Lower corporation tax rates add colour to paint sector's prospects

Earnings upgrades apart it could lead to higher volumes of premium decorative paints

The reduction in the corporation tax rates have boosted the earnings and growth potential of decorative paint companies, which were already (before the cut) an outlier in an otherwise sagging consumption basket.

Factoring in an expected 10-12 per cent direct push to earnings following the lower tax rates announced last week, the stocks of paint majors — Asian Paints, Berger Paints, and Kansai Nerolac — have surged 11-18 per cent in the last five sessions, along with an 8 per cent rise in the Sensex. The effective tax rate for listed paint majors was over 30 per cent in FY19.

In addition, the lower tax rate was expected to provide an impetus to volumes — mainly in the higher-end decorative segment — and also to market share. In the past quarters, till June 2019, the volume growth of paint firms was driven by lower-end products such as distemper and putty.

While Asian Paints and Berger Paints are the decorative majors, Kansai Nerolac has a large share of the industrial paints market (45 per cent of its revenues).

Analysts at ICICI Securities believe the tax cut will help revive demand in the decorative paints segment, especially in the premium category of products. It is also seen helping organised players gain market share from the unorganised market. The latter has close to 25 per cent share, thereby underlining the long-term business potential of organised firms.

The expected traction to high-margin premium paint volumes should propel the overall operating profitability of paint firms. However, any upswing in key raw material prices, such as crude-based monomer and titanium dioxide (TiO2), could also pose downside risks to the expected profitability gains. Nevertheless, current input prices seem to be supportive and analysts do not see any sharp input cost inflation in the near term.

Lower penetration in India and shortening of repainting cycle (from 7-8 years to 3-4 years) are other growth levers. UBS Securities says India’s per capita paint consumption was 4 kg in FY19, on an estimated basis, against the global average of 13.5 kg. Its September 16 report stated that premiumisation in paints was a secular trend. Pricey valuations, however, could limit further upside for stocks of decorative paint companies. Berger Paints and Asian Paints are trading at 50-52x their respective FY21 estimated earnings.

Investors are advised to wait for a correction for a better entry point.