Stocks that painted D-Street in green may lose shine now
Berger Paints and Asian Paints are currently trading around record high levels.
Strong earnings visibility and consistent performance have kept investor sentiment upbeat on the counter. However, the strong outperformance may now pause given the rich valuations, said analysts.
Stocks of the top paint companies outperformed the 30-share benchmark Sensex in the near term as well as long term, making them prominent wealth creators, and darling of asset managers.
Berger Paints and Asian Paints are currently trading around record high levels. Berger Paints has delivered 50.29 per cent return for last one year, 275 per cent for five years and 2,223 for last 10 years. Asian Paints has jumped 33.44 per cent for last one year, 162.14 per cent for last five and 947.81 per cent for last 10 years.
Kansai Nerolac and Akzo Nobel India have also strongly outperformed Sensex over these periods. Akzo Nobel shares hit a record high earlier this month.
In the comparable periods, the Sensex gained 14.84 per cent, 43.90 per cent and 134.66 per cent, respectively.
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Saurabh Mukherjea, Founder of Marcellus Investment Managers, says the paint industry has very high entry barriers, which is why the top three established players –Asian Paints, Berger Paints and Akzo Nobel – are able to hold profit margins and the return on capital very well.
“The fundamental distinction between the paint industry and other industries such as airlines is that entry is easy in the latter’s case and so new entrants have come in and wiped out profit margins for established players such as Jet Airways, Kingfisher and now IndiGo,” Mukherjea said.
“In contrast, paints as an industry is any incredibly hard space to enter, and the top three incumbents have ruled the roost for last 20 years. They have consistently high margins and return on capital,” he said.
“Paints firms allow incumbents to benefit from the growth they see in their top line,” he said.
The Indian paints sector, estimated to be a Rs 50,000 crore industry, is classified into two main segments: decorative - which accounts for 75 per cent of the industry’s value, and industrials, which accounts for the remaining 25 per cent.
The industry consists of a mix of both organised and unorganised players, but former holds a major share of the market. Till financial year 2017, organised players had a market share of about 65 per cent, which has risen to 80 per cent post GST implementation. The top players in the organised sector are Asian Paints, Kansai Nerolac, Berger Paints and Akzo Nobel, which together account for about 68 per cent of the market share.
In financial year 2019, the paints industry expanded at the rate of 12 per cent in volume terms and 15 per cent in value terms.
In general, the growth of the paint industry depends on a number of factors such as disposable income in the hands of public, urbanisation, economic development, monsoon rains, raw material prices, growth in infrastructure and recovery in real estate and auto segments, Care Ratings said in a report.
Care said government initiatives towards infrastructural development, schemes like Housing for All and a reduction in GST from 28 per cent to 18 per cent on the paint industry are likely to boost the demand for paints.
“Post RERA and GST implementation, unorganised players are not able to continue the business at the same pace, and demand is shifting to organised players,” said Rusmik Oza, head of fundamental research at Kotak Securities.
“The repainting segment is not slowing down, even though there is a slowdown in the new homes segment. The companies have good pricing power. So, a hike in input prices is being passed on, and GST rates have also come down, which bodes well for the sectoral leaders,” Oza said.
He, however, raised concerns that the stocks may have run up a bit too much, making valuations stretched.
Asian Paints’ price-to-earnings ratio at 80.1 makes it the highest valued on the S&P BSE Sensex index, according to Bloomberg.
“The valuations are too rich and not sustainable, and there could be a phase when they could underperform in the near to medium term until the real estate sector and the economy pick up,” said Oza. “Their fortunes will still be linked to real estate sector,” he added.