Q2 results portent a dull Diwali for paint stocks investors

The Kansai Nerolac Ltd stock was hammered on Monday following its lacklustre September quarter (Q2) results. It wasn’t just volume growth that was disappointing. Margins also took a deeper hit than expected (see chart).

Volumes in both industrial and decorative segments grew around 10%, analysts said. The company expects near-term growth momentum to be better in the decorative rather than the industrial business.

Gross margins were impacted by higher raw material cost and rupee depreciation.

As a result, the shares of the company tumbled to a 52-week low of ₹ 377.50 intraday on the NSE. The stock ended the trading session down 5.60% at ₹ 393.50. Kansai Nerolac’s unimpressive performance gave the Street a whiff of what Asian Paints Ltd’s earnings would be like.

As anticipated, the leader in decorative paints segment posted off-colour earnings. While paint volumes in the Indian decorative business grew in the low double digits, in line with estimates, consolidated gross margins eroded by more than 140 basis points on a year-on-year basis. Asian Paints’ consolidated net profit and revenue growth in Q2 also fell short of analysts’ expectations.

One basis point is one hundredth of a percentage point.NextMAds

Although Asian Paints announced results post market hours on Monday, its shares had already been punished. The stock fell around 3.5% intraday on the NSE. In a rub-off effect, shares of Berger Paints India Ltd, which will announce earnings on 1 November, also declined around 3% intraday on the NSE.

While paint manufacturers are confident of robust demand in the second half of the year, especially in the decorative business, the margin picture, it is feared, will remain ugly.

Even though paint makers have increased prices by 2-2.5% effective 1 October, the quantum of price hike may not be enough to offset the inflationary impact of raw material costs. Also, if crude oil prices remain elevated, another 4-5% hike may be required to offset the cost pressure and curb margin erosion, analysts said.thirdMAds

Despite the concerns of further margin compression, these stocks continue to trade at rich one-year forward price-to-earnings multiples of around 40 times.

While any upside in these stocks is limited, valuations are unlikely to moderate in a hurry because of expectations of improved demand growth.