As we kick-start a new earnings season, we take a look at three sectors which saw their fortunes decline in the first half of FY23–cement, metals and pipes.
2022 was witness to the consequences of a supply chain crunch, and Putin waging a war on Ukraine. The result - a global energy crisis, volatility in commodity prices, and an economic slowdown in developed markets - disproportionately hurt these sectors.
Higher energy costs and weak realizations hit the bottom lines of cement and metal companies hard. PVC pipe makers also posted heavy inventory losses due to the sharp fall in resin prices. The demand conditions in Q2FY23 weren’t encouraging either, as the quarter is traditionally a weak one with lower demand, as construction activity slows down due to the monsoon.
However, cement, pipe and metal makers began to see indications of green shoots in November 2022. Will these battered sectors see ‘light at the end of the tunnel’ in H2FY23?
A new upcycle? Pipe makers see healthy pick-up in demand as resin prices stabilize
Pipe companies have witnessed a roller-coaster ride in the past two years. They rode high on healthy demand and superior realizations until Q2FY22, and came under intense pressure thereafter, in line with the trajectory of domestic resin prices.
PVC resin prices zoomed to Rs 170/kg by November 2021 and then fell to almost half by October 2022. Pipe makers were sitting on high-cost inventories and had to write off their value with this correction. Distributors started reducing their stocks as the prices headed south, and customers postponed their purchases anticipating cheaper deals.
Resin prices have now stabilized and are operating close to their 10-year average. As a result, pipe makers like Astral and Prince Pipes are seeing good pick-up in demand. Dealers have also started re-stocking the product supplies since December.
Stocks like Supreme Industries and Finolex Industries have gained over 20% in the past quarter with these positive signals.
Prince Pipes is witnessing strong demand from both the plumbing and agricultural segments, according to its management. Demand from the agricultural segment, a price sensitive one, is driven by a good rabi season and fall in product prices. The recovery is expected to be stronger in the next kharif season, which falls in H1-2023.
Pipe makers will also see an improvement in their operating margins from Q4 as most of their high-cost inventory will be consumed in Q3 itself. Analysts expect pipe makers like Astral and Supreme Industries to post double-digit volume growth in the upcoming quarters, backed by favorable pricing. However, the sales realizations for pipe makers might be weaker and may slow revenue growth in Q3FY23.
While the tide is turning in favor of pipe companies, they aren’t coming at reasonable valuations for investors. Companies like Astral and Prince Pipes are trading well above their five-year average PE ratios and are in the sell zone currently. Only Finolex Industries is trading marginally below its historical average.
However, there’s a catch to its discounted value. Analysts see Finolex Industries’ profits falling by over 70% in FY23, owing to the sharp fall in PVC-EDC spreads. Although its profits will recover in FY23, they will be substantially lower than the peak of FY22.
In general, pipe companies will post a swift recovery in their bottomline in FY24. Analysts are particularly positive on the prospects of Astral and see the highest growth coming in from this player. Its foray into bathware and paints, and presence in adhesives will not only aid its growth but also cushion it from the volatility of the pipes business.
Back from the brink? Cement demand recovers in November, energy prices cool-off
Cement companies have been reeling under an unrelenting rise in power and fuel costs over the past few quarters. Weak sales growth did not help their cause either. However, there might be some respite in sight as prices of key energy sources like pet coke and imported coal have corrected by over 30% from their highs.
Things are looking up on the demand side as well. According to Motilal Oswal, cement demand has been on the rise since mid-November, growing in double-digits on an YoY basis.
The volume growth in the non-trade segment has been specifically strong. This segment mainly involves government infrastructure projects. However, demand from the trade segment involving individual house builders is yet to recover.
Cement players also took some price hikes in October and November. All-India average cement prices have gone up by nearly 3% on a sequential basis in Q3FY23. However, these are barely enough to cover the sharp YoY rise in costs. According to Care Edge, cement makers would need to hike prices by another 11-13% to return to the profitability level of FY21.
Given the combination of decent volumes and higher prices, analysts see the top line of cement players growing in double-digits in Q3FY23. Dalmia Bharat is set to clock the fastest growth among others. The operating margins of cement players may also improve sequentially given the cool off in energy prices.
Arun Shukla, CEO at JK Lakshmi Cement, said in a recent interview – “On the cost front, the worst is behind us. We expect a positive impact of 10-12% on our EBITDA/tonne.” JK Lakshmi happens to be the top gainer among large and mid-sized players in the past quarter due to its throw-away valuations.
Interestingly, market leader UltraTech Cement is available at cheaper valuations and is trading in the PE buy zone as well. Brokerages like Credit Suisse expect this stock to outperform in the near term.
Overall, the outlook for the cement sector is positive given the fact that general elections are due in 2024. The government will ramp up the execution of its infra projects, boosting cement demand. Analysts see healthy revenue growth for companies between FY22-FY24. Profits will also rebound in FY24, arresting the expected decline in FY23.
A bet on the dragon? Metal prices bounce back on hopes of demand revival in China
The Nifty Metal index soared close to 14% in the past quarter driven by the expected reopening in China, pull-back of export duties imposed on steel and softening of coking coal prices. Notably, China reopened its borders and withdrew its strict quarantine rules on January 8, after three years.
Metal makers are not complaining as China’s massive market is one of the top consumers of metals globally. Back in November, the Chinese government had announced a ‘16-point plan’ to resolve the liquidity crisis in its real estate sector, the primary driver of metal demand. New reports suggest that the government might relax the ‘three red lines’ rules which basically put a cap on borrowing by property developers.
These positive developments have caused the metal prices on the London Metal Exchange to bounce-back from their lows. LME Steel HRC rose over 20% between October and December 2022. In response, HRC prices in India have also started recovering from December-mid and are up by 5% in past three weeks, according to ICICI Securities.
LME aluminium has also witnessed a modest rise of 8% from the September 2022 lows. Seeing this bounce-back and the expected pick up in Chinese demand, Jefferies has turned positive on the Indian metals sector.
However, analysts back home are cautious, as rising covid cases in China could slow the pace of recovery. The demand scenario in the US and Europe is also subdued. On the domestic front, ICRA sees the demand growing at just 6-7% YoY in 2023.
On the valuations front, Tata Steel and Hindalco are trading lower than their 5-year average PE ratio. Interestingly, the PE ratios of metal stocks fall to their lows towards the end of metals upcycle as the base is higher. Analysts also see the profits of these two players declining in FY23 and FY24. So, these two stocks could be a value trap at best.