“India’s under penetrated paint sector is attractive to many” stated a Mint report dated 08th March 2022. With Grasim Industries, announcing an investment of RS 5000 crore in this business in 2021, thus aiming to become the country’s number two paint maker by profit margins and JSW Paints in 2019, launching its paint products with a capital expenditure plan of RS 600 crore, this industry appears to be providing a leverage for new entrants.
Well, the real story begins from here…. Asian Paints and Berger Paints the incumbents and doyens of the industry have left the new entrant JSW Paints behind. The new firm trails with a mere 0.8% to 1% market share expected in Financial Year 2022, in the third year since it’s product launch, in the last three years and since it entered the painting competition. The shares of the leaders, as per the Mint report dated 24th February 2022, showed Asian Paints leading at 58 times, Berger Paints at 54 times and Kansai Nerolac Paints (another player in the industry), at 33 times their respective estimated earnings for Financial Year 2023 as per a Bloomberg data.
The story does not end here as it continues with the incumbents having to battle it out with the rising costs in the future. Hurting costs and pressure walk together, hand in hand. Brent crude prices hovering above 120 dollars per barrel as on date of the report, prices of key inputs like crude-based monomers feared to rise further as against the backdrop of the 24th of February 2022 Mint report.
Rising crude prices did pose concerns in the industry however, the prices at $95 a barrel, as per the report provided some respite. Also, the industry had exposed itself to significant price rises in the decorative coating business over the course of the Financial Year 2022.
But the report also awaited then, the March Quarter 4 Financial Year 2022 results to reflect the full impact of price hikes taken by the industry thus supporting margin recovery. Also, as most of these chemicals are imported, a weak rupee could add up to the margin pressure. The rising prices could harm the demand and thereby the margins which investors had to remain prepared for.
The firms use water-based paints, however around 35% to 40% of the commodities used by the market leaders is crude-based thus making gross margins vulnerable to oil shocks. Protecting gross margins with price hikes is a key threat to valuations of paint stocks.
The story unfolds further…. Fast, forward to Mint report dated 13th May 2022, rewind to Kansai Nerolac, incumbent, and leader in industrial paints segment. 45% of the firm’s revenue is contributed by this segment hence their gross margin compression is severe compared to that of Asian Paints, thus the firm’s problems compound (rewind to the statement “rising costs and pressure walk together”).
Adding to their then existing margin woes was their solvent-based paints sales in this segment. The crude oil price increase impact was higher here than water-based in the decorative category. Their problems got furthered owing to their low negotiating power in the segment which is business to business (B2B). Their buyers are the firms in the auto industry already suffering and grappling with their respective issues and accounting for 30% of Kansai’s revenues in the industrial segment increasing the bargaining power of their buyers, in the process.
In the given scenario, the firm could afford to increase prices by 18% in Financial Year 2022 so far in the industrial segment with negotiations ongoing with their business partners. And they raised prices by around 16% in solvent-based paints in the decorative segment, losing their market share in the Northern parts of the country, during the quarter. While its competitor Asian Paints concurrently saw a volume growth of 8% year on year in the respective segment.
Kansai lost their battle to Asian in the similar segment with their volumes dipping by around 7% to 8% due to product mix deterioration. Both Asian and Berger are aggressive in their marketing strategies in the decorative premium paints segment unlike Kansai, thus revealing a tough rival power. The topmost harm was done to them by the stock market. The firm’s shares declined by around 30%.
Concurrently their arch-rival Asian Paints experienced a rise of 19%. Berger lost but not substantially compared to Kansai, of around 10% and Berger had not announced their March quarter earnings hence at the point Kansai needed to wait and watch what Berger had to tell.
Asian Paints continued to lead the battle navigating itself through margin contractions despite rising input price cost inflation, parallelly raising prices way too high and thus maintaining their stock market scenario, superbly. In Quarter 4 Financial Year 2022, their consolidated gross margin had stood at 38.7% and improved 195 basis points sequentially. They expect around a 40%-42% rise in their gross margins in Financial Year 2023.
In Financial Year 2022 they had seen a 32%-34% cost inflation and increased their prices by 24%-25%. Their expectations stated that for an incremental inflation of 5%-7% seen in Quarter 1 Financial Year 2023, they felt price increases of about 2% in May and June would have done them good. Thus, Asian paints was having a bargaining power over their buyers, holding their competitors at bay, enjoying a comfortable position in their industry market and the stock market and can absorb the rising cost inflationary pressures concurrently. Woah! Sounded like a perfect strategy mix.
Coming back to Kansai, their stock was trading a steep valuation discount. According to Bloomberg, based on Financial Year 2024 earnings estimates Kansai’s price to earnings ratio stood at 26x far lower than the 55x and 48x multiples of Asian Paints and Berger Paints. The valuation gap between Kansai and Asian is likely to remain in the foreseeable future.
For Kansai the decorative paints segment has always been a struggle and a gap between their volume growth with two industry doyens ruling but it is lagging far behind these two chaps. Thus, “higher exposure to industrial paints and loss of market share makes Kansai more vulnerable than peers” stated the Mint report dated 13the May 2022.
Had the story ended or just begun had to be keenly observed by market analysts? But apparently so the story had yet to reveal some exciting encounters between the incumbents and the new entrants. Whether it was the existing leaders or the new entrants that would win only the future could unfold.
The then scenario clearly marked Asian Paints as the leader followed by Berger Paints with Kansai Nerolac struggling its way in the decorative segment but as yet depicting a clear persuasive strategy in the industrial segment which appeared to have aided the firm in managing its foothold till then but apparently they needed to work more on analyzing their gaps and better marketing strategies compared to the existing aggressive ones, especially in the decorative segment where they are in direct competition with Asian Paints and in both the segments given the then Bloomberg data on their price to earnings ratio, estimates.
The painting competition got more and more fierce with Grasim Industries Limited’s plans to enter the paint sector at full throttle. The company willing to incur capital expenditure of RS 10000 crores by Financial Year 2025, which is twice the investment announced back in 2021, it left a question here what ‘Beehive’ lies in store in the paint industry to attract firms to it? Or are the barriers to entry porous for firms to easily percolate?
Moving on it could be easily deciphered, the competition in the industry was boiling. The market shook not in favor of the incumbents in the industry as the stock prices of Asian Paints and Berger Paints fell by 7%-8% on NSE on 25th May 2022.
On the other hand, Grasim refused to budge. It moved up its paints capacity of 1332 million liters per annum (MLPA) with plants to be commissioned by Quarter 4 Financial Year 2024 and which is clearly 75% to that of Asian. This was a direct competition with Asian Paints if its 1750 (MLPA) capacity is to be considered and is much higher than that of Berger and Kansai Nerolac India Ltd. Apparently, the struggles for Kansai Nerolac remained sustained, unfortunately.
Grasim aims to be number two in the decorative segment over a period, after Asian Paints, the existing leader. Kansai have a long way to go. Analysts suspect of an aggressive strategy (pricing otherwise) by Grasim and disturb the market structure in the industry. They also point out towards a rising competitive intensity yet feel positive on the risk of disruption stating that it is low because “it is difficult to differentiate between the superiority of two paint products, just by looking at product description”.
Does this factor of low levels of product differentiation raise the barriers to entry for those fearful of being wiped out owing to the intensity of the competition in the industry or does this barrier act otherwise but a deterrent where the new entrants willing to risk contemplate of a sustained leadership akin to Asian after they enter and are able to capture a sizeable share in the market?
Grasim was surging ahead targeting the northern markets of the country, first and which has low penetration instead of competing with Asian in the west, Berger in the east and Kansai in the south where these chaps have a stronghold. However, Kansai needed to watch out despite its the then strength in the south. Grasim appeared to be a bull. Oops! Another jolt for Kansai which had already lost its market share in this part in the decorative segment.
Mint dated 26th May 2022 stated, “the Indian Paints industry has high entry barriers”, which is possible due to low product differentiation. They also mention “not many newcomers have tasted huge success here”. Grasim needs to enhance its risk levels to sustain in the industry. “Scalability is among the key challenges that companies such as Nippon Paint Holdings Co Ltd and Jotun have often faced” stated analysts. Hmm… that explains Asian being a consistent market leader and answers the question on entry barriers.
However, Grasim’s increased thrust was a dampener for the incumbents in the industry. The threat from new entrants who are domestic firms turning out to be competitors is much more for the existing firms. Why? Because these domestic companies understand the Indian commodity industry, strong balance sheets and a drive to be among top companies in the industry. Also, the new entrants would leverage on their existing capacities. This brings to the fore the basic principle which the incumbents can consider while devising their strategy roadmap that the barriers for the new entrants into their industry are relative to their capabilities which incumbents need to pay heed to.
But is this not an antithesis to the earlier answered question on entry barriers? Here the earlier analysis of the entry barriers failing to act as deterrent to new domestic entrants, appears to hold true and can be easily deciphered. This is true because plastic pipes maker Astral Ltd and JK Cement Ltd are also making an entry into the sector. Hmpfh! Sad for Kansai. The company needs to gear itself strategically by positioning themselves diametrically opposite to the rising competition.
Adding to the woes of the incumbents especially Kansai were the cost inflationary pressures that tend to drive down their margins thus leading to a fall in the paint stocks by almost 16%-31% so far in Current Year 2022, which was huge especially for a company struggling to levy its hold on their dwindling position in the decorative segment.
The incumbents have raised prices several times in the Financial Year 2022, to cope with the inflation indicating further price increases in Financial Year 2023 as well. Rising input prices combined with the tension of increasing competition tends to bring about an excitement in the paint story no doubt for analysts who then had adopted a wait and watch policy but was heating up the discussions on ideal strategy roadmaps by the incumbents.
Analysts provided a ray of hope for the incumbents as they stated that “succeeding in the paints business has a lot to do with brand recall value rather than just product prices”. Also, “paint stocks are trading at expensive valuations which need to correct”. Bloomberg data showed Asian Paints trading at 53X estimated earnings for Financial Year 2024 followed by Berger at 42X and Kansai at 28X.
The Bloomberg estimates appeared to have dwindled for Asian Paints from earlier 55X to 53X and for Berger from 48X to 42X with Kansai doing a better job here from earlier 26X to 28X. Hmmm… Kansai’s strategic positioning appears to be working. Apparently, a rugged road ahead for Asian and Berger but Kansai may move further up.
Here it can be vehemently pointed that both Asian and Berger especially should not circumvent and undermine the capabilities of the new entrants The telecom industry’s current market leadership by Airtel, leaving behind Jio on number 2 position after it disrupted in 2016 appears to be occurring in the paint industry as well.
Does this bring back the question on barriers to entry acting as deterrents? Wait and watch was the message for the day. Change is the only constant! If this holds true then the concerns over raw material inflation, slowdown in demand and rising competition owing to the new entrants willing to surge ahead as per Mint report on 30th June 2022 painted a different picture especially for the investors.
All this had taken away the sheen over the paint stocks with Asian Paints stock sliding to a 52-week low of Rs 2560 on 17th June on NSE and at just 5% above that level as on 30th June. But not before correcting itself by 20% during the calendar year.
During inflationary period in Financial Year 2011-2012 and Financial Year 2018-2019, Asian Paints could absorb part of the inflation to protect its volume growth and market share. However, in subsequent years the company has regained its margins by calibrated price hikes and operating scale. A positive from the investor perspective.
In the near term an expensive input material may hinder quick recovery in gross margins. However, prices of crude-based monomers and titanium dioxide have commenced easing but are yet high compared to a year ago period. With crude prices commencing to moderate the probability of steep price hikes in Financial Year 2023 is low. A relief to the buyers. To offset cost pressures, the market leader had raised price by around 22% in FY22. But still gross margin contracted by 717 basis points year on year.
If crude oil prices continue to ease, gross margins would start to improve from the second half of Financial Year 2023. Besides a robust volume growth would help the stock see faster bounce back. Hence it can be deduced that investors can have a sprint in Financial Year 2023. Is this something due to which the newcomers need raise their hopes to be in line to gain market leadership and raise hopes for those wishing to enter in the future?
Following the then corrections, valuations of Asian Paints stock had moderated. The shares were trading at 49 times estimated Financial Year 2024 earnings according to Bloomberg data. Its annual report for Financial Year 2022 mentioned of volume and value growth in the decorative segment last year, were 31% and 36% year on year respectively, which was an industry leading growth, and the company continues to gain market share from listed peers and small and regional paint makers. Is Kansai watching this?
The entry of Grasim Industries Ltd in the Paints sector isn’t a big worry for the market leader yet because Grasim aims to capture the North Indian market first instead of competing with Asian Paints in the west which has low penetration except by Kansai Nerolac in the past and where it received failure. Recently Grasim doubled its capital expenditure outlay for the paint business to Rs 10000 crore. Does Kansai need to worry?
The story takes another turn with Kansai’s shares rising nearly 18% to RS 508.30, on 2nd August 2022 thus reversing to a large extent its sharp losses seen prior to this in Current Year 2022 so far. Their stock was 14% down in 2022. Should Kansai celebrate or has it yet to lay out further strategies? What happened, let’s check this out.
The company had reported June quarter results (Quarter 1Fianancial Year 2023) results with standalone revenue ahead of expectations. Kansai had recorded 30% year on year volume growth in Quarter 1 aided by a low base and had taken price hikes of 18%-20% year on year. The company’s decorative paints category saw healthy demand recovery after a subdued Quarter 4, along with better mix which had deteriorated in Quarter 4.
Although their gross margin contracted by 442 basis points year on year, it rose sequentially. The company management stated that while inflationary trend continued there was some softening of input prices for crude based items towards the end of the quarter which was yet to be reflected in derivatives.
Easing gross margin pressure was positive not only for Kansai but for the entire paints sector which has been battling severe cost inflation. Also, improving outlook of the industrial paints segment was one factor contributing to the exuberance in the Kansai stock.
Decorative paints contribute around 55% to Kansai’s overall sales and the balance comes from industrial paints. Within industrial paints, automobile paints are estimated to account for around 30% of total revenues. Maruti Suzuki India Ltd is Kansai’s key client.
From the past few quarters, Kansai’s industrial paints business has been a laggard mainly due to the chip shortage problem in the automobile industry. However, the company confirmed that there had been a revival in demand in industrial paints led by increased demand in automotive due to gradual easing of chip shortages.
The Kansai stock was punished more severely by the stock markets this year due to its high exposure to the industrial paints segment where taking price hikes is more difficult than decorative paints. In July monthly car sales hit a record high and recovery in passenger vehicle segment and auto segment in general should benefit Kansai.
Meanwhile the Kansai stock was far away from 52 week high of RS675 seen in October. Apart from the automobile sales trajectory, improvement in gross margins and rising competitive intensity are the other key parameters that can be monitored by Kansai investors. What happens further? The story gets more and more interesting.
Competition was heating up in the Paints sector. New entrant, Grasim committed to invest RS 10000 crore, Berger Paints adopted an aggressive marketing strategy via network expansions, increased advertising spends and new product launches. It has aimed to add as many as 6000 – 7000 dealers annually as per the June quarter Quarter 1 Financial Year 2023 earnings call against the earlier annual run rate of 4000 – 5000 dealer additions. The incumbents appeared to be gearing themselves up strategically.
As per experts it takes years to break into the existing market and gain a few percentage points, especially for the existing decorative paints companies, hence the road ahead is rough for Grasim to scale up. Will they be able to fall in line with the leaders or will they trail behind akin to the other small players and be one amongst them? The investors will need to hold on.
However, on the flip side from the perspective of the industry, there is a worry that huge capacity additions by newcomers could lead to a pricing war to capture market share. That is not a good sign for Berger’s margin outlook.
Berger’s execution consistency is impressive, and it has held its ground notwithstanding Asian Paints aggression. Remaining cautious is the key as rising competition with Grasim’s entry would way on margins/ valuations.
Grasim wants to enter the North market first where the picture is not all that rosy for Berger. In Quarter 1 Berger had maintained its market share in the South and West and its leadership position in the East with a moderate performance in the North and Central markets.
Due to severe cost inflation shares of paint companies have of late lost sheen, nosediving to their 52week lows. Both Berger and close competitor Asian have recouped for their losses however the former is lagging. From its 52-week low Berger stock is up 21% and Asian Paints has risen 30%. So far in Current Year 2022 performance of Berger has been dull vis -a- vis Asian Paints.
Accordingly, Bloomberg data showed Berger stock trades at Financial Year 2024 price to earnings multiple of 47 times lower than Asian Paints 60 times multiple. Berger’s valuation is expensive though it is lower than of Asian Paints. The valuation gap between the two is likely to remain given the better earnings profile of Asian Paints especially on a three-year compound annual growth rate basis and because rising competition in the sector is not worrisome for Asian Paints. Grasim or no Grasim, Asian Paints is clearly the market leader while the others grapple to stay afloat in the industry.
However, the borders of the industry tend to get porous and the competition murkier. Is this something the incumbents need to worry or as Asian Paints has painted a positive picture with Berger following, they can relax?
References:
Mint, ‘Berger Paints may see patchy recovery amid rising competition’, by Harsha Jethmalani 29th August 2022
Mint, ‘Kansai Nerolac shares shine on improved earnings outlook’, by Harsha Jethmalani 03rd August 2022
Mint, ‘Asian Paints beats the inflation blues with robust volume growth’, by Harsha Jethmalani 30th June 2022
Mint, ‘Grasim’s paints blitz raises risks in sector’, by Harsha Jethmalani 26th May 2022
Mint, ‘Why Kansai Nerolac is more vulnerable’, by Harsha Jethmalani 13th May 2022
Mint, ‘Competition least of paint makers’ worries, by Harsha Jethmalani 08th March 2022
Mint, ‘Spike in crude prices to hurt many sectors’, by Harsha Jethmalani 24th February 2022
