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Stock Recommendation | KANSAI NEROLAC PAINTS LTD – BUY – Target Price : 485
Publish date: OCTOBER 24, 2018
Stable volume growth in the decorative segment, weakness in the industrial segment, continued raw material price inflation, small price hikes in Q2FY19, extended monsoon in key geographies and delayed onset of festive season in CY18 were the highlights of the results for KNPL during the quarter.
■ As per management commentary, KNPL experienced 9% volume growth YoY growth across segments led by decorative segment. Management commented that inflation (including Raw material cost), volatility in crude prices and INR movement was more pronounced this quarter which impacted the operating margins. Management is making efforts to increase product prices and reduce various costs to counter the situation.
■ Sales (excluding GST) was reported at Rs 12.94 bn (+11.1% YoY) with 9% overall volume growth. Raw material price inflation and weakness in the industrial segment (especially Auto) impacted the Gross margin and EBIDTA margin for the quarter.
■ In H1FY19, company had taken a price hike of just 2% to counter the steep increase in raw material (RM) prices including crude derivatives. Post further sharp increase in RM prices, company has taken another price hike of 2/3 % across segments on October 1st which should reflect in the performance of Q3FY19.
■ Management mentioned that the industrial segment including automotive segment is weak and it is difficult to pass on the RM hikes in this segment. While decorative paint segment is strong for the entire paint industry including KNPL.
■ Consequently, PAT was reported at Rs 1.22 bn vs. our expectation of Rs 1.42 bn
We estimate that branded paint demand will remain robust in a country like India where per capita consumption is very low and 30% paint market is still unorganised. Management of KNPL also indicated that the volume trends remain strong for the company in the decorative segment and expect the trend to continue in medium term. However, industrial segment is weak and expected to remain weak in rest of FY19. We also estimate the gross margin of the company to remain under pressure with continued RM inflation and the company's restricted ability to pass on cost inflation to its industrial paint clients (45% of revenue). In view of the impact on gross margins and weakness in the industrial segment, we cut our EPS forecast for FY19E and FY20E by 9% each and assign a lower PE multiple to the stock in a weak macro environment. On the flip side, the stock remains one of the favored companies in the consumer space with a strong brand, credible history, sound management and BS and a reasonable outlook. Maintain BUY with a lower TP of Rs 485 (from Rs 540) at 39x FY20E earnings (from 40x).
Paint Industry uses two key raw material including crude derivatives and Titanium Dioxide. The Paint industry is experiencing increase in prices of raw material since the last one year, with steep increase in Q2FY19. Almost ~60% of the raw material are crude derivatives and with crude at $80/barrel (+50% YoY), prices of crude derivatives have also increased. Even prices of pigments like Titanium Dioxide, Iron oxide and Zinc oxide have increased. Even INR volatility has contributed to cost inflation for the company. To counter this, the management of KNPL have not resorted to price increase in Q2FY19 due to competition and also due to sticky nature of prices for industrial customers.
In H1FY19, company had taken a price hike of just 2% and another price increase of 3% from 1st October to offset increase in RM prices. Company is also continuously engaging with industrial paint customers including Auto companies for price increases to compensate for the input cost inflation. However, industrial customers are rigid and difficult to convince for any type of price hikes. In most cases, there is a lag of 3 months from the time of increase in RM prices and increase in product prices for industrial customers.
Management indicated the sales performance of Q2FY19 could be attributed to:
■ 9% volume growth in the decorative segment
■ Weakness in automotive demand and weak private sector capex leading to weakness in the industrial segment
Industrial segment contributes ~45% to KNPL’s revenues with automotive segment contributing 75% of the industrial segment revenues. KNPL's strong dominance in automotive paints segment is supplemented by its parent Kansai's association with global OEMs that have a strong presence in India.
Automotive production was weak in H1FY19 with volume of 21.04 lakh units (against 19.71 lakh units in H1FY18 and 96.7% YoY) which compelled SIAM to reduce growth forecast for passenger car sales from 11% to 9%. Going forward, cost of ownership of passenger cars can increase by 10 to 15% over the next one year led by—(1) sharp increase in insurance costs as IRDA has made it mandatory to purchase five-year third-party insurance; (2) rising interest rates; (3) increasing crude prices; (4) depreciating INR and (5) rising raw material prices. This could slow down the growth for automobile companies in near term impacting demand for automotive
KNPL has maintained a low double digit or high single digit volume growth rate in the decorative segment for the last 12 quarters in the decorative segment outperforming the performance of market leader Asian Paints and peer Berger Paints driven by:
1) New product offerings - New product launches which are eco-friendly, lead free, low VOC etc.
2) Aggressive marketing by KNPL- KNPL is one of the largest spender on Advertisement, which is around 9% of the decorative segment revenue as against 6% of Asian Paints and Berger
3) Improving geographical reach – north India is the strongest market for KNPL, now the company is focussing on West and South (which are strongholds of Asian Paints)
4) Huge Dealer Base – Company current has 20000+ dealers which is growing at 10% CAGR. These dealers are serviced through 102 depots.
5) Aggressive sales pitch and higher dealer margins
6) Connecting directly with the customers through initiatives like tinting machines- 75% of the dealers of the company have tinting machines
7) Other factors like increasing disposable income, shortening painting cycle to 5 years (from 10 years over a decade) and increase in per-capita consumption to 3.3 kg (from 1.5 kg over a decade)
KNPL has four manufacturing facilities situated at Lote in Maharashtra, Bawal at Haryana, Jainpur in UP and Hosur in Tamil Nadu with an Installed capacity of ~431,000 tonnes with utilization rate of ~75%. We estimate the company to spend another Rs 3.6 bn over FY18 to 21E to add another 106,000 tonnes. Healthy addition of capacities is a lead indicator that the demand for paints is going to remain healthy over the next few years
Management of KNPL mentioned that the company has taken a price hike of 2/3% in July 2018 and a similar price hike in October 2018. This should partly offset input cost pressures (INR depreciation + crude rise). We expect the GST rate cut (28% to 18%) to alleviate impact on consumer demand from such increases. However, we estimate the gross margin of the company to remain under pressure with continued RM inflation and weakness in the industrial segment. Consequently, we cut our EPS forecast for FY19E and FY20E by 9% each and assign a lower PE multiple to the stock in a weak macro environment. On the flip side, the stock remains one of the favored companies in the consumer space with a strong brand, credible history, sound management and BS and a reasonable outlook. Maintain BUY with a lower TP of Rs 485 (from Rs 540) at 39x FY20E earnings (from 40x).
Kansai Nerolac Paints Ltd. (KNPL), a subsidiary of Kansai Paint, Japan, is one of India’s leading paint companies and the largest player in the industrial segment. KNPL had its beginning as Gahagan Paints and Varnishes Co. Ltd. in the year 1920. In over 93 years of its existence the Company has built a strong brand and gained a reputation for high quality, innovation and differentiated product offerings. The Company has 4 manufacturing facilities at Lote in Maharashtra, Bawal in Haryana, Jainpur in UP and in Hosur in Tamil Nadu with a total capacity of 4.31 lakh metric tonnes per annum. The company is the market leader in the automotive coating segment in India with a dominant market share. Over the years, it has maintained its leadership position in the Industrial Coatings segment with a wide range of products in the Automotive, Powder, General Industrial and High performance Coatings space.
BUY - We expect the stock to deliver more than 12% returns over the next 12 months ACCUMULATE - We expect the stock to deliver 5% - 12% returns over the next 12 months REDUCE - We expect the stock to deliver 0% - 5% returns over the next 12 months SELL - We expect the stock to deliver negative returns over the next 12 months NR - Not Rated. Kotak Securities is not assigning any rating or price target to the stock. The report has been prepared for information purposes only. SUBSCRIBE - We advise investor to subscribe to the IPO. RS - Rating Suspended. Kotak Securities has suspended the investment rating and price target for this stock, either because there is not a Sufficient fundamental basis for determining, or there are legal, regulatory or policy constraints around publishing, an investment rating or target. The previous investment rating and price target, if any, are no longer in effect for this stock and should not be relied upon. NA - Not Available or Not Applicable. The information is not available for display or is not applicable NM - Not Meaningful. The information is not meaningful and is therefore excluded. NOTE - Our target prices are with a 12-month perspective. Returns stated in the rating scale are our internal benchmark. Kotak Securities Limited established in 1994, is a subsidiary of Kotak Mahindra Bank Limited. Kotak Securities is one of India's largest brokerage and distribution house.
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