Natural gas under GST regime likely to benefit tile manufacturers

Cheaper gas prices to reduce power & fuel cost and propel margins, say analysts

Stocks of gas utilities and city gas distribution (CGD) firms have done well over the last few trading sessions, even as overall market sentiment has been weak with leading indices seeing a decline. 

The optimism is driven by Prime Minister Narendra Modi’s statement that the government is looking to eliminate the cascading effect of different taxes on gas (including across states) by bringing it under the goods and services tax (GST) regime and boost its adoption by setting aside Rs 7.5 trillion towards augmenting India’s oil and gas infrastructure.

Another large sector — one that provides employment to millions, especially in Modi’s home state of Gujarat — that is also likely to benefit from this is the ceramic tiles sector.

Power and fuel costs account for roughly 25 per cent of the overall revenues for tile manufacturers. Ceramic tile companies in Gujarat and other states pay significant value added tax (VAT) on gas purchase and transportation. 

According to the companies, the cascading tax incidence varies from 15-25 per cent, depending on the state where manufacturing facilities are located. Analysts expect considerable cost savings for these companies, and subsequently expansion in their margins, if the government follows through on the announcement.

“Assuming that entire savings is retained by the companies, we estimate potential annual savings of Rs 70 crore and Rs 35 crore for Kajaria Ceramics and Somany Ceramics, respectively,” said Achal Lohade, research analyst at JM Financial. In other words, potential tax savings could have a favourable impact of approximately 210 basis points (bps) and 160 bps on Ebitda (earnings before interest, taxes, depreciation, and amortisation) margins of Kajaria and Somany, respectively, he added.

Past rulings such as the National Green Tribunal’s order in March 2019 to shut all ceramic units running on coal gasifier in Morbi (Gujarat) as well as recent moves to strictly implement the e-way bill have been positive developments for the organised home décor players, say experts. 

Moreover, continued export demand for Morbi-based players and improving demand visibility for tiles have rubbed off positively on these stocks.

Channel checks conducted by ICICI Securities suggest that export momentum continues to be robust with revenues expected to touch Rs 11,000 crore in the current fiscal, driven by the anti-dumping duty levied by the US as well as other countries on Chinese players. Reduced pressure in domestic market also bodes well for the branded players, say analysts. 

“Tiles shortage continued in the domestic market amid Morbi’s export focus, due to better demand and payment cycle. Due to this, organised players would have likely given lower discounts to dealers, thus, leading to some realisation improvement,” said brokerage firm Equirus Securities.

Additionally, demand is also seen growing at a faster clip, driven by a low base in the first six months of FY21 and volume recovery in metro cities. Kajaria has raised its volume growth guidance for FY22 to 20-25 per cent, versus 15 per cent earlier, and expects 15 per cent volume growth in the next few years. 

There are also expectations of the real estate industry seeing a slew of new launches in the March quarter and in FY22, which will further drive domestic demand.

Not surprisingly, analysts at Emkay Research have increased their earnings per share (EPS) estimates for Kajaria Ceramics by 17 per cent and 22 per cent for FY22 and FY23, respectively, and for Somany Ceramics by 95 per cent and 78 per cent, respectively. 

There is one caveat though. The sharp appreciation in the share price of these companies may limit significant gains from a near to medium-term perspective. Kajaria is up 70 per cent, whereas Somany has more than doubled since October end. Since May 2020 lows, the stocks are up over 3x and 5x, respectively. They now trade at 40 times and 22 times estimated FY22 earnings, respectively. Therefore, corrections could offer decent entry.