Price hikes brighten the picture for paint makers

Asian Paints Ltd, took a price hike of 8-9% effective 12 November, followed by another 4-6% price hike effective 5 December
Asian Paints Ltd, took a price hike of 8-9% effective 12 November, followed by another 4-6% price hike effective 5 December

Summary

  • Asian Paints Ltd, took a price hike of 8-9% effective 12 Nov, followed by another 4-6% price hike effective 5 Dec, according to Axis Capital Ltd
  • Berger Paints India Ltd has announced a cumulative price rise of around 18% in FY22, with the two recent rounds of about 9% on 12 Nov and a 4% hike effective 5 Dec

Troubled by severe cost inflation, paint manufacturers have gone on a spree of hiking prices. Post the September quarter (Q2FY22), the market leader in decorative paints, Asian Paints Ltd, took a price hike of 8-9% effective 12 November, followed by another 4-6% price hike effective 5 December, according to Axis Capital Ltd. On a cumulative basis, Asian Paints has raised prices by more than 20% in FY22, the domestic brokerage house said in a report on 6 December.

Rival Berger Paints India Ltd has announced a cumulative price rise of around 18% in FY22, with the two recent rounds of about 9% on 12 November and a 4% hike effective 5 December, added the Axis Capital report. Past trends show that other paint manufacturers such as Kansai Nerolac Paints Ltd, Akzo Nobel India Ltd, and Indigo Paints Ltd usually follow suit on price increases.

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The steep gross margin compression reported by paint firms in the past quarters is well known by now. In Q2FY22, Kansai’s gross margin saw a steep fall of 1,040 basis points (bps) on a year-on-year (y-o-y) basis primarily owing to a delay in passing on higher raw material costs, especially in the industrial paints segment. One basis point is one-hundredth of a percentage point.

Asian Paints’ gross margins fell by a massive 970 bps, and the same measure for Berger saw 449 bps y-o-y contraction in Q2FY22.

Understandably, these trends have weighed on their stocks. Year to date, the Asian Paints stock rose by 12%, and shares of Berger Paints and Kansai Nerolac have declined by about 2% and 4%, respectively. In comparison, the benchmark Nifty50 index has rallied by around 25% during the same period.

In short, price hikes were the need of the hour to protect margins from further erosion. What’s more, the recent moderation in prices of crude-based raw materials such as titanium dioxide and other monomers is an additional breather. Brent crude has dropped to about $75 per barrel from highs of around $86 per barrel in October. Raw material costs account for about 55% of the paint sector’s total operating expenses. This means that gross margins of paint makers are poised to recover hereon.

“Asian Paints’ unprecedented 14-15% price increase within a month indicates course correction and shift of focus on profitability. This price increase should almost fully mitigate gross margin pressure starting Q4FY22 and drive swift recovery in profitability for the industry," analysts at Kotak Institutional Equities said in a report on 7 December. The brokerage raised FY2022-24 earnings estimates for decorative paints stocks under its coverage by 3-14%.

Axis Capital has also raised FY22-24 earnings per share estimates for Asian Paints by 5-8% and by 2-4% for Berger.

What is also underpinning optimism is the robust demand outlook. The latest management commentaries by paint companies point to a strong recovery in demand in the coming quarters aided by a pick-up in the residential realty sector.

That said, paint stocks are not cheap. Bloomberg data shows that shares of Asian Paints and Berger trade at around 66 times and 69 times estimated earnings for financial year 2023, respectively. While their valuations have corrected from earlier peaks, it is difficult to justify these rich multiples unless gross margins improve substantially. On the downside, it remains to be seen if these bold price hikes weigh on volume growth.

“The focus has shifted to improving profitability with aggressive price hikes, but we need to see whether this impacts market share gains of large paint makers," said an analyst with a domestic brokerage house requesting anonymity.

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