Celebration time

Paints have been associated with celebrations and last year surely was one big celebration for the domestic paints industry. How else can you describe the good showing in segments like housing, auto and white goods - on which the industry thrives - last year? Analysts say the good times are far from over and the industry is set to grow by a handsome 12-13 per cent this year.

They foresee demand coming in from the housing sector with home-loan disbursements increasing 25 per cent this year and urban properties looking hot right now. The auto sector, too, is expected to continue its good show despite the delayed monsoon.

Led by price competition and attractive exchange schemes, the white goods industry has grown by 13-15 per cent last year and is expected to grow 12-13 per cent this year. Replacement demand in the decorative paints segment has also been good, thanks to the pick-up in the economy.

Besides, per capita paint consumption is just about 700-800 gm in India compared with 20-25 kg in developed countries. Even developing countries have a consumption of about 1.5-2 kg.

Therefore, there is a large scope for penetration. Given this backdrop, key players in the Indian market - Asian Paints and Goodlass Nerolac - are likely to see strong growth. We assess their relative market positions, future prospects and stock valuations.

Reality check
The industry is divided into the decoratives and industrial segments. Asian Paints enjoys a 40-42 per cent marketshare in the decoratives segment, followed by Goodlass Nerolac and Berger India with 14-15 per cent marketshare each.

Goodlass Nerolac is, however, the leader in the industrial segment with a 65 per cent marketshare in the key automobile industry. In the industrial segment, Asian Paints has a presence in automotive, powder and protective coatings.

The company's international operations, which account for 30 per cent of its sales, are spread across 22 countries, including South Asia, China, Australia, the Caribbean and the Middle East. It gained entry into 11 of these regions through the acquisition of Singapore-based Berger International.

A comparison of yearly results shows the profitability factor being skewed in favour of Goodlass Nerolac which, due to its size, is more lithe on its profitability growth.

More importantly, the operating margins of the company have shown an improvement of 230 basis points while that of Asian Paints have fallen by about 340 basis points on a y-o-y basis. Analysts say Asian Paints' operating margins were hit by factors like rising input prices, underperformance of its chemicals division and acquisition costs.

Reaffirms Jalaj Dani, vice-president (international operations), Asian Paints, "Last year our chemicals business did not do well. We lost on some production due to the cyclical nature of the business and changes in catalysts, and overall realisations were not very good. These impacted the bottomline" (read the interview with Dani on the next page).

Raw material costs went up 7 per cent y-o-y due to the firming up of titanium dioxide, one of the key raw materials, during the year. Going forward the price of titanium dioxide is expected to strengthen further due to the rise in international crude prices. Packing costs also went up in FY04 due to an increase in the prices of plastic and metals.

However, falling import duties and the strengthening rupee curtailed the effect of the rise in raw material costs to some extent. Dani expects raw material prices to stabilise in the near future.

Analysts say Goodlass Nerolac's operating margins were enhanced by cost-cutting measures and an emphasis on R&D. In fact, it has 150 employees in the R&D division out of which 50 have been stationed at the clients' end, which helps it come out with immediate solutions and reduce the quantity of paint used per unit of production.

"Asian Paints, on the other hand, has diverted its focus towards acquisitions which have not resulted in any such emphasis on R&D," says a senior analyst with a brokerage house.

Growth ahead
Asian Paints enjoys competitive advantages - strong brands, a wide range of offerings across all product categories, and a network of 15,000 retailers. In the wall finishes category, it has brands from the premium 'Royale' to the lower end 'Tractor'.

Over the past few years, the company has created a market for exterior paints, underpinned by a strong marketing and distribution strategy. Dani expects a 20 per cent growth in this segment in FY05. He also expects a 12 per cent growth in international operations.

The industrial segment is set to grow by 20 per cent while the growth in the decorative segment is likely to be 10 per cent. More importantly, the company's presence in overseas markets will enhance its profitability.

The takeover of Berger helped it improve international operations. In fact, analysts say subsidiaries could outgrow the parent in the long-term. However, pressure on margins due to the rise in prices of petroleum products and the competition for leadership in the decoratives segment would be caveats.

Analysts favour Goodlass Nerolac. They say the leverage that the company enjoys in pricing paints combined with its R&D expertise keeps it better equipped to cope with the shrinkage in margins due to the rising cost of raw materials.

Besides, sales growth in the industrial segment is better than that in the decoratives segment on account of good growth in the automobile and white goods sectors and the same is expected to continue going forward.

The strong growth in operating margins brings it to a comparable level with Asian Paints. In addition, the company is making inroads in the decoratives segment. Analysts peg an FY05 EPS of Rs 29.3 on enhanced equity after the company announced a 2:3 bonus issue.

"Topline in international operations may grow 12 per cent in FY05"

Jalaj Dani
Vice-president (international operations)
Asian Paints

What are the ramifications of the Berger acquisition? What kind of a synergy do you have with your subsidiaries?

Berger is a listed entity on the Singapore Stock Exchange (SSE) and Asian Paints owns 50.1 per cent of it. We are the first Indian company to own a firm listed on SSE. Berger was making losses for six years in a row. Under our management, the company turned around within a year and made a profit of around $2.2 million.

We have identified some areas of improvement in the current year also. We expect the bottomline to quadruple and the topline in international operations to grow in excess of 12 per cent in FY05.

We manufacture paints in 22 countries and have maintained alliances in the South Pacific islands for the last 25 years. We also have a joint venture with PPG for automotive finishes which gives us leverage in the fast growing auto segment.

How do international operations differ from that of India?

About 20 per cent of Asian Paints' group sales comes from international operations. Region-wise, the Middle East and the Caribbean contribute the most to revenues while South Asia and South East Asia are better in terms of growth. We have decided to get into other emerging markets as well.

Per capita consumption of markets in construction products (including paints) are expected to grow quite a bit in the years to come. We have also selected markets where there are not too many competitors. This will allow us to be among the top three players in those markets. We also have a good spread of retailers there.

Asian Paints controls about 45 per cent of the decoratives segment in India. How do you plan to maintain your lead in the segment?

We have gained marketshare over the last five years due to the way we price and market our products along with the kind of value proposition we offer to our customers. These measures will continue to help us gain marketshare.

You are not strong in the industrial segment. What is your take on the segment going forward?

The industrial market in India is about 20-30 per cent of the total market. The decoratives market has grown around 10 per cent in the last few years.

The industrial segment, on the other hand, has grown in excess of 20 per cent last year and the pace of growth is likely to continue in the current year also. We expect our industrial paint division to grow 20 per cent this year.

"Growth in decoratives segment decisive"

H M Bharukha
Managing director
Goodlass Nerolac

What are the company's growth prospects this year? What are your thrust areas?

The industry in likely to grow 8-9 per cent this year. We will retain our thrust on both industrial and decoratives segments. Presently the decoratives segment makes up 70 per cent of the paint market in India and we cannot ignore the growth in such a segment.

Therefore, it makes sense to push up volumes in the segment. Over 55 per cent of our revenues comes from decoratives while 45 per cent comes from the industrial segment. We expect a far better share from the decoratives segment.

The spurt in the auto industrial segment combined with the increased focus on the decoratives segment would reap us rich dividends. We would also be investing on marketing activities and brand building.

What are your capex plans?

We have already improved capacity in some plants. Our production capacity currently stands at about 108,000 tonnes. Partially, the increase in capacity has come by way of expansions.

We are putting up a Rs 100-crore greenfield plant which would augment our capacity by about 20,000 tonnes. The plant could start production in the third quarter of this financial year. In terms of logistics, it offers us the advantage of being close to our key customers.

How did the company manage to raise its operating margins?

Our operating margins were enhanced by cost-cutting measures and an emphasis on R&D. We have two dedicated departments in R&D - formulation development department (FDD) and vendor development department (VDD).

While FDD works for value addition and cost reductions, VDD looks for new vendors through whom we could source materials cheaper. Besides, the process engineering department makes our operations more efficient, cost effective and productive. These three departments are responsible for cost savings.

How is the margin scenario in the industry across segments?

Margins are going to be under pressure. In the present environment, companies are unlikely to expect an improvement in margins. Customers will continue to put pressure on margins.

We need to do value engineering through which we could retain margins. We have to look more in-house to increase margins rather than getting price increases from customers.

That would be difficult. Costs are going up. We have to frame measures to contain them. However, there is less pressure in the decoratives segment as most of the cost increases are passed on to the customer.