About a year ago, the main risks for the paint sector, which was otherwise in robust shape, were higher interest rates and rising raw material prices. Both those risks have been playing out. In recent months, home sales have been slowing because of rising interest rates and higher real estate prices. Automobile sales growth, too, has hit a speed breaker.
Costs continue to be a worry. Prices of raw materials used by paint companies rose sharply in fiscal 2011 (FY11). Asian Paints Ltd’s raw material costs rose by about 36% in the June quarter from a year ago, according to stand-alone earnings. Still, investors have taken a fancy to paint stocks, which have outperformed the broader market since May, and especially so since mid-July, when global turmoil hit domestic market sentiment.
Also See | Bright Hues (PDF)
A few reasons may be behind this. One is pricing power. In FY11, Asian Paints raised paint prices by 12%, and has increased them by 8% in the June quarter.
Another reason is strong demand, especially in decorative paints. Rising disposable incomes have ensured that secondary demand—from repainting of existing houses—remains strong. Good demand from smaller cities is another growth driver. Finally, India has entered the festival period, when demand for paints is at its peak—which will last till December.
But can the paints sector remain immune if India’s economic growth slows? A momentary slowdown may not affect demand, as consumer sentiment and disposable incomes will not get severely affected. But if it lasts for more than a few quarters, the situation may be different. A slowdown in real estate development will take a toll on project sales, especially as developers will also ask for discounts—to cut costs. Individual consumer demand should remain robust, except if economic growth slows to such an extent that it affects income levels. That is when discretionary spending—like the repainting of houses—takes a hit. Asian Paints had said that demand in June was less than robust.
Raw material prices continue to rise in 2011-12. Kronos Worldwide Inc., an international producer of titanium dioxide, a key raw material, said it expects prices to remain high because of the low level of inventories and high utilization levels. In the June quarter, it hiked the pigment’s price by 39% year-on-year, and expects prices to further increase in 2011. Pigments, extenders and minerals contributed to about 36% of Asian Paints’ raw material cost in FY11. Some other inputs, which depend on crude oil and vegetable oils, may get some relief from falling prices. But, overall, costs are likely to remain higher in FY12.
Paint companies will try to pass on most of the cost increases, and margins may drop a bit; but high sales growth will continue to propel profits. If demand takes a beating, then their calculations will go awry.
Asian Paints continues to be the strongest among all the paint companies because of an expansion in its capacity, a strong position in decorative paints across segments and a widespread distribution network. Shares of paint firms may appear as safe havens in times such as this, but the twin risks of a slowdown in demand and rising raw material costs should not be taken lightly.
Graphic by Sandeep Bhatnagar/Mint
We welcome your comments at firstname.lastname@example.org