Near-term pain to hit paint, cement stks; long-term outlook robust: Experts

From rising interest rates to elevated cost pressures, the building material sector that includes ceramics, paints and adhesives, pipes, wood panels, cement, and steel, has witnessed headwinds over the past few quarters.

Omicron wave, subdued volume growth, and the delay in passing on the rise in input costs, analysts said, have impacted the sector in the past few months. An improvement in their fortunes, they believe, is still a couple of quarters away.

"Although the demand environment remained healthy from government infrastructure projects and urban housing in the January – March period of fiscal 2021-22 (Q4-FY22), there was slackness in Tier-3 cities and below, and rural segments. The sector as a whole should see improvement in margins from H2-FY23 as energy and key input materials’ costs are likely to recede by then," said Ronald Siyoni, assistant vice-president for research at Sharekhan.

In this backdrop, analysts have downgraded the related sectors, and have cut earnings estimates for FY23 and FY24 factoring the near-term challenges. Nirmal Bang, for instance, has cut its FY23 and FY24 Ebitda estimates for cement sector due to aggressive capacity expansion plans by multiple players, a prolonged cost inflation environment, lack of pricing power given the elevated competition, and deteriorating demand drivers.

"These headwinds will affect earnings in the medium-term. We are now building in Ebitda CAGR of 9 per cent against 18 per cent earlier over FY22-24. We have also cut our target EV/EBITDA multiples for the stocks under our coverage to reflect the weak operating environment. Multiples have further room to decline," a Nirmal Bang report said.

Those at ICICI Securities, on the other hand, cited similar reasons to remain ‘cautious’ on the paints sector. While larger players like Asian Paints and Berger may choose to focus on volumes and market shares given increased competition, smaller players like Indigo Paints and Akzo, analysts at ICICI Securities said, may prefer to protect profitability.

"There will be an increase in net working capital days, too. Thus, with lower margins and higher capital, EVA generation may decline for smaller/unorganized players. We expect lower valuation multiples for most listed players," it said.

As regards the steel sector, Anil Rego, founder and fund manager at Right Horizons PMS, highlighted that coking coal prices are impacting the production cost, affecting margins. Rising gas prices, too, will impact the ceramics industry. The outlook for these segments, he believes, remains weak in the short-term.

Investment strategy

So, what should investors do with the related stocks.

Analysts suggest investors stay put in shares of related companies from a two-three years’ perspective as long-term outlook for each of these companies remain robust.

"We do not believe that home loan rates approaching pre-pandemic levels will be enough to subdue market momentum significantly. The Reserve Bank of India (RBI) having kept the FY23 GDP growth estimate constant gives credence to our belief that residential real estate demand should not be impacted materially in 2022," said Vivek Rathi, director for research at Knight Frank India.

Siyoni of Sharekhan added that the strong commercial and residential real estate sector bookings, coupled with government’s focus on infrastructure creation, easing commodity prices from H2FY23, and lower valuations, present buying opportunities from a long-term perspective. He prefers UltraTech Cement, Asian Paints, Kajaria Ceramics, Century Plywoods, Greenply Industries, APL Apollo Tubes to play the construction / building material-related theme.

Phillip Capital, on the other hand, is positive on Jindal Saw and Maharashtra Seamless, while JM Financial likes Somany Ceramics; and Edelweiss Securities prefers Astral.