Delayed margin recovery, competition woes dull Kansai Nerolac

Kansai’s management is hopeful of the declining trend in input costs to continue. But it still holds high-cost inventory, so the benefits of easing raw material prices on gross margins will start reflecting gradually. This could lead to a downward revision in FY23/FY24 earnings estimates, cautioned analysts.

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Kansai’s revenue performance was underwhelming, with growth at a paltry 1.4% y-o-y to ₹1,717 crore, lower than analysts’ expectations. Revenue growth was impacted by unimpressive decorative paints demand, which was hurt by early Diwali, extended monsoons and channel restocking by dealers in the base quarter. Analysts estimate Kansai’s decorative segment volumes to have fallen by mid-single digit. Larger competitors Asian Paints Ltd and Berger Paints India Ltd fared relatively better on this metric in Q3.

But in the industrial paints business, Kansai saw good demand in the automotive coatings in Q3. Here, demand was aided by paints for passenger and commercial vehicles, while the two-wheeler category was subdued. The management is upbeat on near-term industrial paints demand. Also, raw material costs are softening and price hikes with its key OEMs in Q3, helped offset the impact of elevated inflation to an extent. Note that the industrial segment is a low margin business.

As such, the pace of recovery in gross margin is crucial for all paint stocks. But concern emerges from increased competitive intensity with the entry of new companies with deep pockets. In a bid to capture market share, aggressive pricing strategies could adversely impact Kansai. This has weighed on investors’ sentiment towards the stock. Unsurprisingly, shares of Kansai trade at a deep discount to peers. Bloomberg data shows that Kansai’s FY24 price-to-earnings multiple stands at 29.7x, while that of Asian Paints and Berger is 53.3x and 45.2x, respectively.

Prabhudas Lilladher’s analysts reckon the worst seems to be over for Kansai due to various positive measures including, the Nerolac products’ repositioning and exit from low margin segments. But, incremental market share loss and rising competition from Grasim Industries/JSW Paints and JK Cement remains a key risk, said the broking firm.