Lower oil prices, volume uptick to help paint firms get their shine back

With crude oil prices cooling off and the rupee strengthening a tad against the greenback, paint companies are expected to be major beneficiaries. This is because, prices of key raw materials, besides packing materials, are linked to crude oil prices. The stocks of three paint companies — Asian Paints, Berger Paints and Kansai Nerolac (Nerolac) — surged 15-23 per cent over the last one month vs the 2.6 per cent rise in the S&P BSE Fast Moving Consumer Goods (FMCG) index. A fall in valuation after the recent correction in the FMCG space too supported the rally in the stocks.

Though crude oil prices (Indian basket) are higher on a year-on-year basis, about 18 per cent fall over the last month means that it is now unlikely to reach $90-100 per barrel anytime soon as some experts had projected. The rise in oil prices had earlier led to muted profitability outlook for paint companies and investors shying away from their stocks.

The recent correction in crude oil prices was largely due to the US waiver for certain countries, including India, on oil imports from Iran, coupled with easing supply and concerns over the demand outlook. Experts do not see a sharp rebound in crude oil prices in the near term. “With supply glut, including rising shale oil production in the US and ease of sanctions for importing oil from Iran, we expect Brent prices to remain around $65 per barrel in FY19 (down 13 per cent from FY19 year-to-date average),” says Madan Sabnavis, chief economist at CARE Ratings. Further, chances of a production cut in the meeting of the Organization of the Petroleum Exporting Countries in the December meeting is unlikely, he adds. Brent crude oil is one of the benchmarks.

 

Given the strong correlation between crude oil prices and input costs (see chart), paint companies have been at the receiving end due to a surge in costs of raw materials like titanium dioxide and monomers. Even in the September 2018 quarter, the three paint companies reported around 150-500 basis point contraction in gross profit margin on a year-on-year basis, which impacted margins at the operating profit level as well. Also, with the recent cut in goods and services tax (GST), the paint companies could not undertake price hikes due to anti-profiteering rules. Hence, expected low crude oil prices should directly push up margins of the companies, mainly on a sequential basis, and it will also help cap the slide on margins on a year-on-year basis.

In addition to profitability, the Street will keenly watch out for demand growth. Vishal Gutka from Philip Capital believes volumes are on an upward trend. This, coupled with likely margin improvement on lower crude oil prices, provides healthy earnings visibility for paint companies. He expects additional support to their gross margin from the recent price hikes. Some analysts forecast benefits of lower crude oil to be reflected from the March 2019 quarter onwards and indicated an upward revision in earnings estimates for paint companies.

The impact on each company, however, would be different. Asian Paints and Berger Paints, which have a sizeable share in the decorative segment, would see volume improvement with the recent cuts in GST and progress in rural markets. However, industrial paints maker Nerolac, could see moderation in volume growth due to tepid show by the automobile segment. Around 30 per cent of Nerolac’s business comes from automobile paints.

While Asian Paints and Berger Paints clocked 12-13 per cent volume growth in the September quarter, Nerolac posted a meagre nine per cent volume growth. Overall, if crude oil prices behave as expected, it will help paint companies to get their mojo back, say analysts.