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It has been a somewhat gloomy earnings season for paint manufacturers. Sky-high raw material prices have understandably taken the sheen off profit margins. Gross margins of top listed paint companies have contracted by 631-832 basis points (bps) for the December quarter (Q3FY22). One basis point is 0.01%.

Needless to say, this has become a sore point for investors. Nevertheless, to combat cost pressures, all companies took price hikes, helping the margin outlook. “Top paint makers have taken aggregate price hikes of 21-24% in the decorative coating business during the year-to-date FY22. This is likely to improve gross margins by 80-100bps sequentially in Q4FY22," said Varun Singh, analyst at IDBI Capital Markets and Securities Ltd.

A glimmer of hope
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A glimmer of hope

As such, Q4 should reflect the full impact of price hikes taken, enabling margin recovery. Abneesh Roy, executive director at Edelweiss Securities Ltd points out that prices of some monomers and key input chemical titanium dioxide (Tio2) have started to ease. That, and the easing container shortage worldwide, bode well for margins of paint companies, he said.

Paint companies use crude-based derivatives, monomers and titanium dioxide (TiO2)as inputs. Raw materials account for about 55% of the sector’s total operating cost. From 2021 highs of 255/kg, TiO2 prices have eased to 245/kg, showed Bloomberg data.

While gross margins are poised to see a gradual improvement, near-term volume growth may not be as bright. “For the paint sector as a whole, we expect volumes to somewhat moderate in Q4. Our channel checks show that demand for paints is on the lower side, as of now, compared with the festive quarter of Q3FY22," said Manoj Menon, head of research, ICICI Securities Ltd.

In Q3, on a two-year CAGR (compound annual growth rate) basis, Asian Paints Ltd saw volume and value growth of 25% and 27%, respectively. Analysts estimate close competitor Berger Paints Ltd to have lagged with two-year CAGR volumes and value growth of 23% and 19%, respectively.

According to Menon, another factor that could impact volume growth for the sector is the loading of inventory by dealers ahead of the price hikes in Q3FY22. Since paint companies are now indicating that product price hikes may not be needed anymore, dealers may not add more inventory in the current quarter, keeping volumes low, explains Menon. That said, due to the extended monsoon in many states, pent-up demand could be the joker in the pack for the paint sector, he added.

But it’s not as if valuations are cheap. Bloomberg’s data shows Asian Paints and Berger trade at 68 times and 60 times, respectively, based on estimated earnings for FY23, followed by Indigo Paints Ltd (61 times), Kansai Nerolac Paints Ltd (37 times) and Akzo Nobel India Ltd (30 times).

True, valuation multiples have moderated from their earlier peaks and to that extent, may seem reasonable. Even so, Asian Paints remains an expensive bet, with the stock appreciating by 33% in the past one year. In the same span, shares of Berger, Kansai, Akzo Nobel and Indigo Paints fell by 5-26%. A relatively higher exposure to the industrial paint segment, which remains a laggard, has weighed on the performance of Berger and Kansai, analysts note.

Meanwhile, investors in paint stocks also need to closely monitor rising competition. With the entry of Grasim Industries Ltd expected in the second half of calendar 2022, competitive intensity would increase. The Aditya Birla group company will invest 5,000 crore in this venture and aspires to become the second-largest decorative paint maker.

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