Paint stocks' valuations dicey, investors should await better entry point

Gains from expected business recovery and benign input costs already priced in Asian Paints and Berger Paints' scrips

The stocks of Asian Paints and Berger Paints have gained around 7 per cent each so far in September, outperforming the 0.6 per cent rise in the leading market indices such as the BSE Sensex. Improvement in earnings visibility, led by business recovery and benign input costs, driving investor sentiment towards them. However, analysts do not see valuation comfort in the stocks of paints companies, including Kansai Nerolac, which has a higher share of automotive paints.

On a one-year forward basis, Asian Paints and Berger Paints are currently trading at a whopping 40-55 per cent premium to their historical 5-year mean. While Asian Paints’ current one-year forward price-earnings (PE) ratio is 66 times, it is higher at about 74 times in case of Berger Paints. Even on financial year 2021-22 (FY22) estimated earnings basis (in a normalised business environment), Asian Paints is trading at 58 times and Berger at 64 times.

Varun Singh, analyst at IDBI Capital, says, “Our interactions with paint dealers indicate that business recovery in the decorative segment continues to be strong. This along with falling crude oil prices offers good comfort.” However, Singh adds, “We believe the stocks’ current valuations adequately factor in these positives.” The domestic brokerage has ‘accumulate’ and ‘sell’ rating on Asian Paints and Berger Paints stocks, respectively.

 

 

Over 80 per cent of the business of the two firms comes from the decorative segment. From business perspective, this is one of the very few discretionary segments that are seeing faster-than-expected recovery. Notably, semi-urban and rural areas are driving business, and account for around 45-50 per cent of overall revenue of these companies. According to an industry source, metros/tier-1 cities are also expected to see good pick-up in demand as these areas get unlocked.

Though the real estate sector is still under pressure, it is unlikely to significantly stall the recovery of these companies, say analysts. This is because a large chunk (around 75 per cent at industry level) of decorative paint demand comes from re-painting. In fact, this ratio is evenhigher in the hinterland, at around 85 per cent. However, the jury is out on whether the strong momentum in rural areas will continue, given the rise in Covid-19 cases there.

Amongst other supporting factors for the firms are their safety campaigns and likely market share gains from smaller, local or unorganised players.

Among organised players, analysts expect Asian Paints to gain more market share given its wide distribution franchise, which comprises of around 65,000 dealers, more than twice the network strength of Berger Paints and Kansai Nerolac.

According to an August 30 report by Elara Securities, “Concerns over hiring painters and contractors for homes have reduced due to ‘safe painting’ practices, followed by paint companies selling PPE kits, sanitisers and gloves to painters and dealers (for sanitising shops). Customers are being educated regarding these services, which has reduced the fear factor.” The source mentioned above also said customers are overcoming their fears.

 

 

Further, a likely margin impact from product-mix deterioration, as economy products such as putty and distemper are seeing stronger traction, would get partly offset by lower input prices led by falling crude oil prices. Paint companies’ key raw materials, such as titanium dioxide, are crude derivatives.

Overall, while there are many factors supporting decorative paints companies, the high valuations leave little room for disappointment. Thus, investors are recommended to await better entry.