In stark contrast to the ongoing consumption slowdown, decorative paint companies reported impressive volumes in the June quarter.
Leaders in this segment, Asian Paints Ltd and Berger Paints India Ltd, saw volumes grow in double digits, beating some key fast-moving consumer goods companies in this respect (see chart).
But before investors get carried away, it is important to know what factors led to this improvement and whether they are sustainable.
According to analysts at ICICI Securities Ltd, the headline volume growth of paint companies creates an optical illusion that the paints industry is unaffected by the economic slowdown. “In our view, there are three drivers to overall volume growth of 10-15% (range) for Asian Paints and Berger Paints—(1) 5-6% growth in core decorative paints (a multiplier of GDP) (2) 3-4% growth driven by market share gains from unorganized sector (in bottom-end enamels) post implementation of GST (this share-gain led growth is likely to last till end-FY20, in our view) and (3) 4-5% incremental volume growth from traded goods (putty, primer and other ancillary products)," they said.
The managements of Asian Paints and Berger Paints told analysts that an aggressive sales push helped them in filling up stocks at the dealer level.
Besides, there were some market share gains from the unorganized sector, and better sales of lower-end products such as putty, distemper and economy paints.
However, repeating this performance in the quarters ahead will be a challenge. And, especially so, if the overall economic scenario doesn’t improve meaningfully. Of course, following the dismal June quarter gross domestic product data, expectations of a quick recovery aren’t high.
According to ICICI Securities, a key downside risk is unexpected irrational competition due to deceleration in general consumption demand.
Further, the slowdown in the automobile industry would keep the performance of the paint makers’ industrial coatings businesses lacklustre. While Asian Paints and Berger Paints get more than 70% of their overall revenues from the decorative business, an underperformance in the industrial segment will dampen investor sentiment. Managements of these companies acknowledged that near-term pain in the industrial coating segment will persist.
On the bright side, easing input costs may continue to aid gross margins. Paint makers took some price cuts in the enamel segment to pass on this benefit.
But analysts caution that further price cuts remain a risk to future gross margin improvement.
On the valuation front, Asian Paints trades at a one-year forward price-to-earnings (P-E) multiple of 57 times, while Berger Paints’ P-E is at 55 times. It should be noted that their valuation multiples are higher than some blue-chip fast-moving consumer goods stocks.
Considering the aforementioned concerns, these valuations look expensive.