Stocks of paint companies have risen as much as 33% from their lows seen in the December quarter. With crude oil prices easing and the rupee stabilizing, a key headwind for paint makers is behind them. This should have caused a relief rally; but it has extended into exuberance.
While analysts are upbeat on the sector’s volume growth prospects in the medium term, as well as the relief on the margin front, some of them have revised their ratings on these stocks because of high valuations.
“Given the steady uptrend in stock prices recently, we revise our ratings on Asian Paints and Kansai Nerolac from Buy to Hold and on Berger Paints and Pidilite Industries from Add to Hold," ICICI Securities Ltd said in a report on 31 December.
Standard Chartered Bank has removed Asian Paints from its list of top stock picks. “The current stock price factors all positives related to softening of raw material cost pressures faster than our expectations. Hence, we would like to book profits and exit the stock from the list," it said in a note to clients on 20 December.
From its peak in early October, Brent crude prices have corrected by more than 35%. Similarly, the rupee has recovered by around 7% from the low of 74.39/US dollar it touched on 9 October.
Monomers and titanium dioxide are derivatives of crude oil and used in producing paints. So, easing crude oil prices have resulted in moderation of their cost as well. They account for about 30-35% of the total raw material cost of the sector.
Similarly, vinyl acetate monomer is a crude oil-based chemical and a key raw material for making adhesives. It accounts for 60% of Fevicol maker Pidilite Industries Ltd’s total raw material cost. Most of these input materials are sourced via imports.
Usually, the benefits of favourable moves in the crude oil and/or foreign exchange markets reflect with a lag on the earnings of these companies, especially on the gross margins front. This is because of hedges and advance purchase of materials.
As pointed above, margin gains can’t be ignored. But with valuations of about 40-50 times one-year forward earnings, the markets are pricing in these gains and much more.