Pipe makers face margin pressure; may underperform in the near term

While the sector has grown at 10% over the last five years till FY21, it is expected to grow at a faster pace of 12% until FY25

Listed plastic pipe companies have been major outperformers over the past year, with most of them doubling investors’ wealth during this period. While the largest listed player by market capitalisation, Astral Pipes, has grown 3x from a year-ago levels, the clear winner on the returns front has been Prince Pipes and Fittings. The stock of the sixth-largest pipe player in the country has seen a sevenfold jump over the past year. The sector has witnessed a substantial rerating over the previous year, led by higher growth expectations, record margins, and market share gains for top players. 

While long-term growth prospects of the Rs 40,000-crore sector remain strong, near-term triggers for the sector are lacking. After a strong showing over the last couple of quarters, the segment is expected to see a sequential decline, weighed down by lower volumes and weaker margins. While key players should report strong year-on-year (YoY) growth on the back of a low base, sequential revenues are expected to be pegged back between 30 per cent and 50 per cent. 

The impact on volumes and revenues is largely on account of the muted demand in agriculture, which is the largest end-user segment, followed by the plumbing and construction segments. The pandemic-led disruptions and lockdowns left behind weak demand for agriculture offtake during April and May, which is the peak season (February to July), owing to record-high polyvinyl chloride (PVC) resin prices. Rajesh Ravi and Saurabh Dugar of HDFC Securities say: “As PVC prices started to cool off, leading to a fall in pipe prices, even distributors deferred purchases, impacting the June quarter (Q1) sales for FY22.” 

The bigger impact should be on profitability. Arafat Saiyed, senior research analyst at Reliance Securities, says: “Operating profit margins are expected to contract by about 550 basis points (bps) quarter-on-quarter (QoQ) as higher margins are unlikely to sustain, given the 20 per cent correction in PVC prices from the peak and higher margins seen in Q4FY21.” The extent of volatility can be gauged from the fact that the margin of Prince Pipes, which stood at 19.3 per cent in Q4FY21, is expected to slip as much as 900 bps to just over 10 per cent in Q1FY22.

From its peak on May 12, PVC resin prices have declined by Rs 19 per kg to Rs 118 per kg which will dent realisations of companies. Plastic pipe companies are expected to post inventory losses in Q1FY22, unlike significant inventory gains in Q3FY21 and Q4FY21, say analysts at JM Financial. While these pressures may continue, analysts expect prices to remain firm because of disruptions in the global supply chain and trade. The movement of raw material prices is key for the sector, given that they form about 60 per cent sales.  

What may offset pressures on these companies is their focus on high-margin business, amid the rising share of chlorinated PVC pipes and fittings products. The ongoing consolidation should also help. Ashish Chaturmohta, director (Research), Sanctum Wealth Management, says that the share of the top five players has risen from 22 per cent in FY12 to about 37 per cent in FY21. The top organised players will continue to gain market share and make better realisations, he adds.

Despite apprehensions of a muted Q1, most analysts are bullish about the prospects of the sector. While the sector has grown at 10 per cent over the last five years till FY21, it is expected to grow at a faster pace of 12 per cent until FY25. Saiyed of Reliance Securities says: “The government’s thrust on Jal Jeevan Mission, enhancement of agricultural credit, and increased allocation for rural infra development fund augur well for the domestic PVC pipe companies. We expect volumes to remain healthy over the next 2-3 years.”

While two of the four plastic pipe companies have been multibaggers over the last year, near-term gains may be capped. While revenue growth will depend on revival in construction and agriculture demand, margins would remain range-bound. Investors can consider the stocks on sharp corrections.