The Hindu Business Line : Kansai Nerolac Paints: Hold

Investors may retain their holdings of the Kansai Nerolac stock, which trades at about Rs 900. At this price, the stock is trading at about 20 times its expected per-share earnings for FY-07. Though we continue to remain positive on the prospects of paint companies on the back of a strong demand environment, pressures on input costs compel us to temper our view.

Paint companies have resorted to selectively hiking prices to offset rising input costs. While they are relatively easier to put through in the case of decorative paints, the same is not the case with industrial paints, as the buyer bargaining power is high. Kansai Nerolac derives close to 50 per cent of its revenues from the latter segment.

Quarterly performance

Sales trends have continued to exhibit strength, with top line up 20 per cent, reflecting the underlying robustness of demand

Operating margins declined by about 200 basis points, as the raw materials-to-income ratio moved by three percentage points

As a consequence, earnings at Rs 27.9 per cent was lower by eight per cent compared to the year-ago period

What to expect

With an early festival season this year, a significant demand would have been addressed in the just-ended quarter. Going forward, growth rates are likely to cool off a bit in the quarters ahead, while continuing to remain encouraging. The boom in the realty sector is the principal driver for demand for decorative paints.

With a leadership status in automotive paints, Kansai Nerolac's fortunes are closely linked to that of the auto industry, which is showing signs of slackeningafter growing at a scorching paceover the past few years.

To reduce its dependence on this sector, the company has trained the spotlight on high-performance coatings and powder-coating segments.

With Corporate India in expansion mode and the white goods demand robust, Kansai Nerolac should be relatively insulated from a slowdown in the auto sector. We would, however, keep a watch on the raw materials front.

With the recent climb down in the prices of crude oil, a softening of input costs (as key raw materials are derivatives of crude oil) is expected, though with a lag, in the quarters ahead. A benign crude oil environment will be beneficial to paint companies across the board.

Valuation

At the current valuation, the stock would trade at a discount to market leader Asian Paints. There does not seem to be much scope for downside from current levels.

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