Expensive valuations aren’t denting India’s painting

Do you see through tinted spectacles for a clue?
Growth never comes out of the blue.
The recovery is still a grey area camouflaged by green shoots
Markets are tickled pink without seeing their roots
Sure, you wouldn’t be any duller
Only if you see true colours!
Identify the black sheep first and stir clear of yellow press
Betting on golden opportunity isn’t any race

Any discussion regarding the on-going fierce rally can’t be complete unless we talk about paint companies.

As you know, Asian Paints has been the poster boy of India’s consumption story for decades now. The stock has never been cheap and anybody exiting it citing its lofty valuations must have regretted the decision later. Besides Asian Paints, Berger Paints, Kansai Nerolac and AkzoNobel are a few other dominant players in India.

Most of them are trading near their lifetime highs and the valuations of paint companies have soared to astronomical levels.

Real returns but surreal valuations?

Market-Cap data as on January 07,2021
TTM: Trailing Twelve Months
RoE: Return on Equity
PE: Price to Earnings
(Source: Ventura Research)

Does that mean that these stock prices are going to crash? Well, expensive valuations do not automatically drag stocks, provided companies manage to keep up with their expected growth momentum.

Here, taking a helicopter view might help.

According to the Indian Paint Association (IPA), India’s paint industry was valued at Rs 50,000 crore in 2019.

Decorative paints account for 75% of the sectoral revenue while industrial paints make up the remaining 25%. Organized companies hold approximately 65% of the market. Re-painting demand constitutes 78% of total demand for decorative paints in India. Asian Paints is the market leader with its ~34% market share, Berger Paints ranks second and holds a market share of ~13% and Kansai Nerolac has a market share of ~11%.

Did you know, India’s per capita paint consumption is just 4.1 Kilograms and the decorative paints market is 6% of the total FMCG market? Per capita paint consumption in developed countries, such as the US and Singapore is around 15 Kgs and that in other developing markets, such as Indonesia and south Africa is 6-7 Kgs.

Asian Paints derives 95% of its revenues from decorative paints and Kansai Nerolac is the largest player in industrial paints with 45%-50% of its revenues coming from the industrial paints segment. Such market dominance and limited options available in the listed space have helped paint companies enjoy premium valuations all these years. Shalimar Paints, another listed player, is a loss making company thus we haven’t considered it in our evaluation.

But investors may soon have one more alternative when Indigo Paints launches its IPO, for which it has already secured SEBI’s go-ahead lately. It remains interesting to see at what price Indigo Paints offers shares in the IPO. Basis its FY20 earnings, if it decides to demand multiples enjoyed by the market leader, it may ask for Rs 1,000-Rs1,100 a share. On the flip-side, if it contents itself with multiples enjoyed by the cheapest listed company, it will quote at Rs 475-500 apiece.

Industry trends to watch out for…

• Various government initiatives such as housing for all, smart-cities, industrial corridors and Atmanirbhar Bharat amongst others are likely to offer exciting growth opportunities in the coming years.
• Various industry reports suggest that re-painting cycles in India are shortening from 8-10 year to 4-5 years. This could further reduce the dependence on the primary growth in the real estate sector.
• Between FY14 and FY20, enamels and emulsions have witnessed 14% and 11% compounded annualized growth, respectively. Experts are expecting this trend of premiumization to continue in future, as people may try to upgrade their colouring budgets with growth in per capita income.  
• Given the nature of business, the paint industry has relatively high entry barriers. For instance, not only manufacturing but even distribution is getting technologically advanced and demanding. Installing tinting machines that help create different shades, maintain consistency and accuracy are pivotal to leveraging the distributor network and accelerate the pace of growth in the premium segment, such as emulsions. Dealers often refuse to install such machines due to space constraints.
• Ad spends plays a crucial role in brand-building. In FY 20, Asian Paints had an advertisement spent of Rs~300 crore. Indigo Paints spent Rs 64 crore on promoting its brand through various mediums such as TV, print and Radio, amongst others—which is almost at par with what Kansai Nerolac spent in FY20.   

A broad-brush…

PAT: Profit After Tax
(Source: Company records)

This happens only in India (perhaps)…

Decorative paints fetch better margins but consume 300+ ingredients in the process of manufacturing. Raw materials form a close to 60% of input costs of which Titanium Dioxide accounts for 20%-25%. Surprisingly, raw material suppliers failed to keep up with the pace of the paint industry, owing to which paint manufacturers are largely relying on the imports of Titanium Dioxide. Isn’t this a surefire candidate for Atmanirbhar programme?

Concluding thoughts

Although valuations of paint companies are insanely high, favourable demographics suggest that the industry has a long way to go before it reaches a point of saturation. With manufacturing getting more green and tech-savvy and distribution becoming more demanding, leading paint companies are toiling to maintain their core competencies and expand in new areas.

The surprises, if any, may come from players that can manage to grow faster than the industry, report margin improvements and quote at a considerable discount to the market leaders.

How will the aspirant market entrants position their IPOs? It remains crucial to watch. After all, greed and fear often affect investors and promoters in a similar way.

Please Note (read as a disclaimer): None of the stocks discussed in the article are recommendations to buy, hold or sell. This could just be the starting point for deeper analysis that you might want to carry out on your own. You may also take professional help as you feel appropriate.

All references pertaining to a potential IPO of a colour company are only for informational purposes and analysis thereof doesn’t construe any recommendation, hint or a suggestion to subscribe or not to subscribe to an IPO at any future date.

If you are investing in any family run company, besides governance, you may also want to take stock of significant developments in the lives of the promoters. Sometimes, their personal life can overshadow market sentiments. Also pay attention to issues such as pledging of shares by the promoter group and the working capital.

You may also like to read: Pharma sector revived in 2020; will it flourish in 2021?

Disclaimer:

We, Ventura Securities Ltd, (SEBI Registration Number INH000001634) its Analysts & Associates with regard to blog article hereby solemnly declare & disclose that:

We do not have any financial interest of any nature in the company. We do not individually or collectively hold 1% or more of the securities of the company. We do not have any other material conflict of interest in the company. We do not act as a market maker in securities of the company. We do not have any directorships or other material relationships with the company. We do not have any personal interests in the securities of the company. We do not have any past significant relationships with the company such as Investment Banking or other advisory assignments or intermediary relationships. We are not responsible for the risk associated with the investment/disinvestment decision made on the basis of this blog article.