The stock of Kansai Nerolac Paints Ltd. has declined by about 23% in the last one year. The increasing competitive intensity is a concern. Also, margin recovery has been slow. In the December quarter (Q3FY23), Kansai’s standalone gross profit margin contracted by 115 basis points year-on-year to 30.2% as the company still held high-priced inventory. Sequentially though, gross margin has expanded.
Kansai’s management expects the downward trend in input costs to continue. But it still has high-cost inventory, so the benefits of lower raw material prices on gross margin will slowly start to show through. Analysts have cautioned that this could lead to a downgrade in FY23/FY24 earnings estimates.
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Kansai’s revenue performance was underwhelming, with a modest 1.4% year-over-year growth 1,717 crore, below analysts’ expectations. Revenue growth was impacted by subdued decorative paint demand, which was impacted by the onset of Diwali, extended monsoon and channel restocking by dealers in the base quarter. Analysts forecast Kansai’s ornamental segment volume to fall to mid-single digits. Larger rivals Asian Paints Ltd and Berger Paints India Ltd did relatively better on this metric in the third quarter.
But in the industrial paints business, Kansai saw good demand in automotive coatings in the third quarter. Here, demand for paints for passenger and commercial vehicles was supported, while the two-wheeler category registered a decline. Management is bullish on the demand for industrial paints in the near future. In addition, softening of raw material costs and increased prices with its major OEMs in Q3 helped offset the impact of elevated inflation to an extent. Note that the industrial segment is a low margin business.
Thus, the pace of gross margin recovery is crucial for all paint stocks. But rising competitive intensity with the entry of new companies with deep pockets raises concerns. In order to capture market share, aggressive pricing strategies may adversely affect Kansai. This has affected investors’ sentiment towards the stock. Unsurprisingly, Kansai’s shares trade at a deep discount to peers. Bloomberg data shows Kansai’s FY24 price-to-earnings multiple stands at 29.7x, while Asian Paints and Berger’s stand at 53.3x and 45.2x, respectively.
Analysts at Prabhudas Lilladher believe the worst is over for Kansai due to various positive measures including repositioning of Nerolac products and exit from low-margin segments. However, lack of incremental market share and increasing competition from Grasim Industries/JSW Paints and JK Cement remain key risks, the broking firm said.
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