Paint companies have had a great run over the last three years, with stock prices surging 50-100% thanks to the steady uptick in both sales and profit. This has led to a sharp re-rating of the stocks, with the poster boy of the industry Asian Paints trading at 36x FY17 estimated earnings as against 33-34x for Berger Paints and Kansai Nerolac. The other major player, AkzoNobel India, is trading at 29x FY17 estimated earnings.
The steep fall in the crude price has been a major trigger and has eased the raw material costs of paint companies. Brent crude traded at an average price of $53 in CY15. While companies are yet to declare their full FY16 numbers, analysts expect raw material costs as a percentage of sales to have come off by 200-300 basis points during this fiscal. In Q3FY16, Berger Paints, AkzoNobel India, Asian Paints and Kansai Nerolac reported an average 20% growth in their bottom-line.
But, with the crude price now stabilising around $40, the colourful hues are getting a little dull. For instance, analysts at Nomura feel that the market leader Asian Paints’ valuation may have already priced in all the positives including earnings stability and margin expansion. “We would wait to see an uptick in consumption before reviewing our numbers,” said their latest report. For Berger Paints, analysts offer a similar view. “We continue to find the sector’s prospects attractive but Berger’s near-term valuation appears stretched,” analysts at JM Financial say in a note.
Meanwhile, paint companies are also expected to go for a price cut to fend off competition from unorganised players and sustain demand. Asian Paints went for a 2% price cut in its economy segment recently, citing strengthening rupee and fall in commodity prices. “… beyond a certain point, very high margins are unhealthy as it gives competitors a leeway to enter,” KBS Anand, CEO of Asian Paints, told a business channel. However, a fund manager, who has exposure to the sector, says that the paints business is a branded play concentrated among 4-5 players and unorganised players typically lose out in this kind of model. At 18%, Asian Paints’ latest EBITDA margin was at a 20-quarter high, according to an analysis by Nomura.
The product mix deterioration seen by Asian Paints in recent quarters could also be a cause for concern for the industry. Low-price categories such as exterior wall putty have grown at a higher rate than decorative paints, which has upset the value-volume equilibrium of the company and resulted in flattish year-on-year growth in realisation. While structural drivers such as the repainting cycle shortening from seven years to five years and fall in interest rates remain, the upside for paint companies may be capped in the absence of any near-term triggers.
