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The stocks of Asian Paints, Berger Paints and Kansai Nerolac have outperformed the S&P BSE Sensex since July. While the first two made new highs in August, Kansai Nerolac touched its all-time high last month. While continued strength in demand for decorative paints and recovery in industrial paints are among the reasons for this rally, the recent softening in crude oil prices, which impacts prices of titanium oxide — a key raw material — should also benefit the companies.
In the June quarter, all three companies witnessed improved volume growth in the industrial paints segment. As demand for industrial paints picks up along with economic recovery, Kansai Nerolac stands to gain more, given that it gets 45 per cent of revenues from this segment, compared with 20 per cent each of Berger Paints and Asian Paints. Kansai Nerolac is the leader in Indian industrial paints segment and the third largest in overall paints market.
Berger has been focusing on improving its brand equity over the past year and also on premiumisation to drive growth. Although these steps have helped it garner market share from smaller players, that of its larger peer Asian Paints has remained intact. For Asian Paints, its core decorative paints business has posted consistent performance so far and the company continues to enjoy strong pricing power. However, its diversification into the home improvement segment (modular kitchens, faucets, etc) is not well received by some analysts even as many others cheer this move. However, given the small amount invested in this high potential business, of 3.5 per cent of capital employed, this is unlikely to dent its financials.
On the whole, analysts remain positive on the sector and believe a shift towards premium products, higher frequency of repainting cycle and higher purchasing power of the end user will drive growth. Strong distribution network and brand equity of leading players will play to their advantage. An economic recovery will only boost demand for both, industrial and decorative paints. The key downside risk, though, remains intensifying competition from current levels, which could put pressure on pricing/margins of these companies as they vie for higher market share, say analysts.
However, rich stock valuations might cap further upside for a few of these in the immediate future. Asian Paints currently trades at 32 times FY16 estimated earnings, Berger Paints at 27 times, and Kansai Nerolac at 24 times, compared to their historical averages of 30 times, 20 times and 25 times, respectively. All paint companies have re-rated in recent times thanks to improving growth prospects. Analysts though believe that the premium of Asian Paints over its two peers might reduce going forward.
“Although we expect Asian Paints to trade at a premium rating to these peers, the quantum of this premium deserves to be lower than current levels. Moreover, capital misallocation risks limit the visibility of its longer-term cash generation at the consolidated level,” says Rakshit Ranjan of Ambit Capital. He believes the firm’s aggression in acquiring companies in home improvement and paints segment could put return ratios under pressure.
