Goods and services tax (GST) on paints and varnishes has been reduced to 18% from 28%, effective 27 July. Similarly, GST on wall putty has also been cut. Putty is a powdered substance that is applied on the walls and ceilings before priming and painting. Clearly, a 10% reduction in tax rate comes as a major relief for paint manufacturers. Especially since it comes at a time when the sector is struggling with input cost pressures and any cost saving is welcome.
Given the anti-profiteering provisions, companies are expected to pass this benefit on to consumers in the form of price cuts. However, paint companies may not lower prices by the same quantum immediately.
That’s because the costs of crude-based monomers and titanium dioxide have remained elevated for the past few quarters. As a result, margins of paint companies have faded (see Chart 1). And since paint makers import most of these raw materials, the recent rupee deprecation is adding to the pain. So, these companies might want to retain some of the tax gain to better their margins.
In a bid to protect margin erosion, paint companies raised prices by around 5% in fiscal year 2018. Analysts say prices were raised in the June quarter as well. Consequently, margins of Asian Paints Ltd and Berger Paints India Ltd are expected to expand.
As of now, only Kansai Nerolac Ltd has reported earnings for the first quarter of fiscal year 2019. While the company did hike prices by 2.2% in the decorative paints segment, its margins contracted due to higher exposure to the industrial paints business, where it usually takes a longer time to pass on cost increases.
Meanwhile, the reduction in tax rate is expected to provide a fillip to paint demand. Kansai Nerolac Ltd reported double-digit volume growth in the decorative as well as industrial paints segments. Its peers too are likely to post similar sales volumes growth in the June quarter. However, it might take a couple of quarters for any increase in demand due to the reduced tax rate to reflect in actual volume growth.
It should be noted that shares of Asian Paints Ltd and Berger Paints India Ltd recently touched their respective 52-week highs.
On a year-to-date basis, they have given 21% and 13% returns respectively. They have done much better than the Nifty500, which has posted negative returns in the same span. But the valuations at which they are trading are expensive (see Chart 2).
That said, in a knee-jerk reaction, paint stocks may move up on Monday.