For investors in paint companies, worry over cost inflation is a thing of the past
Marked by high cost inflation, paint manufacturers recently increased their prices. After the September quarter, decorative paints market leader Asian Paints Ltd increased prices by 8-9%, effective November 12. This was followed by another 4-6% price hike, effective Dec. 5, according to Axis Capital Ltd. December 6.
Competitor Berger Paints India Ltd is also said to have reported a cumulative price hike of around 18% in FY22 with the two recent rounds of almost 9% in November and 4% in December, the Axis Capital report added. . Past trends show that other paint manufacturers such as Kansai Nerolac Ltd, Akzo Nobel Ltd and Indigo Paints Ltd generally follow suit with price increases.
The strong squeeze in gross margin reported by paint companies in recent quarters is now well known. During the September quarter, Kansai’s gross margin declined sharply by 1,040 basis points (bps) year-on-year, mainly due to a delay in passing through higher raw material costs, in particularly in the industrial paints segment. A basis point is one hundredth of a percentage point. Asian Paints saw its gross margins drop 970 basis points and the same metric for Berger recorded a contraction of 449 basis points year-on-year in Q2FY22.
These trends weighed on their stock market performance. Since the start of the year, the three aforementioned stocks have underperformed the benchmark Nifty50, which has gained around 22%.
In short, the price increases were the necessity of the moment and were taken to protect the margins from further erosion. Plus, the recent moderation in the prices of crude-based raw materials like titanium dioxide and other monomers is yet another respite. Brent crude is down to $ 73 a barrel from the level of $ 84 a barrel a month ago. Raw material costs represent approximately 55% of the industry’s total operating expenses.
This means that paint manufacturers’ gross margins are on the verge of recovering.
âAsian Paints’ unprecedented 14-15% price increase in one month indicates a course correction and a shift in focus towards profitability. This price increase is expected to relieve the pressure on gross margin from 4TFX22 almost entirely and lead to a rapid recovery in industry profitability, âKotak Institutional Equities analysts said in a Dec. 7 report. The national brokerage has raised its profit estimates for fiscal year 2022-24 for decorative paints. stocks under its 3-14% coverage.
Axis Capital also increased the earnings per share estimate for fiscal 22-24 for Asian Paints from 5% to 8% and for Berger from 2% to 4%.
What also underlies the optimism is the robust demand outlook. The latest comments from the management of the paint companies point to a strong recovery in demand in the coming quarters, helped by a recovery in the residential real estate sector.
That said, paint inventory doesn’t come cheap. Shares of Asian Paints and Berger are trading at a one-year futures price-to-earnings ratio of 92 times and 89 times, respectively, according to Bloomberg data. While their valuations have corrected from earlier peaks, it’s hard to justify those rich multiples unless gross margins improve noticeably. However, it remains to be seen whether these bold price increases weigh on volume growth.
âThe focus has shifted to improving profitability with aggressive price increases, but we need to see if that impacts the market share gains of the big paint manufacturers. In addition, the growing competition with the entry of new players and its impact on volume is another key element to watch for On the demand front, a faster recovery in sales in small towns is important, âsaid an analyst from a national brokerage on condition of anonymity.
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