Sector View. Paint stocks may continue to shine, despite crude shocks

The stock prices of paint companies have been on a roll, in an otherwise volatile market. The softening crude prices (until recently) and the companies’ strong June quarter performance have found favour with investors.

With crude prices doing a sudden volte-face and spiking over the past week, following drone attacks on Saudi Arabia’s largest oil producing company — Saudi Aramco — the stocks could see some near-term correction.

That said, strong volumes, despite slowing consumption, good pricing power, aiding margins, and market share gains, are key positives that should hold these companies in good stead over the next year. The upcoming festival season could also lift demand.

A look at what’s driving earnings for these companies and how well they can weather the demand and crude price shocks in the near term.

Growth in decorative paints

The rally in the stocks of paint companies until recently was driven by the strong June quarter performance. Amid economic slowdown, led by the fall in consumption and tight liquidity conditions, paint companies delivered solid performance with double-digit volume growth. These companies have beaten key FMCG companies (reporting single-digit or low double-digit growth in volumes) in the June quarter. Promotional and marketing initiatives, market share gains and fall in raw material costs are some of the factors that aided revenue and profit growth.

The demand for paints has been growing steadily, thanks to the Centre’s efforts to boost infrastructure development such as the ‘housing for all’ schemes in the country. While the recent slowdown in the economy has taken its toll on consumption, paint companies have reported impressive volume growth. While exact volume growth numbers are not known, according to industry experts, the volume growth may have been in the 13-16 per cent range for the June quarter.

The growth in volumes was driven primarily by the decorative paints segment. Key players in this segment are Asian Paints and Berger Paints, which derive over 75 per cent of their revenues from decorative paints. The balance 25 per cent is from the industrial paints segment. Asian Paints registered a revenue growth of 17 per cent Y-o-Y, while Berger Paints — another key player in the market — reported 16 per cent Y-o-Y. While the industrial paint segment was affected by the slowdown in the automobile industry, the volume growth from decorative segment was able to offset the pain to a large extent.

However, for Kansai Nerolac, the industrial paint segment contributes nearly 45 per cent of revenues (55 per cent from decorative paints). Though the company was able to register double-digit growth in decorative paints, the revenue growth was impacted by low volumes from industrial paints. The company reported an overall revenue growth of 9 per cent Y-o-Y for the quarter ending June 2019.

Marketing push

The aggressive sales push efforts taken by paint companies at the dealer level, along with higher sales from the lower-end products, boosted volumes in the decorative paint segment. Stable demand in the rural and small markets also helped to increase revenues.

In addition, the companies’ efforts to improve market penetration appear to have paid off. Market share gains from unorganised players due to GST implementation (subsequent reduction in GST rate few quarters ago) is also driving demand.

The reduction in raw material costs in the June quarter gave paint companies the much-needed respite; they undertook several price hikes across products in FY19 to cushion their margins. As the raw materials for paints are derivatives of crude, the decline in crude oil prices worked in favour of the companies. They were able to push the stocks to the dealers at better rates and improve margins.

For instance, Asian Paints cut prices by 0.4 per cent (in May and June). Its operating margins improved to 23 per cent in the June quarter from 20 per cent in the same quarter last year. Similarly, for Berger Paints, the operating margins for June quarter stood at 18 per cent, up from 16 per cent last June. Kansai Nerolac maintained an operating margin of 15 per cent.

Concerns

With the festival season around the corner, the demand for paint companies is likely to be healthy. However, the sharp rise in crude prices recently need a watch. While paint companies are able to pass on price hikes, margins could be under pressure in the near term, if crude prices rise sharply.

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