Tile manufactures Q1 review: Prefer Asian Granito for the long term

Tile manufacturers continued to report muted set of Q1 FY19 earnings. Asian Granito outperformed its larger peers Kajaria Ceramics and Somany Ceramics

by reporting strong double-digit volume growth. However, realisations for all players took a hit as prices of glazed vitrified tiles remained weak during the quarter gone by and consistent increase in natural gas prices further dented operating margin. Despite a lacklustre quarter, players remain optimistic of broad-based demand and price recovery as the industry reforms. Also, government policies should have a positive impact on these building material companies over the long run.

Among the three listed industry players, Asian Granito delivered a healthy 23 percent volume growth in tiles. Somany reported 18 percent volume growth owing to a low base (volumes de-grew about 16 percent in Q1 FY18 due to implementation of enterprise resource planning).

Revenue growth for all players lagged behind volume growth due to 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 constant pressure on realisations.

Kajaria reported 5 percent increase in revenue while the same for Somany increased 15 percent in Q1 FY19. Last quarter, Somany increased its focus on improving receivables, which impacted topline by around Rs 20 crore. The same is expected to continue in Q2 as well.

Despite a very strong volume growth, Asian Granito reported a revenue growth of just 6 percent on account of weak realisations and a softer product mix.

While the cost of raw materials remained largely stable, operating margin for all the players came in lower as gas prices rose sharply. Tile manufacturing is a power-intensive industry with natural gas and electricity accounting for 40-45 percent of total costs. Natural gas has seen a steep rise of around 23 percent in the past one year and this increase has been the primary reason for the significant dip in operating margin.

Gujarat-based tile manufactures enjoy a cost advantage as they receive natural gas subsidies from the state government. Average gas price per scm stands around Rs 32 in Gujarat compared to Rs 37 outside the state. Industry players have been unable to undertake price hikes due to uneven price distribution of natural gas across states.

In July, players have taken a small price hike of 2-3 percent across categories to pass on the higher input costs. This should help in arresting margin erosion to a certain extent, although continued depreciation of rupee against the dollar could hamper margin recovery.

All the three companies are focusing on increasing dealer presence to increase customer touchpoints and shore up sales volumes in a competitive environment.

Over the past few years, Asian Granito has shifted its focus from business-to-business (B2B) to business-to-consumer (B2C) segment. The company has expanded consumer presence in a gradual manner and it operates over 240 franchise owned franchise operated (FOFO) exclusive tile stores across geographies. It also has 16 display centres operated under the company owned company operated (COCO) model. During the quarter gone by, it added around 30 dealers, which took its total dealer network tally to 1,230 at June-end. It plans to add around 300 dealers in FY19.

Somany and Kajaria are leaders in the tile segment and are now focusing on bathware and faucets to grow their business. Both companies are leveraging their existing distribution network to penetrate this segment and are reporting revenue growth of over 40 percent in these products.

Somany had a dealer gross addition of around 600 last fiscal. This year, the company plans to add 50-60 dealers on a quarterly basis and is also planning to open around 100 stores.

Kajaria had a distribution network of around 1,400 dealers at FY18-end. The company is gradually ramping up its dealer network and plans to expand its dealer count by 10-15 percent this fiscal.

The tiles industry has had a challenging last 9-12 months as demand has been impacted by number of factors including demonetisation, rollout of the Goods & Service Tax and implementation of Real Estate Regulatory Authority (RERA).

The e-way bill is anticipated to be a game changer as it will reduce the extent of tax evasion from unorganised players and aid market share of organised players. Current e-way bill surveillance measures needs to have stricter controls to have higher level of tax compliance and create a level playing field for organised players.

Earnings visibility remains weak in Q2 as 8-day truckers strike in July impacted sales of all building material companies, including tile manufactures. Margins would bottom in the next 1-2 quarters as the upward movement in gas prices as well price erosion of glazed vitrified tiles appears to have halted. We expect the sector to witness a gradual demand and price recovery towards FY19-end.

From an operational standpoint, Kajaria enjoys best-in-class operating metrics and therefore trades at a premium to its peers.

We remain optimistic on the long term prospects of all three players, but prefer Asian Granito considering the risk-reward ratio at current valuations. The stock has seen a sharp correction after its weak Q1 earnings.

Asian Granito has been consistently delivering industry-leading double-digit volume growth for the past few quarters. It continues to expand its retail footprint in an aggressive manner and is focusing on value-added products to enhance margin. It has also has appointed Vector Consultants to streamline its working capital cycle. We feel increasing scale with free cash flow generation and declining debt should result in decent capital appreciation over the long term.

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