Demand worries, higher input costs may derail Kansai Nerolac's Q1 show

While the first three weeks of April saw robust demand in what is considered a seasonally strong period, lockdown in multiple states has seen offtake collapse

After a strong start to the June quarter, Kansai Nerolac Paints is facing a double whammy in the form of weak demand and higher commodity costs. While the first three weeks of April saw robust demand in what is considered a seasonally strong period, the lockdown in multiple states has led to a collapse in demand. About 70-90 per cent of depots and distributors are shut while the rest are open for a limited period.

The company is facing demand challenges in both its key segments of decorative paints and the industrial (auto) segment. While the semi-urban and rural segments were less impacted and recovered quite strongly post the lockdown last year, demand weakness this time around is spread across states.

Given the restrictions, cautious approach of customers, demand in the decorative segment which accounts for 55 per cent of revenues is muted. With most automakers shutting down manufacturing operations, orders from the automotive segment (30 per cent of sales) are also drying up. This follows strong double-digit growth in the March quarter for both segments on a low base.

In addition to demand revival the street will look at the impact the lack of operating leverage will have on margins. The rise in raw material prices led to a 409 basis points decline in gross margins. With the raw material prices rising 13-14 per cent since the March quarter and demand drivers missing, it will be hard for the company to pass on the inflation to the consumers.

Kansai Nerolac has taken a price hike in March which will partially offset the rise in commodity costs. While the company has indicated the need to maintain profitability, the same will depend on demand, moves by competition, consumer acceptance and the trend in raw material prices. Aggressive cost control and overheads management helped to improve the operating profit margin by 235 basis points y-o-y in the March quarter; this will be a lever the company will bank on to protect margins in the near term.

The multiple headwinds on the demand and margin front weighed on the stock which shed over four per cent in trade on Monday. While the management is confident of medium term growth trajectory, investors should keep an eye out for the impact of the second wave on demand as well as raw material inflation.