Berger's premium valuations versus Asian Paints unsustainable

Street remains positive on Kansai Nerolac, as it is likely to gain most from improving demand for industrial paints

Asian Paints, Berger Paints and Kansai Nerolac Paints, leading ones in the sector, had a mixed set of numbers for the September quarter.

All three players missed the Bloomberg consensus revenue estimate. A delayed festive season (versus 2014-15) and continued weakness in domestic decorative demand were key factors. Their revenues grew 4-5.7 per cent from the September 2014 quarter.

Price deflation was also responsible. Analysts believe domestic decorative volume growth was healthy, pegging it at eight to nine per cent each for Asian Paints and Berger, and 10-11 per cent for Kansai.  

They also estimate all three gained some market share in the quarter in decorative paints as customers switch from the unorganised segment. Unorganised entities account for about a fourth of India’s decorative paints market. Thus, there is scope for the organised ones to gain market share via price cuts.

Berger’s market share is estimated at 19 per cent in domestic decorative paints and Kansai at 15 per cent. Aggressive expansion of the distribution network enabled Berger to gain market share and maintain its number two position in the segment, says Rakshit Ranjan, analyst at Ambit Capital. Asian Paints is a strong market leader, with 53 per cent share. The distribution network has a key role in market positioning and Asian Paints has at least 35,000 dealers, compared to Berger’s 15,000.  

Berger’s stock trades at 37 times the FY17 estimated price to earnings ratio, a bit higher than Asian Paints' FY17 estimated 36 times. With the latter's superior positioning, analysts believe Berger should trade at a 15-20 per cent discount to Asian Paints. Kansai trades at a reasonable valuation of 29 times the FY17 earnings. With its leadership position in industrial paints (45 per cent of overall revenue) and strong performance of this segment in the past two quarters, analysts believe Kansai stands to gain the most.  

Festive demand will play a key role in determining their performance in the second half of this financial year. Though revenues were impacted by falling realisations, volume trends remained healthy. Additionally, all three had a healthy expansion in operating revenue margin, of 162 to 280 basis points in the quarter. Significant reduction in interest costs was a factor aiding Berger’s profit. Asian Paints' net profit was aided by healthy other income.  

Input cost inflation is likely to remain benign and will aid their margins, beside allowing them to keep prices down and gain volumes. Any rise in rural demand and the trend in festive demand will be things to keep an eye on in the second half.