Lower input costs may soften the impact of demand slowdown for paint firms

Lower input costs would help soften the impact of demand slowdown for paint companies. Brokerages had cut the net profit estimates of the listed paint companies after the March 2019 quarter (Q4) results due to the miss on profitability and volume growth.

However, current prices of Brent are down 10 per cent from March 2019 level (22 per cent down from June 2018) and that of titanium dioxide or TiO2 have fallen 4 per cent (13 per cent down from June 2018). And, crude oil prices are unlikely to rebound significantly in the near term, which should improve their bottom lines. TiO2 and crude oil derivatives, such as monomers and packing materials, are key operating costs of paint companies.

Not surprising then, stocks of three paint majors — Asian Paints, Berger Paints, and Kansai Nerolac — gained 6-12 per cent in the past one month, outpacing a 3 per cent rise in the BSE Sensex, despite earnings miss in March 2019 quarter.

T Gnanasekar, director, CommTrendz, said: “The market is now focusing on demand, which is weakening. Crude oil prices are unlikely to see sharp upsides in the near term despite supply concerns or issues in West Asia.” Investors, however, should be watchful of news flow on trade talks and geo-political tensions, that could trigger significant upside risk in crude oil prices, he said.

Benefits of low crude oil prices, however, would vary depending upon share of solvent-based products. Berger Paints has a higher share of solvent-based products than Asian Paints. In fact, in case of Asian Paints, a likely higher operating cost due to major capacity expansion (more than 50 per cent) in FY19 and the US (besides Taiwan) being a major supplier of TiO2 could cap the margin gains while benefiting Berger Paints. TiO2 prices in the US are expected to be comparatively higher. Another key factor in favour of Berger Paints is operating efficiency.

Pratik Poddar, analyst at Narnolia Financial Advisors, said: “Berger Paints’ operating efficiency helped it to restrict the impact of highly volatile crude oil prices at Ebitda (earnings before interest, tax, depreciation, and amortisation) level in FY19. Continuing the strong operational performance, any recovery in gross margins with the lower crude oil prices would comparatively reap higher benefits for Berger Paints in the near term.”

While Ebitda margin of Asian Paints is estimated to expand by 85 basis points in FY20 to 19.1 per cent, that of Berger Paints will go up by 110 basis points to 15.6 per cent. The earnings growth of the two firms would grow by 20 per cent and 28 per cent, respectively, in FY20.  For Kansai Nerolac, on the other hand, revival in automobile demand is key for overall performance, as the company derives a large chunk of its business from the industrial segment. In FY19, too, the company posted a 12 per cent decline in consolidated earnings.

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