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Grasim's entry into paints may have limited impact on existing players

Ability to penetrate distribution network and creating brand equity key challenges, say analysts

paint
What should help Grasim stock is improvement in its core business, better outlook for subsidiaries and capacity expansion.
Yash Upadhyaya Mumbai
4 min read Last Updated : Jan 26 2021 | 12:19 AM IST
The domestic paints industry has a new kid on the block. Grasim Industries announced its plans to enter the high-margin business with an investment of Rs 5,000 crore over the next three years mainly towards adding new capacity at multiple locations in the country.

The company plans to become the second largest player and has a target of 20 per cent internal rate of return (IRR). To achieve this, it intends to leverage the distribution network of its subsidiary Ultratech Cement. Ultratech’s Birla White brand is well known for putty and white cement and has a reach of 35,000-40,000 paint dealers.

While investors cheered this and the stock rose by 6.4 per cent in trade, analysts are skeptical about the impact the company can have. Though it is better placed than other recent entrants, high entry barriers in terms of penetrating the distribution network and strong brand equity of existing large players are key challenges, say experts. They say the dynamics of the business are different compared to white cement/ putty and require stronger ties with retailers and distribution network. A successful expansion of distribution network would depend largely on recognition of brand among potential dealer partners and acceptance of tinting machines at new locations. This has proven to be a key entry barrier in the past.


“Historically, we have not seen new players like JSW, Jotun, Nippon, etc, have significant impact on existing paint players like Asian Paints and Berger Paints. In paints, distribution is a very big entry barrier as most paint shops are quite small with most of them having space for just two paint players for their tinting machine,” said Abneesh Roy, research analyst, Edelweiss Securities. Further, there is a need for higher ad spends, which is another challenge.

The next challenge is brand loyalty among customers. “Painting is a once in 6-8-year activity and, hence, consumer loyalty to brands is high. With smart advertising, the top 4 players (65 per cent of market share) have strong brands and created a strong emotional gratification around the category. Hence, inclination to consider new brands is generally low,” said analysts at Kotak Institutional Equities.


Having said that, the competitive intensity will definitely rise, which may have a negative impact on incumbents. “Grasim’s entry may provide impetus to volume growth over the medium to long term, but it’s also likely to impact margin and profitability of incumbents,” Emkay’s Ashit Desai said in a note. With paint companies trading at eye-wateringly high valuations, Roy of Edelweiss Research expects these stocks to see some profit booking in the near term, which should be used as a buying opportunity. The top three paint stocks were down 3-6 per cent in trade on Monday.

What should help Grasim stock is improvement in its core business, better outlook for subsidiaries and capacity expansion. These are expected to reduce its holding company discount. 

The profitability of its standalone business should improve, given that viscose staple fibre prices (VSF) have increased on an average by 20 per cent in Q3. Its consolidated performance is also expected to improve with better outlook for investment companies and subsidiaries. Similarly, concerns on telecom business (Vodafone Idea) too are reducing on expectations of price hikes by sector leaders. Additionally, the company is expanding its VSF and chemicals capacity by 38 per cent and 27 per cent, respectively, by the end of next fiscal. This might generate operating cash flows of over Rs 2,500 crore per annum beyond FY23, said analysts at ICICI securities.

Given this , analysts have upped forward estimates and target prices. Kotak Institutional Equities has increased its consolidated EPS by 10 per cent, 8 per cent and 7 per cent for FY21, FY22 and FY23, respectively, while maintaining ‘add’ rating on the stock.

Topics :GrasimPaint companiesUltraTech CementAditya Birla GroupVodafone Idea