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Kansai Nerolac: Reeling under pressure - Views on News from Equitymaster

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Kansai Nerolac: Reeling under pressure

Mar 6, 2007

Performance summary
Kansai Nerolac announced mixed results for the third quarter and nine months ended December 2006. Topline growth at 9% YoY during the quarter was lower as compared to its peer Asian Paints, which had recorded a growth of 13% YoY during the same period. Operating profits declined owing to a rise in raw material costs and other expenses. The 58% YoY fall in the bottomline was due to the impact of the extraordinary income that the company received in 3QFY06. Excluding this impact, bottomline growth has been robust at 80% YoY.

Financial performance: A snapshot
(Rs m) 3QFY06 3QFY07 Change 9mFY06 9mFY07 Change
Net sales 2,845 3,091 8.6% 7,724 8,938 15.7%
Expenditure 2,401 2,681 11.6% 6,486 7,650 18.0%
Operating profit (EBDITA) 444 411 -7.5% 1,238 1,288 4.0%
EBDITA margin (%) 15.6% 13.3%   16.0% 14.4%  
Other income 46 79 72.6% 173 138 -20.3%
Interest 2 2 21.1% 5 7 22.6%
Depreciation 86 88 2.8% 225 238 5.9%
Profit before tax 402 399 -0.8% 1,182 1,181 0.0%
Extraordinary income/(expense) 504 - - 504 - -
Tax 250 126 -49.8% 509 388 -23.8%
Profit after tax/(loss) 656 273 -58.3% 1,176 793 -32.5%
Net profit margin (%) 23.0% 8.8%   15.2% 8.9%  
No. of shares (m) 25.5 25.5   25.5 25.5  
Diluted earnings per share (Rs)         40.5  
Price to earnings ratio (x)         15.7  

What is the company’s business?
Kansai 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 paints, Kansai has been making a concerted effort to increase contribution from the decorative paint market. It is estimated that the industrial-decorative contribution of the company at the current juncture is at 50:50. India ranks among the top three international markets for Kansai Paints, apart from Japan and the US (Nerolac contributes to 11% of Kansai's net sales).

What has driven performance in 3QFY07?
Subdued topline growth: As we have mentioned above, Kansai Nerolac is the second largest player in the paint sector. But unlike Asian Paints, which is very strong in the decorative paint segment, Kansai Nerolac is the market leader in the automotive coating segment. Topline growth of 9% YoY during 3QFY07 was subdued due to the preponement of the festive season sales to 2QFY07 (sales during 2QFY07 grew by 20% YoY). While the automotive segment is likely to have been the major contributor, we believe that the decorative segment, where the company is aiming to gain market share, has also played a role in contributing to the revenue growth. However, with competition growing rapidly in the automotive segment, auto manufacturers will look to squeeze key suppliers to protect margins. In this context, we expect realisations to remain under pressure.

Input costs impact margins: Operating margins witnessed significant pressure in 3QFY07. This was largely on account of rise in raw material costs and other expenses (as percentage of sales). With hardening petrochemical and crude prices, input costs witnessed a rise and the full impact could not be passed on to the customers, consequently affecting operating profits (down 7.5% YoY). Due to uncertainty on the crude price front, margins will remain under pressure going forward.

Cost break-up
(Rs m) 3QFY06 3QFY07 Change 9mFY06 9mFY07 Change
Raw materials 1,681 1,840 9.5% 5,057 5,807 14.8%
% sales 59.1% 59.5%   65.5% 65.0%  
Staff cost 156 153 -1.7% 416 437 5.2%
% sales 5.5% 5.0%   5.4% 4.9%  
Other expenses 452 530 17.3% 1,353 1,605 18.6%
% sales 15.9% 17.1%   17.5% 18.0%  
Change in stock 113 158 39.1% (339) (198) -41.5%
% sales 4.0% 5.1%   -4.4% -2.2%  

‘Extraordinary’ effect: Bottomline during the quarter fell by 58% YoY. However, this was on account of the extraordinary income of Rs 504 m that the company received in 3QFY06 on the back of sale of investments in an associate company. Barring this effect, bottomline has grown by an impressive 80% YoY despite the fall in operating profits. This has been on the back of higher other income and lower tax expenses.

What to expect?
The stock currently trades at Rs 634, implying a price to earnings multiple of 11.7 times our estimated FY09 earnings. Going forward, in the long-term, while paint sales will track the GDP growth rate, margins are likely to remain under pressure, especially if crude prices remain firm. With competition growing rapidly in the automotive segment, auto manufacturers will look to protect their margins. In such a scenario, Kansai Nerolac might feel the heat given its strong presence in the automotive segment.

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