Bright Q3 at paint firms drives earnings upgrades, crude price a concern

The paint industry uses crude oil and its derivatives such as resins, monomers, etc as raw material – accounting for about 50 per cent of total expense.
Paint companies have been trending on the bourses, with the recently concluded December quarter (Q3) results being a major factor. Asian Paints, Berger Paints, and Kansai Nerolac — the industry’s big three — reported better-than-expected numbers in the seasonally strong quarter.

Berger paints — the last of the three to post its Q3 results — on Tuesday reported its highest ever quarterly sales, earnings before interest, tax, depreciation and amortisation (Ebitda), as well as net profit for Q3.

Revenue jumped 25 per cent year-on-year (YoY) to Rs 2,118 crore, led by the 32-per-cent growth in decorative segment volumes, similar to industry leader Asian Paints. Gains on the volumes front surpassed analysts’ estimate of 15 per cent. This outperformance was driven by the strong festive season, pent-up demand, recovery in tier-1 and metro cities, and a pick-up in construction activity.

Ebitda margins grew above 200 bps to 19.6 per cent over the year-ago period, aided by lower raw material cost. This resulted in a 50-per-cent jump in the bottom line to Rs 275 crore, against the Street’s expectation of Rs 245 crore.

Asian Paints and Kansai Nerolac saw stronger profit growth at 62 per cent and 74 per cent, respectively.

Even as some of these tailwinds are unlikely to be present in the upcoming quarters, companies across the board remain confident of sustainable growth.

“Demand conditions in Q4 are expected to be strong, with robust recovery in consumer sentiment. The Covid vaccine rollout augurs well for domestic demand recovery to become broad-based and well-entrenched,” said Amit Syngle, MD and CEO of Asian Paints, in an investor call. However, any surge in Covid cases could have a negative impact, he cautioned.

Analysts have, on an average, increased their earnings estimates by 10-14 per cent for Asian Paints, Berger Paints, and Kansai Nerolac for FY21-23.

However, there’s also a note of caution. Even as improving urban demand, pick-up in construction activity, and the low base of last year are likely to support growth rates over the next couple of quarters, the trend could normalise from Q2FY22, said analysts at Equirus Securities.

A more immediate impact, however, is expected on operating profit margins following the sharp increase in raw material prices. The price of Brent crude oil has risen by over 50 per cent since the end of October and surpassed the $60 per barrel mark on Monday, after more than a year.

The paint industry uses crude oil and its derivatives such as resins and monomers as raw material — accounting for 50 per cent of the total expense.

“As business returns to pre-Covid levels, such high margins will become unsustainable, given that a large part of these cost efficiencies is seen going out,” said Anand Tandon, co-founder of Gryffon Advisors. “Therefore, we expect margins to normalise,” he added.

Typically, firms catering to the decorative segment enjoy a fair bit of pricing power and are able to pass on the higher cost to customers. However, the same cannot be said for Kansai Nerolac, which derives 40-45 per cent of its revenues from the industrial segment, in which there is less flexibility owing to long-term contracts.

Additionally, the entry of Aditya Birla Group and aggressive expansion of smaller players is being viewed as a potential threat, even though the impact is likely to be limited in the near term, say experts.

These concerns have caused the outperformance of paint stocks, over leading indices such as the Sensex, to narrow since the past one month.

While the Street is overwhelmingly positive on the long-term outlook for the paint industry, investors should note that valuations continue to remain high, ranging from 65-108x the trailing 12 months earnings, according to the BSE.

Sanjeev Hota, vice-president and head (research) at Sharekhan, says that in case of any negative surprise, investors are better off sticking to Asian Paints, thanks to its leadership position, high corporate governance standards, and superior balance sheet. He advises investors to accumulate the stock on correction with a long-term horizon.

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