Paint Stocks Fall After ICICI Securities’ Downgrades
The brokerage downgraded Akzo Nobel to 'add', Asian Paints, Indigo Paints, Kansai Nerolac to 'hold' and Berger to 'reduce'.
Shares of India’s leading paintmakers declined after ICICI Securities downgraded all of them by a notch.
“While we remain positive on their business model due to strong competitive advantages and long-term growth opportunity, the increase in input prices and elevated competitive pressures will impact their near-term earnings,” the brokerage said in its Oct. 24 report.
Also, “two divergent strategic approaches are at play in the paints industry”, prior to Grasim Industries Ltd.’s impending entry next year, it said. They are:
Market leader Asian Paints Ltd. is endeavoring to accelerate industry formalisation by dropping profit pool, so that Grasim can’t reach the easy 5% share by gaining from informal players.
Indigo Paints Ltd. and Nobel India Ltd., among others, are likely protecting their profitability to have adequate ammunition for the inevitable heightened competition in calendar year 2022 and beyond.
“We stay believers in the Akzo turnaround story, though, we reckon that short term remains cloudy, may be a tad underwhelming,” ICICI Securities said.
The brokerage downgraded Asian Paints, India’s largest paintmaker, after an “unprecedented” gross margin decline of 1,000 basis points in the second quarter. “It will sequentially get better in Q3 which may assuage consensus’ worries. Any excitement, however, will be short-lived as the industry is entering a phase of heightened competition.”
Drawing comparison with the hyper inflationary era of FY08-10, ICICI Securities said lost margins could be recouped over a period of time via price hikes and some stability in input prices. “But the players will have to choose between market share and margin over the next two years which will dampen value creation and act as catalyst for de-rating of valuation multiples.”
While larger companies like Asian Paints and Berger Paints Ltd. may choose to focus on volumes and market share, smaller peers like Indigo Paints and Akzo would like to protect profitability, which will give them ammunition to compete with new entrants. “There will be increase in net working capital days, too. With lower margin and higher capital, value generation will decline for smaller, unorganised players. We also expect lower valuation multiples for most listed players.”
Key upside risk: better-than-expected gross margins due to correction in input prices.
Key downside risk: unexpected irrational competition due to deceleration in general consumption demand.