Cost inflation has not spared anyone, be it Asian Paints Ltd., a leader in the decorative paints business or Kansai Nerolac Paints Ltd., a leader in the industrial paints segment. However, we should not paint them with the same brush. For Kansai, gross margin compression is a more serious issue than for Asian Paints as the industrial paint segment contributes about 45% of its total revenue. Analysts say when inflation picks up, Kansai’s problems worsen. The company’s standalone gross margin hit an all-time low of 28% in the March quarter (Q4FY22).
“They sell more solvent-based paints in the industrial segment, so the impact of the increase in crude oil price is greater in the decorative category as compared to water-based products. Also, the negotiating power is low due to the business-to-business nature of the industrial segment and the ongoing problems of the automobile industry,” said Varun Singh, Analyst, IDBI Capital Markets & Securities Ltd.
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Automobile paints account for around 30 per cent of the revenues of the industrial paints segment. Maruti Suzuki India Limited is a major customer of Kansai. Kansai’s auto paint segment can be expected to remain sluggish, at least in the short term. Note that Kansai has hiked industrial paint prices by 18% in FY22 and is negotiating price hikes with business partners, management said in a post-earnings call.
In the decorative segment, Kansai increased prices in solvent-based paints by about 16%, but lost market share in North India during the quarter. “If you are a consumption company and you have lost market share (decorative) despite being at number three, it is a matter of great concern,” said an analyst covering the paint sector, on the condition of anonymity.
In Q4, Asian Paints saw a year-on-year (YoY) growth of 8% in Decorative Paints volumes. Management said that for Kansai, decorative paint volumes fell about 7-8% due to a decline in the product mix. Also, Asian Paints and Berger Paints India Ltd are quite aggressive in the decorative premium paint category unlike Kansai, as per the analyst cited above. Therefore, Kansai has not been able to capture the story of premiumisation.
Against this backdrop, it should come as no surprise that Kansai’s shares have fallen nearly 30% over the past year. Berger has seen a relatively small decline of about 10%, while Asian Paints stock is up 19%. Berger has yet to announce earnings for the March quarter.
Asian Paints being able to navigate margin contraction coupled with sharp price hikes has kept the stock in good stead. In Q4FY22, consolidated gross margin improved 195 basis points (bps) sequentially, at 38.7%. One basis point is 0.01%. Asian Paints’ management expects gross margins to recover to around 40-42% in FY13. In FY 2012, it saw inflation of 32-34% and increased prices by 24-25%. For incremental inflation of 5-7% seen in Q1FY23, a price hike of around 2% will be effective in May and June.
Not surprisingly, the stock of Kansai is trading at a huge valuation discount as compared to its peers. Based on FY24 earnings estimates, Kansai has a price-to-earnings ratio of 26x, far lower than Asian Paints’ 55x and Berger’s 48x multiples, according to Bloomberg data. The valuation gap between Kansai Nerolac and Asian Paints is likely to continue in the near future. In the decorative paints segment, there was always a gap between their volume growth, but now it has reached a historic high,” said Amnish Agarwal, Head of Research, Prabhudas Lilladher. The segment makes Kansai more vulnerable than peers, ” They said.