Adding colour

POUND WISE

Thanks to a strong parent and surging demand for paints, Goodlass Nerolac is poised to see a brighter future.

Goodlass Nerolac, the second largest paints company, should thrive going forward, given the backing received from an able parent and a spanking thrust on the decoratives segment, coupled with a boom in the automobile and construction industries. At a P/E multiple of 13.35, it seems a good bet to colour up your investment portfolio.

Goodlass Nerolac, to be rechristened Kansai Nerolac Paints, currently caters to 21 per cent of the market. The domestic paints industry, valued at Rs 7,500-8,000 crore, has almost doubled over the past five years, reflecting a CAGR of around 15 per cent as per a CMIE report. 
 

STANDING TALL
Category	Market Share (%)	Rank
Industrial paints	44	1
- Auto paints	60	1
- Powder coating	24	1
Pre-treatment chemicals	23	2
Decorative	14	2
Overall	21	2

In terms of end-use, the industry is divided into decorative paints and industrial coatings, with decoratives accounting for 75-80 per cent of the market.

Both industrial and decorative paints contribute equally to Goodlass's revenues. Eighty per cent of the demand for the Rs 1,200 crore organised industrial paints industry comes from the automobile sector, in which Goodlass has a dominant 60 per cent market share.

Goodlass holds a 14 per cent market share in the Rs 4,200 crore decorative paints market. Thus, the company will benefit from the boom in both the auto sector and construction.

Goodlass is a 66 per cent subsidiary of Kansai Paints, Japan, a global paints major with intense focus on industrial and auto paints.

Not only has this association with Kansai added a few customers to its kitty, but also Kansai's R&D efforts have played a major role in scripting Goodlass' success story in the automotive segment. Because of Kansai's association with Suzuki, Goodlass is a major supplier to Maruti.

Also, it is a major supplier to companies like TVS, Hero Honda and Bajaj Kawasaki that have a Japanese collaboration. "All the leading manufacturers are buying from us, barring one or two," says Ashok Saini, vice-president, special projects, Goodlass Nerolac.

Goodlass leads the industrial paints market with a 44 per cent share. The company was the first to introduce Acrylic CED (cathodic electro-deposition) coat "� a Kansai innovation "� for two-wheelers in India.

The company also introduced the 3-coat-1-bake system "� another Kansai innovation "� for Maruti's Swift, thus resulting in Goodlass becoming the sole supplier for Swift.

Both these innovations help save considerable production cost and time. The company also meets the entire demand for Maruti's export models. "Kansai's presence in 23 countries offers collective bargaining power in the case of raw material purchase as well," Saini says.

Going forward, the decoratives segment is the area of focus as margins are better here. This is not the case in the automotive category, as continuous price reduction initiatives are stealing away the pricing power from Goodlass. 
 

PEER COMPARISON
(P/E based on FY06 earnings)
Goodlass Nerolac	13.35
Asian Paints	29.10
Berger Paints	20.62
ICI India	24.45

"The true aggression will be seen in decoratives," says Saini. "We will continue to invest in brand building, launch value-added products "� at different price points, both in interior and exterior coatings, especially emulsions," he adds.

Innovative products like 'Nerolac Disney' have helped Goodlass not only maintain the market share but also reduce dependency on low value-added products. Analysts see great potential in its wood finish and auto refinish businesses, too.

The company is also attempting penetration in the rural markets for its decorative business.

"We are working on the FMCG model whereby distributors are appointed to cater to the demand of smaller, remote markets, where companies cannot reach directly on account of high distribution/ logistics cost. Even the size of the dealers in remote areas will be small, thus not viable," says Saini.

Goodlass has picked up 55 per cent stake in a non-profitable Rs 50 crore Malaysian decorative paints company.

"This was more to understand the decorative business globally "� foreign markets, products, processes and delivery. It will take four-five years to recover," says Saini.

Over the last 10 years, Goodlass has recorded a PAT CAGR of 23 per cent. Rising raw material costs, along with aggressive pricing, have impacted industry-wide profitability.

However, cost-saving initiatives and product strategies have enabled Goodlass to improve operating margins in the past few years. The company has shown the best margins for FY06. Its new plant at Bawal, Haryana, is a closed-loop factory where the company claims production losses of 0.5 per cent against the norm of 3 per cent.

The 'Colour Scape' system, adopted, not only reduces the inventory requirement for Goodlass as well as the dealer, but also transportation costs for the company.

However, concerns do remain because of fluctuating prices of oil affecting prices of solvent. Also, the company is largely dependent on the automobile sector, which, as Saini puts it, is "known for peaks and valleys". Nevertheless, Goodlass has projected 8-9 per cent y-o-y growth in this sector.

India has a huge potential market for paints given that its per capita consumption is as low as 900 gm. Thus, a sustained paints demand over the long term is expected.

Increase in residential construction activity and rising income levels in the rural as well as urban population are likely to create demand for premium category paints.

Pick-up in construction of commercial infrastructure, like shopping malls, which focuses on aesthetics, is also expected to be a demand driver for the industry. 
 

FINANCIALS
Rs Crore	FY06	FY05	FY04
Net sales	1009.58	879.49	760.46
y-o-y growth (%)	14.79	15.65	16.39
Operating profit	232.16	158.73	112.12
y-o-y growth (%)	46.26	41.57	36.93
OPM (%)	23.00	18.05	14.74
Net profit	138.76	91.96	57.96
y-o-y growth (%)	50.89	58.66	45.48
NPM (%)	13.74	10.46	7.62

Also, companies' market shares in the paints industry have been stable during the last five years. The main entry barrier into the industry is building a distribution network to match that of the market leaders.

Thus, going forward, analysts see a stable industry structure with the top four players broadly maintaining their market shares. Motilal Oswal pegs growth in top line for Goodlass at around 18 per cent over the next three years.

Based on earnings expectations of Motilal Oswal, the stock is trading at 16.15x, 13.12x and 10.74x its estimated earnings of FY07, FY08 and FY09 respectively, at its current price of Rs 726.