With lockdown restrictions lifting should you bet on building material stocks?

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The decline in Covid 19 cases has been good news on the healthcare front as well as on the economic front. With as many as 15 major states lifting lockdown restrictions,  the construction activity has resumed across the country. A key beneficiary of an uptick in construction activity is the building material sector.

Higher investment

Citing this, research firm CGS CIMB initiated coverage on the building materials sector and believes that discretionary retail consumption, industrial capex and government project expenditure are key demand drivers for building material products. To meet rising demand most companies plan to invest to widen/deepen their national distribution reach and create supply commensurate.

“Improved ability to pass on input cost inflation, better sales mix due to higher value-added product sales, optimum manufacturing capacity utilisation and COVID-19-led cost discipline to result in EBITDA margin expansion for sector companies. Strict working capital management and unfinished capex led to lifetime-high free cash flow in FY21. Average EPS (earning per share) CAGR (compounded annual growth rate) of 18% over FY21-23F and FY23F RoCE of +25%,” said the report released by CGS CIMB.

Stock views

While the structural demand will shift towards national brands, GCS CIMB is bullish on Apl Apollo Tubes, Kajaria, Century Ply and Cera. On the other hand, the firm sees limited or no upside for plastic pipe stocks and, hence, has ‘Reduce’ rating on Astral and ‘Hold’ on Supreme and Finolex.

APL Apollo Tubes | Rating: Add | Price target: Rs 1,592 

APL is a clear market leader with ~50% volume market share (FY21) in structural steel tubes. It is the lowest cost producer in a highly commoditised industry. Revenue CAGR (compounded annual growth rate) of 20% over FY21-23F backed by more market share gains. Value-added products (VAP) form 57% of total sales (FY21) and management intends to scale upto 75% over the next three years. VAPs earn 2x EBITDA (earnings before interest tax depreciation & amortisation) per tonne of over Rs4,000/tonne vs. a standard product’s EBITDA of ~Rs2k/tonne. EBITDA CAGR of 31.4% with margins at 8-9.5% over FY21-23F. Meaningful working capital release and unfinished capex led to meaningful improvement in FCF (free cash flow) of over Rs 680 crore in FY21 that would normalise over FY22F-23F averaging at Rs 350-400 crore. Return ratios to improve further and RoE (return on equity) of 31.1% and RoIC (Return on invested capital) of 43.3% by FY23.

Kajaria Ceramics | Rating: Add | Price target: Rs 1,176

Kajaria had a revenue market share of ~10% in FY20 and is well ahead of its closest competitors in the Indian tile market. Tile volume/revenue is expected to grow at a CAGR of 14%/16% over FY21-23F. Factors like higher capacity utilisation, bathware scale/profitability, price hikes and lower discretionary spending are key levers for gross/EBITDA margins improvement over FY21-23F. Gross/EBITDA margins of 59.5%/18.5% in FY23F, respectively. Cumulative capex of Rs 350 crore and steady net working capital cycle at 55-60 days of sales implies cumulative free cash flow of Rs1,150 crore over FY21-23, up 3x from Rs 380 crore over FY18-20.

Century Plyboard | Rating: Add | Price target: Rs 469

Wood panel companies saw volume growth recovery across plywood, laminates, medium density fibre (MDF) and particle board (PB) segments during FY21. Optimum utilisation of existing capacities and large new capex announcements would lead to revenue CAGR of 17.7% led by MDF revenue CAGR of 34.5% over FY21-23F. Plywood/laminates revenue CAGR at 14.3%/15.6% respectively. Improving sales mix, focus on cost leadership and recovering volumes throughput would likely result in operating leverage benefits. EBITDA CAGR of 23.7% and margins to rise by 163bp (218bp over FY20-23F) to 17.5% over FY21-23. Cumulative operating cash flow of Rs 930 crore to be entirely utilised to create new MDF capacities and replacement/balancing capex over FY21-23. The company can deliver return on equity at 18.8% and Return on Capital employed 22.2% in FY23F with earnings per share CAGR of 22.9% over FY21-23.

Cera Sanitaryware | Rating: Add | Price target: Rs 5,140

Revenue CAGR of 17%, with faucets growing fastest at 17.5% CAGR over FY21-23. It has a well-balanced revenue mix with tier-3/-4 markets at 58% of revenues (Mar 2021), while premium products have a 50% overall share (Dec 2020). It has an asset-light manufacturing strategy with an optimum mix of in-house and outsourcing partnerships. EBITDA margin to increase by 210 basis points (FY23F: 15%) and EBITDA CAGR of 26% over FY21-23. Planned capex remains low at ~Rs 350 crore/year, while the net working capital cycle will be stable at 50-55 days of sales. Cumulative free cash flow of Rs 420 crore over FY21-23 and a net cash balance of Rs 570 crore by FY23.

Finolex Industries | Rating: Hold | Price target: Rs 180

Positive on Finolex due to its leadership position in agri-pipes, increasing market share, structural improvements in business mix, healthy cash flows and strong return ratios. However, the stock rose 55% since 1 Feb 2020 and currently trades at an FY23 price to earnings ratio of 19.6x giving a limited upside potential from current levels.

Supreme Industries | Rating: Hold | Price target: Rs 2,345

High profits led to the stock rising by 60%+ (Nifty Midcap 150: +56%) since Feb 2020 due to pent up demand and inventory gains. Supreme’s focus on retaining market leadership, profitable capital reinvestment and consistent free cash flows are key positives. However, the recent stock rally, peaking margins and earnings per share CAGR of -8% over FY21-23 leaves limited upside potential.

Astral | Rating: Reduce | Price target: Rs 1,720

Astral’s stock price rose at a CAGR of 55% over FY14-21. This is a function of consistent market share gains, capital allocation discipline and compounding cash flows. A similar situation going ahead. However, the risk-reward unfavourable at the current stock price.

(Disclaimer: The recommendations in this story are by the respective research and brokerage firm. Money9 & its management do not bear any responsibility for their investment advice. Please consult your investment advisor before investing.)