cost). Nonetheless, leading players remain optimistic on future growth and have guided for mid-teen volume growth in FY24. We maintain BUY on Kajaria (KJC) and Somany Ceramics (SOMC) and maintain HOLD on Cera Sanitaryware given rich valuations.

* Tile demand improves for leading companies in 4QFY23: KJC/SOMC posted tile volume growth of +8/+9% YoY (+6%/+3%, 4-year CAGR) respectively in 4QFY23 as demand improved after a weak 3QFY23. Companies remain optimistic on business momentum and have guided for 13-15% volume growth in FY24 owing to a) demand revival in Tier 2, 3 cities and continued distribution network expansion in these cities, b) healthy real estate launches, and c) Morbi’s focus on exports due to sustained demand momentum (c. INR 15-17bn/month). Note that volume grew 12%/10% YoY in FY23 for KJC/SOMC, albeit on a low base (+6% each, 4-year CAGR).

* Fuel prices (constitute 25-35% of tile realisation) in favourable zone: Fuel prices, which remained elevated during most of CY22 and 1HCY23, have softened since Nov’22. RasGas prices have dipped 10% QoQ in 4Q23 to INR 47.8/scm, and Gujarat Gas declined 22% QoQ in 4QFY23 on account of lower offtake from tile manufacturers in Morbi. Asia Spot LNG prices slumped by 43% QoQ to INR 60/scm in 4QFY23. Spot prices have further declined (-42% QoQ) to INR 34.8/scm during 1QFY24 while Gujarat Gas prices are estimated to fall 13% QoQ. Further, gross margin (post P&F) of Kajaria / Somany expanded by 160bps /110bps QoQ on the back of reduction in gas prices coupled with a partial switch to alternative fuels such as propane, bio-fuels and LPG. Kajaria estimates savings of INR 1.5bn in FY24 on account of fall in gas cost, some of which will be passed on to the channel in discounts/ schemes.

* Tile exports momentum remains robust: Export of tiles has improved from a monthly average of INR 13bn during Apr-Aug’22 to INR 15-17bn during Nov’22-Apr’23. During FY23, tile exports grew 25% YoY to INR 160bn. The industry expects tile exports to grow further by 25% YoY in FY24 to a record INR 200bn. During FY23, Indian tile exporters became more cost competitive on account of a) higher electricity cost and gas cost in other exporting countries – Italy, Spain and China – while Morbi was highly competitive in export markets, and b) lower ADD on Indian tile manufacturers (c.7% on India vs. 40% on Turkey) by Europe. Industry players expect Morbi’s cost competitiveness to sustain in the near term despite the marginal improvement in the gas situation in European countries. Moreover, industry expects removal of ADD on Indian tile manufacturers, which will further boost export momentum.

* Insights from channel checks: Our interaction with channel partners and a few industry players revealed that a) demand remains subdued, b) demand for premium (GVT) and larger size slab is growing, and c) competitive intensity among domestic players has heightened with higher discounts/ schemes by larger players (given savings in P&F cost) coupled with expansion in distribution by a few regional players.

* Maintain BUY on Kajaria and Somany; HOLD on Cera: We maintain BUY on KJC/ SOMC with a Mar’24 TP of INR 1,350/ INR 860 (valuing it at 35x / 22x Mar’25 EPS) respectively and maintain HOLD on Cera with a Mar’24 TP of INR 7,000 (valuing it at 30x Mar’25 EPS). We continue to prefer the wood panel sector over the ceramics sector given sector tailwinds (function of real estate inventory absorption) and construct of the industry (relatively lower competitive intensity).

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