Maruti Suzuki’s production cut has Kansai Nerolac investors worried

News that Maruti Suzuki India Ltd is cutting production in March has investors in Kansai Nerolac Paints Ltd worried. The paint maker’s shares have fallen 5% since, even while the markets have risen.

There are two reasons why Kansai Nerolac would be among the casualties of a slowdown in the automobile sector. One, it is the market leader in the industrial paints segment, which forms 45% of its revenue, with the auto industry having the highest share. Two, Maruti Suzuki is the company’s biggest client. So, this double whammy of sorts would accentuate pressure on its already struggling industrial paints business.

To put things into perspective, Kansai Nerolac’s paint volumes grew in the high double-digits in the December quarter. The growth was largely led by the decorative paints segment. The industrial segment, including automotive, is weak, making it difficult to take price hikes, the company’s management told analysts.

Back then itself, analysts were worried about the delay in price hikes for industrial clients. As a result of the ongoing slowdown, operating margin would remain under check.

Brokerage house CLSA Ltd sees increased risk for industrial segment margins, because price hikes may be difficult in the auto segment given the weak demand. “We cut our earnings per share forecast 2%-4% (following a 6%-7% cut in January 2019), as we trim our growth forecast for industrial and also slightly tone down our margin assumptions,” it said in a note to clients on 22 March.

On the bright side, the rupee’s appreciation coupled with price increases in the decorative paints business should provide some respite. A stronger rupee means raw material imports would be cheaper. However, that may not be sufficient for a significant improvement in margins. Also, while the price of titanium dioxide, a key input derived from crude oil, has declined from its peak, it remains elevated.

No wonder then that the Kansai Nerolac stock is trading at one-year forward price-to-earnings ratio of 38 times. Valuation-wise, it is far cheaper when compared to peers Asian Paints Ltd and Berger Paints India Ltd. It’s evident that the continued weakness in the industrial business has weighed on its valuations.

Of course, the impact on revenue growth can be offset to some extent if the decorative paints business maintains momentum. However, as this column recently pointed out, there are telltale signs of weakness in overall consumption demand in India. So, some analysts caution that the demand for discretionary spending such as painting may also be hit.