Oil price gains for paint stocks are still some time away1 min read . Updated: 26 Nov 2018, 09:17 AM IST
Because the benefit of the oil price drop depreciation will come with a lag, the pain on the margins front may not yet be over for Asian Paints, Berger Paints, Kansai Nerolac and Pidilite
Crude oil prices have corrected by over a fifth in the last one month. At the same time, the rupee, which had taken a hard knock, is stabilizing. This comes as a huge relief for companies who were hit by the double whammy of rising crude oil and a falling rupee. Paint and adhesive makers are the major beneficiaries. In the last one month, shares of Asian Paints Ltd, Berger Paints India Ltd, Kansai Nerolac Paints Ltd and Pidilite Industries Ltd have risen between 10% and 19%, outperforming the broader market.
Monomers and titanium dioxide used in paints are derived from crude oil, and account for about 30-35% of the total raw material cost of the sector. Similarly, vinyl acetate monomer is also a crude oil derivate and a key raw material for making adhesives. It accounts for 60% of Fevicol maker Pidilite’s total raw material cost.
And since these firms meet their input material requirements through imports, this undesirable combination was hurting their margins.
But while the favourable moves in the crude oil and forex markets are welcome, it will take some time for these developments to reflect in their earnings, especially on the gross margins front. On account of hedges and advance purchase of materials, benefits of a price drop usually reflect with quite a lag.
In the September quarter, these companies saw their gross margins shrink 150-400 basis points on a year-on-year basis. And in a bid to curb further margin erosion, they took price hikes of around 3% effective October. So far in FY19, prices of these products have been increased by nearly 5%.
But, because the benefit of the price drop depreciation will come with a lag, the pain on the margins front may not be over for these companies yet. As such, some investors may well be disappointed with the results in the near term. Even recent management commentary suggests caution on the margin front.
Meanwhile, the demand outlook for these sectors is upbeat. Paint companies have guided for double-digit volume growth in the decorative paints segments. Having said that, valuations of some of these stocks are expensive at 43-60 times FY19 earnings, especially given the earnings growth expectations of around 20% at best.