Kansai Nerolac Paints Ltd - Stock Valuation and Financial Performance

M.Cap Rs. 23,952 cr

CMP Rs. 444 | PE ~58x

Key Highlights:-

·         In automotive segment, introduced products in PVC sealers and underbodies, a good size market where they were not present before.

·         In performance coating segment, got approval for Ahmedabad-Mumbai bullet train project and Vande-Bharat express project.

·         In coal coating business, exited a lot of unprofitable and low margin product segments.

·         The inflation in raw material prices still continues, so 3% increase taken in price of sales.

·         In decorative paints category, getting good response from advertisement strategies like “Paint plus”, “Mission Kashmir” campaigns launched last quarter.

Management Outlook:-

·         The decorative paint segment has been under stress due to rains continuing longer than average, people generally tend to paint their houses after rains but before Diwali.

·         Nerofix adhesive introduced to take advantage of their distribution network and the synergy with their core business, however no special focus on this segment.

·         Trying to bet on super premium category in decorative paints as it is one of the segments where they have limited salience.

·         Waterproofing segment to grow based on both domestic and industrial applications.

·         The overall strategy is to increase the margins in Industrial paints and invest in decorative segment.

Kansai Nerolac Paints (KNP) has market share of ~ 16% in decorative segment and ~60% in industrial paints. It also is a leading supplier for powder coatings, industrial coatings and infrastructure coating to major companies. As mentioned in the earlier note, paint companies have adverse impact on their earning due to fluctuations in crude oil prices. While the paint industry has good pricing power in decorative segment, industrial and automobile segment tend to be negotiate prices as they are informed buyers having bargaining power. KNP generates 55% of its revenues from decorative segment and 45% from automobile paints and industrial coatings segment. Hence, in case of Kansai, its gross margins are relatively lower than the peers who have higher share of decorative segment.

In the decorative segment, KNP has traditionally focuses more on mid and premium range of paints (Price being > 350-400 Rs / litre). Though, this is high margin segment, KNP faces a stiff competition from Berger India paints and Asian Paints in this segment. Also, in an attempt to increase its volumes in decorative segment, it has launched emulsion paint (low range product) product at a discount to the products of its peers. Since Kansai is smaller than the other two players, it has its limitations in pricing of decorative segment. Also, since larger chunk of the revenues comes from industrial paints, margin expansion may not be the key value driver for the company in the long run.

On the positive side, KNP has been ahead in focussing on R&D in industrial coatings segment. It also has an advantage of access to technology provided by parent company (Kansai Paints Co., Japan). It has also focused on building a brand by spending on advertising and branding. With a competent management and strong product focus, we expect KNP to have sustainable earnings growth over long term.

We like the business because, in general, paints industry can create very high return on investment sustainably. However, current stock price factors in very high growth and it trades around 48X EPS which is at cyclically high margins. Growth rate in Autos is around 10-13% CAGR and likewise in decorative segment. Additionally, the company may not have a muscle to retain high margins as crude oil prices have normalized to fair levels. But we believe it would continue generating high Returns on equity.

We have been cautious and recommend SELL as the past 20 year analysis of the company’s data suggests there’s could be a drastic hit on the net margin level during the upcycle of the crude oil prices.