Spike in crude oil prices takes away the gloss from paint companies’ shares | Business Standard News

lipped from: https://www.business-standard.com/article/companies/spike-in-crude-oil-prices-takes-away-the-gloss-from-paint-companies-122030401303_1.html

Margins could be badly impacted, while weak demand across segments could disrupt top lines

Asian Paints

The paints industry has seen margins crunched by the spike in crude oil and gas prices since this is base raw material which accounts for a significant percentage of costs. Another factor that may worry the industry is weak consumption demand.

Weak demand could play a role in housing (decorative paints), in commercial real estate (also decoratives) and in the auto industry (industrials). Vehicle sales are weak. The rural and semi-urban economy is seeing weak demand, which may affect affordable housing. The Work from Home protocols are still in place in many ways, and there’s less demand for commercial real estate. The top five paint companies have seen PBT (profit before tax) margins contract by 632-832 bps for Q3, FY2021-22.

There could be continued pain in the medium term for the paints segment and share prices have corrected to reflect this. However, the market leaders in the paints segment have good balance sheets, good management and competent promoters. There’s a moat even if the sector is struggling, it’s unlikely new competitors can enter the fray. Hence, if the paints industry suffers several quarters of low margins and low demand and their share prices fall, this could be an opportunity for the long-term investor who finds lower valuations attractive.

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Market leader Asian Paints saw margins negatively impacted in Q3, 2021-22 itself due to higher crude prices – and it’s likely Q4 margins will be even lower, since crude prices have moved even higher in Q4. Another point is that Asian Paints has gained volumes in high-volume, low-margin segments such as putty and construction chemicals – the current product mix is lower-margin.

In year-on-year (YoY) terms, every paints company has seen growth in both revenues and profits due to the base effect of 2020-21. They have also gained sequentially in every quarter since Q3, 2020-21. However, Q4 of 2021-22 is likely to be low growth and the EBITDA margin of Asian Paints could fall by 500-600 basis points for this fiscal versus the last. There should be a 300-400 basis points rebound in 2022-23 operating margins. One brokerage says there’s likely to be a deceleration in the Q4 revenue growth and volume growth. There are “sell/ reduce” calls from an analyst with a 12-month price target of Rs 3,050. The stock has dropped from Rs 3,242 on Feb 23 to a current price of Rs 2,780.

Akzo Nobel has strong international parentage and good brand recognition, especially for its Dulux brand. It has tried to develop higher penetration in Tier 3/4 cities for its decorative paints. Akzo registered its highest ever quarterly revenue of Rs 914 crore (18 per cent YoY growth) in Q3, FY2021-22. Akzo raised prices but it still saw a margin drop. It hiked prices by an average of 17 per cent in Q3 and it raised prices again by 5 per cent in January 2022. It has a strong balance sheet with zero debt and an excellent dividend record. The stock price dropped from Rs 1,900 to Rs 1,832 in the last seven sessions.

Berger Paints saw similar trends in tighter margins (PBT margins dropped by 750 basis points YoY) and slower revenue growth because of its greater exposure in the industrials segment. It has also raised prices by an average of 24 per cent across categories in the last 12 months. The share price has dropped from Rs 727 to Rs 653.

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