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Asian Paints, Berger Paints and Kansai Nerolac Paints put up a good show in the September quarter. This was driven by double-digit volume growth (12-13 per cent) and strong gross margin expansion (up 67-287 basis points). While strong traction in the decorative paints segment and price increases of about four per cent fuelled top line growth, gross margin expansion was driven by benign input costs.
However, Ebitda (earnings before interest, taxes, depreciation and amortisation) margin expansion was pared by higher advertising spends, as well as recent capacity additions and higher forex losses (both typically included in ‘Other Expenses’). Net of both, bottom line growth was still better than the expectations for most of these companies. Positively, the management commentaries from all these entities remained buoyant. Analysts also remain optimistic and believe demand in the decorative segment will hold up in the second half of this financial year, as the marriage season starts (further pushing the repainting demand) and rural income improves due to a better monsoon.
Abneesh Roy, associate director, institutional equities - research, Edelweiss Securities, says: “We expect strong volume growth to sustain for the next two quarters, as companies expand their distribution network in smaller cities and consumers move from unorganised to organised players.” He says the coming marriage season is important, as there are 20 per cent of more marriage dates this financial year, and this could be a big positive for the sector.However, Ebitda (earnings before interest, taxes, depreciation and amortisation) margin expansion was pared by higher advertising spends, as well as recent capacity additions and higher forex losses (both typically included in ‘Other Expenses’). Net of both, bottom line growth was still better than the expectations for most of these companies. Positively, the management commentaries from all these entities remained buoyant. Analysts also remain optimistic and believe demand in the decorative segment will hold up in the second half of this financial year, as the marriage season starts (further pushing the repainting demand) and rural income improves due to a better monsoon.
However, the industrial paints segment continues to be under pressure, with the weak Index of Industrial Productivity numbers and muted automobile sales. “Decorative paints fared very well and witnessed good growth across geographies, especially in Tier-II and Tier-III cities in the September quarter. The industrial coatings business continues to be affected by the economic slowdown,” said K B S Anand, managing director, Asian Paints.
While Asian Paints and Berger are relatively less impacted from the softness in this segment, Kansai is likely to feel the heat, as the segment accounts for about 45 per cent of its revenue. “We believe decorative paints demand would continue to grow, on the back of sustainable repainting demand. However, automotive paints’ demand would take longer to recover,” believes Sanjay Manyal, analyst at ICICI Securities.
Also, current valuations largely factor in the positives and, hence, investors can consider the stocks of Berger and Asian Paints on dips, say analysts. According to Bloomberg data, while most analysts remain positive on these scrips, their average target price implies limited upsides from current levels. The average target price of analysts polled in November so far stands at Rs 236 for Berger (four per cent up) and Rs 450 for Asian Paints (12 per cent down). The price to earnings multiple (PE), based on FY15 estimates, also works out to a little over 25 times, which is not cheap.
Rohit Chordia, consumer products analyst at Kotak Institutional Equities, says: “Valuations are demanding and strong operating performance needs to be sustained against that backdrop. We are sceptical about sustenance and, hence, cautious.”
While traction in the decorative segment is likely to continue in the second half of FY14, analysts believe the current margins are difficult to sustain and could come off. A weaker rupee versus the dollar and continued investments in advertising and promotional activities will be the key pressure points.
“Higher gross margins in the first half of this fiscal are a bit deceptive, as they reflect actual consumption average and not spot prices, which hardened in dollar and rupee terms. We believe gross margins will come under some pressure in the second half, driven by a weaker rupee, high cost inventory and inching up of input prices such as titanium oxide, monomers, solvents and PAN (Phthalic Anhydride),” adds Chordia.
Kansai and like companies might have to bear a large part of the higher input prices, as they have limited pricing power, with large clients in the industrial segment. Asian Paints and Berger, on the other hand, might not face much difficulty in raising prices, a fact they have displayed over the past few quarters. Notably, they have taken a combined price increase of fojur per cent in the financial year so far. In a statement this month, H M Bharuka, managing director of Kansai, said the company was able to pass on the increase in cost of production in decoratives, thereby protecting the margin. In industrial paints, however, it had been able to only partly pass on the cost increase, resulting in pressure on overall profitability.
“Demand in decoratives is expected to improve, however, both automotive and infrastructure (industrial paints) are expected to remain under pressure, due to the high interest rates and various bottlenecks. The outlook for the short term, thus, remains cautious. Overall, however, demand remains positive over the long term,” said Bharuka.
