Paint makers get a taste of their own medicine as  Grasim  enters  their  turf

Grasim Industries Ltd’s shares rose as much as 11% at one point on Monday, after the company announced its foray into the paints sector. Stocks of paint companies such as Asian Paints Ltd and Berger Paints India Ltd are among the most expensive on the Street, with the companies’ one-year forward price-earnings ratio at 62 times and 77 times, respectively. Some of that is already rubbing off on Grasim’s valuations. Conversely, the stocks of paint firms fell between 3% and 6%, on worries about increased competition.

Grasim has said it will invest a massive ₹5,000 crore in the next three years and is eyeing the second position in the sector in terms of market share.

The company plans to enter the decorative paints business, which is a ₹40,000 crore industry in India, the management told analysts. The industry has posted an 11% compound annual growth rate from FY14-19, it said, and expects an internal rate of return of more than 20%.

Earlier the JSW group had forayed into the paints sector, giving the impression that the sector is getting crowded and that return ratios will be on the decline.

However, profit margins and returns are likely to be better compared to Grasim’s current mainstay business, fertilizers. “Paints companies reported Ebitda margins of 14-22% and RoCE of 18-33% in FY20, compared with 7-11% margins in the fertilizer business during FY18-20,” analysts at Emkay Global Financial Services Ltd said in a report on 25 January. Ebitda is short for earnings before interest, tax, depreciation and amortization.

Capturing market share in a space with large, well-entrenched firms, will be easier said than done. A key entry barrier here is distribution.

In Grasim’s case, it may have an advantage, as the distribution network of its subsidiary would come in handy.

UltraTech Cement Ltd sells putty under the ‘Birla White’ brand, which has a network of 54,000 dealers. Of these around 70% are said to have an overlap with paints and this can give it the second-largest distributor network in the paint industry.

The big worry, of course, is the price competition that arises as a result of Grasim’s entry. Citing examples of consumer giants Colgate-Palmolive (India) Ltd and Hindustan Unilever Ltd, analysts at JM Financial Institutional Securities Ltd point out that historically, consumer valuation has reacted adversely whenever there is excessive price-led competition.

Paint companies have recently made forays into adjacent products such as white cement and putty, where traditional firms such as Grasim and its group arms already have a footprint. This almost gives the impression that Grasim’s move is in retaliation.

So, investors should brace for a scenario of irrational price competition in paints as well as adjacent products. To that extent, the weakness in paint stocks is understandable. However, at the same time, it seems foolhardy to assume that Grasim will have sufficient gains to justify its large investment plans. Investors are perhaps ignoring this risk as they think they can afford to do so given Grasim’s relatively low valuation of around 11 times earnings.