Margin worries, valuations weigh on Berger Paints amid strong Q4 show

The company's Q4 show, however, was better than market leader Asian Paints

Berger Paints’ performance for the March quarter (Q4) outperformed peers, such as Asian Paints and Kansai Nerolac. Revenue growth at just under 49.5 per cent over the year-ago quarter was higher than that registered by Asian Paints (43 per cent) and Kansai Nerolac (35 per cent). Yet, the stock has seen a decline after the results. While there are some concerns over the impact of the pandemic on rural sales, analyst recommendations indicate that the stock may underperform larger peer Asian Paints.

Analysts estimate Berger Paints’ volume growth to be upwards of 55 per cent, as compared to Asian Paints’ 48 per cent, though the former’s base quarter growth at -7 per cent is weaker than the market leader’s 2 per cent. On a two-year basis, Berger’s domestic sales growth marginally trails Asian Paints, given the higher share of the industrial segment in the former’s product mix. 

Ashit Desai of Emkay Research says the growth trends of the two are similar, with traction in the domestic business indicating stronger rural demand, a recovery in metros and market share gains from the unorganised segment. However, brokerages believe these high-volume trends as seen in Q4 are not sustainable and expect some moderation in FY22. The top line, however, may see some support from higher product prices, which will support sales growth.

What surprised the Street was the gross margin performance, which saw a slight expansion as compared to the much sharper 260 basis points decline for Asian Paints. A better product mix, price hike in the industrial paints segment, and some inventory gains have led to a better gross margin. 

However, despite the gross profit gains and significant operating leverage for Berger Paints, the same did not play out at the operating profit level, with margin expansion limited to 118 basis points. Higher other expenses in the form of advertising and promotion costs, which were up 63 per cent YoY, led to moderate profitability. In comparison, Asian Paints’ standalone and consolidated Ebitda margin expanded by 160 bps and 130 bps, respectively, for Q4.

Richard Liu and Vicky Punjabi of JM Financial believe Berger Paints’ spends reflect the need to drive revenue, given its growth in the first nine months of FY21 trailed Asian Paints. Further, more spending was needed as the competitive intensity in the paints segments increased. While Berger Paints raised prices (as did Asian Paints) in May, analysts believe it is not enough to overcome the sharper jump in raw material prices.

Though Berger Paints outperformed its peers on the sales and gross profit fronts, its stock price has slipped 2.6 per cent after its results on May 26. The Asian Paints stock -- up 0.6 per cent during this period -- is up 14.7 per cent after its Q4 results on May 12. 

In addition to weak demand trends and margin pressures, the valuation is in the expensive zone for Berger Paints despite the recent underperformance. The stock is trading about 80x its FY22 earnings estimates, fetching a 10 per cent premium over the decorative paints market leader Asian Paints. Despite strong execution, most analysts have not changed their estimates for Berger Paints. JM Financial has a sell rating and highlights that Berger’s revenue growth trajectory still remains below Asian Paints, despite the latter being more than 3x its size.

According to Bloomberg’s poll, only two of 27 analysts have a “buy” rating on Berger Paints; three have “hold” and 22 “sell”. Their average one-year target price is Rs 667, indicating a downside potential of 16.4 per cent.

In comparison, 20 of 41 analysts have a “buy” on Asian Paints; nine have “hold” and 12 “sell”. Their average target price of Rs 2,690 indicates a potential downside of 8.2 per cent.