Shine to continue for paint companies

Asian Paints, Berger Paints & Kansai Nerolac remain favourites of most analysts, due to strong prospects, valuations

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The shares of Asian Paints and Kansai Nerolac Paints have outperformed the benchmark S&P BSE Sensex in the past month. The index fell 4.4 per cent in this period and the shares of the two companies fell a mere 0.3 per cent and 0.8 per cent, respectively.

As for Berger Paints, it has outperformed the Sensex in most time periods and made a new all-time high of Rs 283.5 on February 5. With its rich valuation, though, there was some profit booking recently by holders of this scrip.

Berger is now trading 26 per cent below its peak level; Kansai and Asian Paints are at 11 per cent and five per cent below their peaks. The valuations are pricing in their near-term growth. Both Berger and Kansai are trading closer to their historical average one-year forward price to earnings ratios of about 35; Asian Paints is trading at 39 times the FY17 estimated earnings, with its leadership position and strong brand equity in the industry.

Over the next three to five years, too, a healthy show is expected from these companies, on the back of continued traction in demand for decorative paints. So, buying on dips with a longer time horizon could be considered.

Says Abneesh Roy of Edelweiss Securities, “We are quite positive on paints stocks, a play on urban consumption. Housing for all, smart cities, road developments and similar initiatives should boost demand for these companies.” An uptick in demand from automobile and other industrial segments will be another positive. Especially for Kansai, given its strong leadership position in this segment, believe analysts.

Falling input costs have pushed the operating earnings margins of some of these companies to historical peaks. Even as crude oil prices seem to be firming up, analysts say pricing power remains strong. This and the increasing share of premium products will support margins in the medium term, though this metric could see some moderation as a high base effect starts kicking in. Still, most analysts remain positive on these companies.

Among the three, Berger has been consistently gaining market share from peers such as Kansai in decorative paints. And, its recent joint venture with Nippon Paints will strengthen its position in the industrial segment. Its earnings are expected to grow at a compounded annual rate of 26-30 per cent over the next two years and push both margins and return ratios meaningfully higher. Analysts at MOSL expect Berger’s return on equity to increase 340 basis points this financial year and another 100 bps in FY17, to 26.6 per cent.

Despite rising competitive intensity, Asian Paints has held its market leadership in the domestic decorative paints segment and continues to see good growth in both the Indian and foreign businesses. Analysts at JPMorgan raised their earnings estimates by three to six percentage points for the two years ending FY18 after the December quarter results. Its home improvement businesses (Sleek, Ess Ess) will help diversify the revenue stream in the longer run but need investments in the medium term. It has huge growth potential but its current share in the company's overall business is small and not have a meaningful impact on the financials.

Last Friday, Asian Paints closed its factory at Rohtak, Haryana, due to the ongoing stir. While it is too early to assess the impact of this on its financials this quarter, the company might step up production at its other plants.