Building material - Sector Update - ICICI Securities

Balance sheet discipline and cost control take precedence

The Covid-19 led countrywide lockdown in Mar'20 disrupted Q4FY20 volumes of majority of building material (BM) companies under our coverage. However, gross margin expansion demonstrated by majority of these companies was the key silver lining for the quarter. While sales disruption is likely to persist for at least the next couple of quarters, BM companies at large have already taken aggressive steps with regards to strengthening of balance sheet and cost saving initiatives which would enable them to cushion a material fall in their EBITDA margins (for FY21) and also ride through these testing times. Our top picks in the space are Century Plyboards (which replaces GRLM - our earlier top pick, which has already performed to our expectations) and Astral Poly Technik.

- Q4FY20 hits and misses. Majority of BM players (ex-GNPL) reported a sharp decline in their Q4FY20 revenues with PIDI and SIL reporting a single digit decline while others in double digits. However, lower input costs and better product mix enabled all BM companies (ex-MTLM) to report gross margin expansion for the quarter. However, it did not trickle down to the same extent (ex-GNPL) to EBIDTA margins due to lost sales in Mar'20 on account of sudden Covid-19 led lockdown announced by the Centre leading to operating deleverage. Despite higher inventory pressure due to Mar'20 lockdown, companies like CPBI, GNPL and ASTRA were able to report significant improvement in working capital over the last one year. CPBI, however, stood out reporting higher RoCEs (up 200bps) in FY20.

- Rural India, pent-up and channel inventory filling marks better-than-expected recovery in May and Jun'20. In the wake of Covid-19 led extended countrywide lockdown, the demand for major building material categories took a beating in Apr'20. However, our checks suggest that majority of building material categories (with plastic pipes relatively outperforming in growth versus tiles and wood panel space) have seen an impressive recovery in demand in May and Jun'20 largely led by an impressive demand in upcountry regions/rural India, inventory channel filling and pent-up demand to some extent. We, however, cannot construe this as a trend (with focus on secondary sales) and would rather focus on volume offtake in Jul and Aug'20 and Covid-19 crisis to depict any trend for the current fiscal.

- Categories likely to recover faster. Besides branded plastic pipe players, which is expected to benefit from sustained consolidation in PVC/CPVC pipes segment, we expect recovery in MDF (driven by expected higher demand for modular furniture post Covid-19 era) and laminate (firm exports demand and market share gains in domestic laminates) segments to be ahead of other branded categories like tiles, sanitaryware and plywood (high discretionary based categories).

- Aggressive cost control measures – key to margin sustenance. Besides rationalising their brand spends, majority of building material companies have resorted to employee salary cuts (except for categories like plastic pipes) and cut in other fixed costs like branch/warehouse rentals, travelling expenses and other admin costs which may cover up (to an extent) for the likely volume decline in this fiscal. As far as input costs are concerned, gross margins are likely to remain firm (until H1FY21 atleast) with prevailing input cost deflation on account of lower demand for these categories in the near term.

- Focus to intensify on cash collections and balance sheet strengthening. We expect our building material coverage universe to continue focusing on cash collections, which alongside inventory liquidation (post inventory build-up witnessed in Mar'20 due to nationwide lockdown announced by the centre), would result in improved working capital cycle in FY21. Higher cash collections, muted capex and resultant paring of debt would result in balance sheet strengthening for majority of BM players, which would enable these companies to survive in these testing times.

Source : Equity Bulls

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