Paint companies better-placed to tackle higher crude prices, say experts

Robust rural demand, pricing power to mitigate the risk of increase in input costs

Shares of paint companies, after correcting as much as 5 per cent from their all-time highs on worries of rising crude oil prices, are again trading firm. Analysts say, while higher oil prices would have an impact on operating profits, companies are better-placed to handle it.

Last week, oil prices hit their highest level since March on hopes of a faster global economic recovery following positive news flow on coronavirus vaccine. International oil prices are up 25 per cent in a month. Crude oil and its derivatives account for about half of paint companies' cost. Oil prices and operating profit of paint companies typically have an inverse correlation. So, lower the oil prices higher the operating profits and vice versa. Benign raw material prices and overall cost control had helped paint companies report their highest-ever operating margin in the September quarter.

"While higher crude prices may impact gross margins in the near-term, we don't see any major impact over the medium-term as paint companies enjoy significant pricing power," said Anand Shah, Senior VP-Consumer Sector, Axis Capital. Secondly, some bit of reversal in margins is also priced in by the Street.

“As business returns to pre-Covid levels, such high margins would become unsustainable as a large part of these cost efficiencies is seen going out,” said Anand Tandon, co-founder, Gryffon Advisors. “Therefore, we expect margins to normalise going forward,” he added.

Having said that, there are other levers that could help mitigate cost pressures, a key one being the rebounding housing demand and a strong rural economy.

Sale of residential properties in Mumbai Metropolitan Region during October rose 36 per cent year-on-year. "One of the biggest catalysts for this growth has been the reduction of stamp duty by 300 basis points, which has been further matched by developers who have offered to absorb the remainder, thus significantly reducing the total outflow towards new home purchases," Knight Frank said. The reduction in home loan rates helped improve homebuyers' loan eligibility and also aided sales growth, it added.

Importantly, rural sales account for 60 per cent of revenue of paint companies. Good monsoon coupled with government support and lower penetration of the pandemic (compared to top cities) has enabled paints demand from smaller cities 

and towns to grow at a faster pace. Company managements in their analyst call also highlighted demand returning to pre-Covid levels for these regions and are confident of the momentum to sustain as painting cycle tends to pick up post monsoon.

The sharp run up in the stocks over the last 12-months, however, means that valuations continue to remain expensive. Analysts though are selectively bullish. “Since in the current environment there is a preference for businesses that are relatively more resilient, sector multiples at current levels in near term will look expensive,” said Vishal Punmiya, research analyst, Nirmal Bang. Overall, unless demand falters or oil surges sharper-than-expected, the party may continue for paint companies.