What’s In Store For Building Material Stocks?BloombergQuintOpinion
Obituaries were written for home improvement and building material companies at the peak of the Covid-19 prompted lockdown. Downtrading, demand postponement, lower discretionary capital in the hands of the consumer—you would find all these reasons scattered across articles and interviews. The comeback has surprised many, and it is not restricted to building materials companies, but home improvement at large. PVC pipes, structural tubes, wood panels, and paints—all are themes where managements are now sounding confident about H2FY21. The investor is asking, is there still money to be made?
Let’s look at some of the segments.
PVC pipes and steel pipes are a clear beneficiary of higher construction activity, have seen demand growth picking up steadily since the opening up of the economy. In the PVC pipes segment, large organised players witnessed a sharp recovery in plastic pipe volumes mainly on the back of:
- A sharp recovery in demand for plumbing and SWR pipes from the housing segment in tier-2 and smaller cities;
- Healthy rural demand; and
- Market share gains.
Add to this the probable uptick in demand due to a likely strong Rabi season, and the decks for strong demand are laid out, ceteris paribus.
An added factor is that PVC prices continue to skyrocket on account of supply shortage globally. Since India imports over 50% of its requirement, the stage is set to shift more in favour of larger players, which operate in the listed space. Industry consolidation, which was already underway, might accelerate as smaller players are likely to struggle to get material, given working capital challenges. 40% of the piping market is unorganised and following the lockdown, unorganised players found it harder to restart their business. If you add both the factors, they augur well for the leading players in terms of volume and margin performance in HFY21. The stocks have gained since the beginning of November, with Astral Poly Technik Ltd. having clocked in 30% gains, Finolex Industries Ltd. up 26%, Supreme Industries Ltd. rallying 17%; versus a 13% gain for the Nifty and an 18% gain for the Nifty Smallcap 250 index.
Even structural steel companies like APL Apollo Tubes Ltd. recorded 32% YoY volume growth in Q2 FY21, coupled with higher capacity utilization rates. Analysts expect APL to record around 6% YoY higher volume (earlier estimated 5% growth) in FY21E supported by further improvement in demand from the construction and infrastructure sector in H2FY21.
However, one has to question the gains possible in these companies after valuations have run-up to the levels they have. As per the Bloomberg estimates:
- Astral Poly now trades at 88x FY21E earnings versus a five-year average of 66x.
- Similarly, Supreme Industries trades at 45x FY21E earnings versus a five-year average of 33x.
- Finolex is at 23.1x vs a five-year average of 20.4x.
There are select exceptions like APL Apollo, which used to trade at PE multiples of 20x one-year forward before Covid-19, now trades at 27x FY21E earnings per share, but at about 23x FY22E EPS. Not staggeringly expensive, for a business which has seen an earnings upgrade as the year has gone by. Yes, it’s more expensive than it has ever traded in its history, but that can be said of almost any stock that has growth visibility.
The recovery in the paints sector has been quite a talking point in recent months. The sector witnessed a strong recovery in Q2, with major players recording double-digit decorative volume growth. The volume growth for Asian Paints Ltd., coming with higher Ebitda, is testimony to the fact that there is demand growth. The management said that in the quarter gone by, there was sequential month-on-month growth, and then the festive demand would have helped, which the company saw evidence of for October. This means that the upward trajectory would most likely have lasted. The question is, are valuations pricing those in? Well, yes, one could. The sector leader Asian Paints trades at a hefty 60x FY22E PE multiple. Berger Paints Ltd. is 70x for the same period and the third-placed player, Kansai Nerolac Paints Ltd., trades at 45x.
There are proponents, who argue that Asian Paints, for example, gets valued at the multiples it does not just for its earnings, but also for its competitive advantage of distribution, data, and analytics, which gives it a working capital cycle of below 10 days, something not matched by anyone else. It may well be true for Asian Paints, but is that true for the others? All these companies are trying to open up newer avenues for business, which may add to business growth, but a skeptic would argue that despite all the positives, a reasonable price is a pre-requisite for any investment. It is just that caution has been out of favour in recent times. In May, when Asian Paints was around Rs 1,600 a share, Goldman Sachs downgraded it with a target price of Rs 1,111. The stock is now well over double that target.
Ceramic and wood panel companies have also clocked in better performance in Q2 versus consensus estimates. The top branded ceramic tile players showed an impressive recovery from July, and a report by ICICI Securities suggests that the recoveries would have lasted into Q3 as well, because of market share gains for top branded players. Firms operating in the ceramic hub of Morbi in Gujarat have intensified their focus on exports, and pricing has remained stable, too. Higher market share and higher prices could aid operational performance, and thus these companies could get traction if the earnings growth stays strong in the second half. These stocks aren’t expensive, but certainly not very cheap either. Trading volumes are very low for some of them, which may deter institutional participation.
Ply and laminate volumes were weak, but a JM Financial report says the players are hoping to report positive growth in the second half of the current year. MDF recovered smartly (19-31% YoY) and sales are expected to remain strong given robust demand from OEMs. There have been many reports of how the Government of India might be considering imposing tighter restrictions on imports of several items, including furniture, which may add to the lustre of these companies. However, one would think that the proof of the pudding is in the eating. Not one of these furniture and ply companies has a market capitalisation of over Rs 5,000 crore. The stocks can gain if earnings come by, but institutional interest would still be some time away.
The larger point here is to pick and choose wisely in this pocket. Of late, the arguments that fall in favour of home improvement and building material stocks have been more noticeable. However, the ones which have strong visibility seem priced to perfection, and the ones where the multiples may be slightly better are either very small companies or predicting their earnings growth is fraught with risk. Whether or not your portfolio can improve by building it with these names is an open question, for all the reasons mentioned above. It might be prudent to follow earnings and take a calculated bet as opposed to go with the flow and bet your house on these names.
Niraj Shah is Markets Editor at BloombergQuint.