The good news for Berger Paints India Ltd’s investors is that its decorative business registered double-digit volume growth in the December quarter (Q3) despite demonetisation. Larger competitor Asian Paints Ltd saw low single-digit volume growth in the same segment. The bad news is that although volume growth at the company has been resilient, the adverse impact on margins due to surging input costs is a matter of concern.
Cost of raw materials consumed, which includes crude oil-based solvents and monomers, jumped nearly 4% year-on-year, denting the gross margin. In a bid to avert further margin erosion, Berger Paints announced a price hike of nearly 3% for its decorative segment with effect from 1 March 2017. The decorative business contributes more than 70% to the company’s sales. Its general industrial coatings segment saw modest growth in the third quarter of fiscal year 2017 (Q3FY17).
In a post-earnings conference call, the management said steady inflation in raw materials, in particular titanium dioxide, resulted in a 57 basis points gross margin contraction in Q3FY17 and this price increase would enable it to maintain margins at Q3 levels.
One basis point is one-hundredth of a percentage point.
But some analysts don’t seem to be very convinced; they still see inflationary raw material costs as a risk to the company’s gross margin and feel that current valuations do not adequately factor in the risk. The Berger Paints stock is trading at a stratospheric one-year forward price-earnings multiple of 50.28 times. Its valuations are richer than peers Asian Paints (48.27 times) and Kansai Nerolac Paints Ltd (38.88 times).
Berger Paints’ consolidated Ebitda (earnings before interest, tax, depreciation and amortization) margin, which fell 130 basis points to 14.2% year-on-year, was also hurt by higher employee costs and other expenses. The management said there was an increase in other expenses, and while some of it may continue in Q4FY17, it is unlikely to sustain in FY18.
To be sure, the Kolkata-based paint maker’s consolidated net profit declined 3% year-on-year to Rs109.12 crore and consolidated net sales rose 5% year-on-year to Rs1,296.56 crore in Q3FY17, beating Bloomberg analysts’ estimates of Rs107.90 crore and Rs1,189.10 crore, respectively. But the Street seems to hardly care about that. Shares of the company have fallen a little over 3% in the past three trading sessions.
Raw material prices continue to harden, so the focus will be on how soon the margin recovers once the price hike comes into effect, and to what extent. Investors would do well to remember that with the stock priced to perfection, the risks are all on the downside.