Paint industry could see further downsides on demand, competitive pressures

Q3 could see weak volumes; hurdle for incumbents is new entrants in the sector

The paints sector has been an underperformer with most listed majors shedding 17-25 per cent since their highs in August. Barring Akzo Nobel, which has generated positive returns in this period, paint companies have lagged the benchmarks and their peer indices that have delivered flattish returns over this period.

Despite the weak returns, brokerages believe that there are multiple near- to- medium-term worries for the sector, which could open the way for further downgrades and disappointment on the return front. These include weak December quarter earnings, muted volumes, competitive pressures as new players enter the segment, and a lack of valuation comfort.

The near-term risk for the major players remains in sales. Elara Securities expects muted volumes across segments with low, single-digit growth in decorative coatings due to early Diwali and prolonged monsoons. Its checks indicate muted demand post-Diwali and the slowdown in business. Analysts led by Amit Purohit of the brokerage, believe that industrial paints too are likely to be muted due to a dip in automobile production (2 per cent dip in Maruti Suzuki's passenger vehicle production), led by electronics components shortage. ICICI Securities too expects volume growth to be impacted due to a strong base (early Diwali last year) and steep general inflation.

While prices of raw materials such as titanium dioxide are down over 10 per cent year-on-year (YoY) and crude oil price has corrected from its highs earlier in FY23, they continue to be higher YoY. Given the high-priced inventory, benefits of correction in raw material prices will likely be realised in the December quarter, say analysts led by Manoj Menon of ICICI Securities.

The biggest hurdle for incumbents in the medium term is new and deep-pocketed entrants in the sector and their need to expand market share.

While Grasim Industries wants to become the second largest player in the sector, JSW group is eyeing a tenth of the market by FY26. Jefferies Research points out that the marketing spending of the new entrants and other players is going up. Nippon and JSW are spending as much as 15-20 per cent of sales in a bid to expand their presence as against less than 5 per cent for incumbents.

Though there is a lack of clarity about their ability to make deep inroads, brokerages believe that they could dent the margins of the sector. Analysts led by Vivek Maheshwari of the brokerage believe that an aggressive strategy by new entrants will likely entail steps like channel push, higher discounts and promotions for dealers and even painters, which could impact the industry's profitability, at least in the medium term. The issue gets compounded, given that small-to-mid-sized players (Kamdhenu Paints is looking to scale its revenues to Rs 1,000 crore by FY26) are also eyeing the opportunity and may adopt a regional strategy.

Given these worries, analysts at Kotak Institutional Equities believe that there is further scope for de-rating in the case of Asian Paints, Berger Paints and Kansai Nerolac. This is on the back of multiples remaining on the higher side despite de-rating in the past nine months and the fact that market structure will worsen with the entry of one potential disruptor (Grasim) and aggressive intention of other newcomers (JSW Paints).

On the valuation front, the multiples of Berger Paints and Kansai Nerolac have de-rated significantly in the past few months and are trading below pre-pandemic multiples due to disappointing volumes and/or concerns about new competition. However, Asian Paints is still trading well above its pre-Covid peak multiples, say Kotak analysts.