Paint biz goes off-colour, likely to see a fresh coat of downside in demand

Q3 witnessed weak volumes; valuations do not factor in risks

The paint sector has been an underperformer, with most listed majors shedding 24-30 per cent since their highs in August and September of 2022-23 (FY23). Except for AkzoNobel, paint companies have lagged behind benchmarks and peer indices on returns during this period.

Notwithstanding weak returns, brokerages believe there are multiple near- to medium-term worries for the sector, opening the way for further downgrades. These include weak October-December quarter (third quarter, or Q3) earnings, muted volumes, competitive pressures as new players enter the segment, and lack of valuation comfort.

The near-term risk for significant players remains a hit to sales emanating from demand woes. Market leader Asian Paints’ Q3 performance is indicative of this trend. Its three-year domestic decorative paint volume growth slowed to 16-17 per cent (from 19 per cent in the July-September quarter), on the back of a flat volume performance in Q3 due to an extended monsoon, higher base, and shorter Diwali season. Growth was muted across urban and rural markets. There was some downtrading in certain premium products, given the sharp price hikes taken earlier.

The non-automotive (auto) segment, too, is expected to be muted.

Analysts, led by Amit Purohit, of Elara Securities, believe that the market for industrial paints is likely to be unexciting due to a fall in auto production (a 2 per cent dip in Maruti Suzuki India’s passenger vehicle production), guided by a shortage in electronic components.

Even as the prices of raw materials, such as titanium dioxide, are down over 10 per cent year-on-year (YoY) and crude oil prices have corrected from their highs earlier in 2022-23, they continue to be higher YoY.

The Asian Paints management indicated that softening raw material prices assisted the expansion of gross margins, expected to improve further in the current quarter (January-March). After a slow start in Q3, volume growth hit double digits in December.

Motilal Oswal Research, however, expects near-term volume to be under pressure, with operating profit margins under check for the next two to three years because of potential competitive pressures and expanding capacity.

The biggest hurdle for incumbents in the medium term is the entry of challengers with deep pockets and their need to aggressively expand market share.

While Grasim Industries wants to become the second-largest player in the sector, JSW Group is eyeing a tenth of the market by 2025-26 (FY26).

Jefferies Research points out that the marketing spending by newcomers and veterans is going up, with Nippon Paint and JSW Paints spending as much as 15-20 per cent of sales in a bid to expand their presence, against less than 5 per cent for incumbents.

Although there is insufficient clarity on their ability to make deep inroads, brokerages believe they could possibly dent margins.

Analysts, led by Vivek Maheshwari, of Jefferies, observe that an aggressive strategy by fledglings will likely entail steps like channel push, higher discounts and promotions for dealers and even painters, in turn impacting the industry’s profitability, at least in the medium term.

The issue gets compounded, given that small- to mid-sized players (Kamdhenu Paints is looking to scale its revenues to Rs 1,000 crore by FY26) are also eyeing a slice of opportunity and may adopt a regional strategy.

Given these worries, Kotak Institutional Equities (KIE) analysts surmise that there is further scope for derating for Asian Paints, Berger Paints, and Kansai Nerolac Paints. This is on the back of multiples that are still on the higher side, regardless of derating in the past nine months, and the fact that market structure will worsen with the entry of Grasim as a potential disruptor and JSW Paints putting out feelers.

On the valuation front, the multiples of Berger Paints and Kansai Nerolac have derated significantly in the past few months and are trading below pre-Covid multiples due to disappointing volumes and/or concerns about the new competition. However, Asian Paints is still trading well above its pre-Covid peak multiples, observes KIE.