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Goodlass: All falling in place

Feb 17, 2005

Performance summary
The paint sector is a lot more predictable, at least in terms of topline growth. It has been observed from the trend in the cumulative topline growth of top four paint majors that growth is typically 1.5 times to 2 times GDP growth. But if the performance of paint majors in 3QFY05 is any indication, some assumptions have to be revisited. Goodlass Nerolac was one among them. While the company posted 23% growth in net sales during the quarter, helped by higher other income, net profit grew at a much faster pace.

(Rs m) 3QFY04 3QFY05 Change 9mFY04 9mFY05 Change
Net sales 2,075 2,549 22.8% 5,788 6,745 16.5%
Expenditure 1,770 2,163 22.2% 5,006 5,694 13.7%
Operating profit (EBDITA) 306 386 26.3% 783 1,052 34.4%
EBDITA margin (%) 14.7% 15.1%   13.5% 15.6%  
Other income 15 83 457.7% 64 185 189.0%
Interest 4 3 -22.2% 11 6 -46.5%
Depreciation 58 52 -9.9% 159 148 -7.2%
Profit before tax 259 414 59.9% 676 1,083 60.1%
Tax 90 131 46.2% 230 352 53.2%
Profit after tax/(loss) 169 283 67.1% 447 731 63.7%
Net profit margin (%) 8.2% 11.1%   7.7% 10.8%  
No. of shares (m) 15.3 25.5   15.3 25.5  
Diluted earnings per share (Rs)* 26.6 44.4   23.3 38.2  
Price to earnings ratio (x)         11.6  
(* annualised)            

What is the company's business?
Goodlass Nerolac is the second largest paint company in India with an estimated market share of 23% in the organised segment (Source: Company). It is the leading OEM paint supplier to the likes of Maruti, Mitsubishi and Telco (40% share). To reduce the dependency on automotive paint, Goodlass has being making a concerted effort to increase contribution from the decorative paint market over the years. It is estimated that the industrial-decorative contribution of the company at the current juncture is at 50:50. Kansai Paints, the Japanese paint major, holds 64.5% stake in the company. India ranks among the top three international markets for Kansai Paints, apart from Japan and the US (Goodlass contributes 11% of Kansai's net sales).

What has driven performance in 3QFY05?
Automotive-decorative push:  We believe that the topline growth of Goodlass was led by not only increased demand for automobiles in 3QFY05, decorative paint demand was also healthier in light of the festive season. As far as the auto segment is concerned, the graph here highlights the volume growth of key segments in the auto sector. Since Goodlass is a market leader in the OEM segment, the topline growth in 3QFY05 is healthier. Also adding to the growth is the company's consistent effort to grow its other industrial and decorative paint contribution (decorative contribution estimated at around 50% in FY04). For 9mFY05, the topline growth at 17% is higher than our full year estimate and there is a need to revise our topline growth estimate for FY05.

Margin continues to surprise:  Despite the apparent increase in raw material costs, Goodlass has been able to improve operating margins on a YoY basis in the recent quarters. While a combination of reasons like better sourcing of materials, economies of scale and improved employee productivity have contributed to this, as compared to other paint majors, the improvement in margins is a surprise. We will meet up with the management to understand the sustainability of the same and update our subscribers soon. Though we had assumed lower margins at the start of the year, we had upgraded our margin estimate post the 1HFY05 results and we will hold by margin estimate for now.

Other income push at the net level:  Though operating profit grew at 26% in 3QFY05, the net profit growth was significantly higher primarily due to a sharp rise in other income. While we do not have details of the same, the company has sold one of its properties and the resultant profit from the same is one of the reasons.

Asian Paints outperforms this time:  Goodlass has been outperforming Asian Paints, the market leader, for the last few quarters, both at the operating and at the net level. But in 3QFY05, while operating margins of both the companies have converged at 3QFY05 levels, Asian Paints has outperformed Goodlass at the topline level, led by higher growth in industrial paints.

What to expect?
The stock currently trades at Rs 444, implying a price to earnings multiple of 11.1 times our FY07 earnings estimate. While we have to upgrade our earnings estimate for FY05 by more than 12%, we have factored in marginal decrease in raw material costs as a percentage of sales in our FY06 and FY07 estimates (around 50 basis points fall). Having said that, we believe that the current topline growth is not likely to be sustained and we will be comfortable at 10% to 12% CAGR in topline over the next two to three years.

We had re-iterated our positive view on the stock at Rs 392 in December 2004 with a target price of Rs 520 with a two to three year perspective. We maintain our view on the stock.

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