Spike in crude oil prices unlikely to be slippery for paint companies

Stable prices of other inputs and pricing power should protect margin profile, say analysts

After demand worries for the discretionary space were pointed out by some experts a few weeks back, the recent spike in crude oil prices, which were up over two per cent on Monday, has added to the concerns of investors, particularly for those who've bet on paint companies. Stocks of paint majors such as Asian Paints, Berger Paints and Kansai Nerolac fell by around two per cent in Monday’s trading session, following the decline in broader market indices, which were down 1.3 per cent.

However, margin outlook still remains intact for paint companies.

With the news that the US is set to extend Iran sanctions to all importing nations, crude oil prices surged over 2 per cent on Monday. This questions the earnings outlook and margin profile of paint companies, as some key raw materials such as monomer, which account for around 30 per cent of their production cost, along with packing material, are linked to crude oil prices.

However, despite their relevance in production costs, analysts do not see this as a concern for now.

According to Parth Poddar, analyst at Narnolia Financial Advisors, despite today's spike crude prices have been lower than FY19 highs. Also, lower prices of TiO2 (titanium dioxide) and the cumulative price hikes of 6 per cent (by Asian Paints and Berger Paints) in FY19 would be sufficient enough to offset costs pressure at current levels. Prices of TiO2, accounting for around 20 per cent of paint companies’ raw materials costs, have decline by 2.5 per cent from average FY19 level.

Further comfort on profitability also stems from pricing power enjoyed by paint companies. Paint companies normally enjoy good pricing power as paint demand isn’t impacted materially due to price hikes, say analysts.

Poddar also believes that if crude oil prices remain at US$78 – 80 a barrel in FY20, paint companies can stomach the price increase without much impact on operating margin.

The good news is that the Street isn’t factoring for further increase in crude oil prices. “There are some crude oil supply disruptions in producing nations and the latest better-than-expected gross domestic products of China could drive up crude oil prices. However, overall crude oil demand is almost stable due to growth worries of importing countries,” says Devendra Pant, Chief Economist at India Ratings, who foresees crude oil prices to remain at US$65-70 per barrel in FY20.

Yet, sequential pressure on the paint companies’ operating margin cannot be ruled out in next two quarters of FY20, due to higher base effect of March 2019 quarter led by probable operating margin expansion, apart from the recent spike in cure oil prices. The earlier correction in crude oil price, lower TiO2 prices, rupee stabilizing against US dollar and price hikes by some companies, are expected to aided profitability the March 2019 quarter for paint companies.

For instance, some analysts expect the market leader - Asian Paints, to report 80-100 basis points operating profit margin in March 2019 quarter, though inferior product mix with higher share of low-margin putty may restricted margin gains. Besides, demand concern for the entire consumer space is still not behind paint companies.