Stock Fundamentals

Why should you book profit in Kansai Nerolac stock

Bavadharini KS BL Research Bureau | Updated on May 08, 2021

The sector will witness increased competition from deep-pocketed new entrants

The stock of Kansai Nerolac has delivered about 60 per cent returns to shareholders from March lows last year. Besides benefit from low crude oil prices last year, release of pent-up demand with the economy fully opened up post lockdown restrictions getting eased, and festive season gave a boost to paint companies. This is reflected in the earnings of paint companies, including Kansai Nerolac, which have been improving in the last three quarters.

Unlike other paint players whose mainstay is decorative segment (about 80 per cent), Kansai Nerolac has a dominant presence in automotive and industrial paint segments as well, deriving 40 per cent of its revenue from this segment . This helps the company to benefit not only from the recovery in decorative paint business from real estate but also from cyclical recovery and pick-up in industrial and automobile demand. In its December 2020 quarter and in its recent March 2021 quarter Kansai Nerolac reported strong double-digit volume growth in both its segments. It reported a revenue growth of 35 per cent y-o-y to ₹1,460 crore and profit growth of 89 per cent y-o-y to ₹124 crore during March quarter.

Also, over the years, the company had been slowly expanding its non-auto segment to powder coatings, auto refinishes, and other coatings such as protective and coil coatings to reduce the exposure to cyclical risks. This has helped the company to withstand the slowdown in automobile segment to an extent. This should aid in revenue growth going ahead as well. The company’s fundamentals are good, and negligible debt levels provide room for future expansion. Despite these positives, investors can book profits in this stock.

Expensive valuation of Kansai Nerolac is one of the main reasons for booking profit. At ₹591, the stock is trading at 61 times its trailing twelve month earnings. While this multiple is lower compared to peers such as Asian Paints (97 times) and Berger Paints (101 times), Kansai Nerolac is still pricey. In the past three years, it has traded in the range of 17-52 times earnings.

Also, with second wave of Covid-19 raging across the country and many states imposing localised restrictions, the automotive industries may face a slowdown in the short-term. This could take a toll on the company’s revenue even if decorative segment perform well.

Adding to this, the rise in input costs too could dampen the business prospects in the near-term. Since October last year, crude oil prices have been slowly inching up. Paint companies’ raw materials are predominantly crude oil derivatives and with crude prices rising, their margins could take a hit. From $35-$37 per barrel in October, crude oil is around $65-68 per barrel now.

The competition in the industry also is a key factor to be watched out. Paint industry used to be an oligopoly (where only a few players operate in the market). Recently Grasim and JSW Paints have entered the market which could impact revenue/market share growth.

Slowdown in business

With many states including Maharashtra, Karnataka, and Uttar Pradesh implementing lockdown to control the spread of the virus, it impacts the business segments that Kansai Nerolac operates. For instance, major auto players have witnessed a decline in monthly sales due to the control measures put in place by the states. Also, painting and car/bike purchase are discretionary spends ; and given the current uncertainties, individuals may postpone such expenses. This could dampen the growth prospects for the company at least for 2-3 quarters.

On the other hand, adding to the woes, the crude oil prices are on the rise. For Kansai Nerolac and other paint companies, raw material costs forms about 50-55 per cent of the revenue and most of them including titanium dioxide and zinc oxide and other solvents and additives are crude derivatives. With crude oil prices on an upward trajectory since October last year, the company’s margins have already come under pressure. In March 2021 quarter, the company’s EBITDA margins came down to 15 per cent from 20 per cent in December 2020 quarter. The company has taken price hikes across its products to tide over the input cost increase. According to the management, the company will take more price increase in its products going forward to compensate for the inflation.

Competitive market

Kansai Nerolac faces stiff competition in both its segments. In decorative paints, Asian Paints and Berger Paints have higher market share of roughly about 42 and 12 per cent respectively. Asian Paints, being the market leader, is better placed in terms of pricing and distribution of products. This tight competitive space could result in pricing pressure, and could impact the company’s earnings at a time when input costs are on the rise. Similarly, in the industrial segment, the company faces competition, with other paints companies slowly increasing their presence in segments such as coatings and wood finishes. With deep pocketed conglomerates such as JSW and Grasim vying for a good chunk of this market, the next few years could see some challenges.

Published on May 08, 2021

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