According to estimates, nearly 55% of the raw material used by paint companies are crude oil derivatives
In fact, with crude oil prices on a weak footing now, the outlook on margins has improved
At a time when volume growth is lacklustre, a welcome development for paint companies is the easing of input cost inflation. Paint producers Asian Paints Ltd and Berger Paints India Ltd have cut prices for their enamel products by 2-3%, to pass on the moderation in crude oil prices.
In a post-earnings conference call, Berger Paints’ management highlighted that a price reduction across its enamel portfolio would not have a material impact on its earnings. “Enamels account for 15-18% of the decorative industry sales, in our view," it said.
Analysts tend to agree. Apart from the high correlation of enamel with crude oil prices, the other reason margins are unlikely to be significantly impacted is the low share of these products in the overall revenue contribution, they said.
In fact, with crude oil prices on a weak footing now, the outlook on margins has improved.
“Gross margins of paint companies declined for the second consecutive year in fiscal year 2019 by 100-335 basis points (bps). However, crude oil price has corrected recently (WTI crude down c.15% over FY19 average). We build-in 50-70bps expansion in gross margins in FY20 for all paint companies," ICICI Securities Ltd said in a report on 5 June. A basis point is one-hundredth of a percentage point and WTI is West Texas Intermediate crude oil.
Apart from softening raw material prices, price hikes taken in the decorative paints portfolio by these companies would also help. In FY19, paint makers had announced a nearly 6% aggregate price hike.
Brent crude prices have declined nearly 15% from their recent peak of $74.57 per barrel seen in April 2019. According to analysts’ estimates, nearly 55% of raw material used by paint companies are crude oil derivatives. These account for 30-35% of the total raw material cost of the sector.
As for volume growth, despite a dull FY19, companies are anticipating decorative paints volumes to recover to double-digits in FY20. According to analysts, the outlook on industrial paints remains subdued due to muted automobile demand. Revival in decorative paints would depend on how soon the consumption slowdown eases, they said.
Meanwhile, paint stocks are trading at a one-year forward price-to-earnings multiple of 50-42 times. These valuations are expensive considering their poor returns. While these stocks have been underperforming the Nifty 500 index this year, a look at their valuation multiples suggests the correction should continue.