Losing sheen?

SPECIAL REPORT

High reliance on the industrial segment hurts paint-maker Kansai Nerolac.

"J ab ghar ki raunak badhaani ho, deewaaron ko jab sajaana ho..." "� The jingle may have left a lasting impression on most of our minds but unfortunately it didn't quite paint a rosy picture for Kansai Nerolac (earlier Goodlass Nerolac). Despite best attempts to increase its market share in the decorative paints segment, Nerolac has met with limited success. And this is costing the company dearly.

Compared to its competitor and the No 1 paint-maker Asian Paints, the company earns lower margins as it struggles to pass on cost increases to its customers who are largely from the industrial segment. As for the stock, it trades at a discount to its peer and the gap is unlikely to be bridged soon.

Nerolac commands an overall market share of 23 per cent among the organised players while being a leader in the automotive (60 per cent share) and industrial paints (40 per cent). In the decorative segment, Asian Paints is the clear winner with roughly 45 per cent market share, followed by Berger Paints (20 per cent) and Nerolac (14 per cent).

Looking at this year's financial performance of Asian Paints and Nerolac, it is evident that the former is reaping the benefits of its supremacy in decorative paints while the latter is having to pay a price for its leadership in industrial paints.

A raw deal
Here is how. Last year, paint companies grappled with the rising prices of key raw materials including crude-based solvents, titanium-dioxide and vegetable oils. While the average price of raw materials for decorative paints was up 5.5 per cent in FY07, industrial paints were hurt more as their basket of raw materials went up 11 per cent.

While companies were able to pass on the cost increases in decorative paints by hiking the prices 5-6 per cent, the same was not possible in the case of industrial paints.

"We had to absorb the rise in raw material prices since cost is one of our prominent selling propositions," says H M Bharuka, managing director, Kansai Nerolac. To be precise, the cost of raw materials for Asian Paints was up 25 per cent in FY07 while the same for Nerolac was significantly higher at 31 per cent.

Similarly, raw materials as a proportion of sales stood at 61.63 per cent for Asian Paints as against 65.71 per cent for Nerolac. Since raw material prices have shown signs of easing up, paint companies are likely to face lesser pressure on margins going forward.

Although Nerolac reported a 21 per cent growth in topline during the year, operating profits rose only by nine per cent. Operating margins remained flat at 11 per cent. Asian Paints' revenues from the paints segment grew 22.2 per cent y-o-y with a marginal improvement in operating margins.

More significantly, the two companies differ considerably when it comes to their return ratios. Since Nerolac needs to incur capital expenditure in the form of technology and equipment at its clients' end, mainly in the automotive segment, it earns a lower return on capital. 

PEER COMPARISON
	Kansai Nerolac		Asian Paints*		ICI India		Berger Paints
	FY07	FY08E	FY07	FY08E	FY07E	FY08E	FY07	FY08E
Revenue	1556	1797.2	3670	4254.7	955.1	1027	1162.9	1215.2
OP	171	217.9	514.5	638	133.6	143.8	111.6	115.5
OPM (%)	11	12.12	14	15	14	14	9.6	9.5
Net Profit	102	112.5	280.4	336	92.6	101.7	74.4	79
NPM (%)	6.6	6.26	7.6	7.9	9.7	9.9	6.4	6.5
EPS (Rs)	39.9	44.1	29.3	35.1	22.6	24.9	2.3	2.5
P/E (x)	17.5	15.9	26.4	22	19.9	18.1	17.4	16.2
* Consolidated

"Asian Paints earns higher profit margins with low investment and also enjoys tighter working capital cycles, which aids the company in generating a better ROCE," says Sumeet Budhraja of Edelweiss Securities.

To add to its woes, Nerolac has significant amount of capital blocked in two of its facilities, one in Lower Parel, Mumbai and another in Thane, which are not operational. "Both the plants are under the labour court, and it is uncertain when the matter would be resolved," says Bharuka.

The brighter side
However, the future looks bright for both companies with India's per capita consumption of paints still very low at 1-1.1 kg, compared to China's 2.5 kg and 21 kg for the US. The paint industry is thus estimated to grow at 1.5-1.75 times GDP growth which translates into 12-14 per cent considering that India's GDP would continue to grow at about eight per cent.

In the medium-term, however, this growth may not happen evenly across all segments. "The growth in automobile sales is expected to slow down, and hence automotive paints segment may grow at about 10 per cent, while decorative paints may grow at nearly 15 per cent in the coming year," suggests Nirjhar Handa of Pioneer Intermediaries.

Currently, the size of the Indian paints industry is estimated at Rs 10,200 crore, of which, Rs 2,700 crore is contributed by unorganised players. In the organised segment, decorative paints constitute over three-fourth of total sales and one-fourth comes from industrial paints.

Currently, Kansai Nerolac trades at 16 times its estimated FY08 earnings, almost a 30 per cent discount to that of Asian Paints, which trades at 22 times its estimated FY08 earnings.

Nerolac's revenues are expected to grow in line with the overall market, and there does not seem to be any significant trigger to boost the stock. For now, the only thing that can add raunak to the stock is an early resolution of the dispute relating to its properties.