Bright outlook but valuation high for Indigo Paints, say analysts

Set up in March 2000, Indigo Paints has quickly grown into India’s fifth-largest decorative paint company, aided by its focus on differentiated products and increasing its presence in tier-2/3/4 cities and rural areas. 

According to analysts, the company’s revenues (ex-acquisitions) have grown at a compound annual growth rate of 29 per cent in the past five years, making it the fastest growing paint company in that period. With a proven formula and high growth potential of the industry, analysts believe Indigo could continue to grow at a similar clip in the mid- to near-term future. 

Indigo has been consistent in coming out with products that create a new category as well as offer niche products in existing categories. It was the first to introduce metallic emulsions and tile coat emulsions. The value-added portfolio comprises of products such as dirt-proof and waterproof exterior laminate, acrylic laminate and others. This has not only helped the company stand out but has also resulted in superior gross margins.

“Aggregate gross margin in differentiated products is 8-10 percentage points higher than the rest of the portfolio. Moreover, it has resulted in creating cross selling opportunities for rest of its portfolio,” IIFL Securities said in a report. On an average, differentiated products accounted for about 28 per cent of revenue over the last three years.

To create demand for its differentiated products, Indigo taps into tier-3/4 towns and rural areas, where brand penetration is easier and dealers have greater ability to influence customer decisions. Typically, when Indigo enters new states, it begins by doing business with dealers in such places and, subsequently, leverages this network to engage with dealers in larger cities.

However, successful expansion of the distribution network depends on recognition of the brand among potential dealer partners and acceptance of their tinting machines at such new locations. Installation of a tinting machine, according to Indigo, increases the sales throughput from a particular dealer by 2.5x. As of September 2020, Indigo had 4,603 tinting machines across its dealer network.

To enhance its brand, Indigo has been investing aggressively on advertisement and sales promotion — spending about Rs 62 crore in FY20 on ads, which was only slightly lesser than Berger Paints, and on a par with Kansai Nerolac. But, as a percentage of its overall sales, this is significantly higher (13 per cent) than its peers (average 5.5-6 per cent). However, the impact on margins won’t be significant as analysts expect ad spends to moderate on the back of rapid top line growth.

In this backdrop, analysts are bullish over Indigo’s medium-term prospects. “We forecast sales, Ebitda (earnings before interest, taxes, depreciation, and amortisation) and net profit growth on a compound annual basis of 20 per cent, 36 per cent, and 48 per cent, respectively, over FY20 to FY23,” said IIFL Securities. 

Having said that, experts believe the valuation is priced to perfection and leaves little scope for any disappointment.

“At the upper band, post money market cap stands at Rs 7,010 crore, valuing it at PE of 146x (industry median: 62x) and 11.3x EV/sales (industry median: 9.4x) on FY20 basis,” say analysts at Elara capital.

On FY21 estimated earnings, too, PE valuation is 87x. In comparison, much larger peers Asian Paints and Berger Paints trade at 89-113 times, while the third and fourth-largest peers (though have higher share of industrial paints) are available at 66x and 43x.

So, long-term investors with an appetite for risk may consider the offer.