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Kansai Nerolac: The raw material dampener - Views on News from Equitymaster
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Kansai Nerolac: The raw material dampener
Jun 19, 2007

Performance summary
Kansai Nerolac announced mixed results for the fourth quarter and year ended March 2007. Topline growth at 21% YoY during the year was largely led by the decorative segment. Operating margins declined owing to a rise in raw material costs (as percentage of sales). The 22% YoY fall in the bottomline during the year was due to the impact of the extraordinary income that the company received in FY06. Excluding this impact, bottomline growth has been decent at 22% YoY.

Financial performance: A snapshot
(Rs m) 4QFY06 4QFY07 Change FY06 FY07 Change
Net sales 2,372 2,852 20.3% 10,096 12,224 21.1%
Expenditure 2,038 2,490 22.1% 8,524 10,509 23.3%
Operating profit (EBDITA) 333 362 8.7% 1,572 1,714 9.1%
EBDITA margin (%) 14.1% 12.7%   15.6% 14.0%  
Other income 73 92 26.3% 246 241 -2.3%
Interest 3 3 12.0% 8 10 23.1%
Depreciation 93 95 1.8% 318 336 5.6%
Profit before tax 311 357 14.9% 1,492 1,610 7.9%
Tax 101 124 22.8% 610 533 -12.6%
Extraordinary income/ (expense) - -   504 -  
Profit after tax/(loss) 210 233 11.1% 1,386 1,077 -22.3%
Net profit margin (%) 8.8% 8.2%   13.7% 8.8%  
No. of shares (m) 25.5 25.5   25.5 25.5  
Diluted earnings per share (Rs)*         42.2  
Price to earnings ratio (x)*         16.3  
* on a trailing 12-month basis

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 FY07?
Decent 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. The company recorded a decent 21% YoY growth during the year, which was largely led by the decorative business. The company stated that the growth in the industrial segment was relatively lower and the rise in cost could not be passed on to the consumer. However, in the decorative segment, since Kansai was able to undertake price increases to the tune of 5.2%, the company was able to record a strong growth in the overall topline.

Input costs impact margins: Operating margins witnessed pressure in FY07 and declined by 160 basis points. This was largely on account of rise in raw material costs (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 margins. Due to uncertainty on the crude price front, margins will remain under pressure going forward.

Cost break-up
(Rs m) 4QFY06 4QFY07 Change FY06 FY07 Change
Raw materials 1,392 1,842 32.3% 6,110 7,783 27.4%
% sales 58.7% 64.6%   60.5% 63.7%  
Staff cost 144 149 3.6% 559 596 6.5%
% sales 6.1% 5.2%   5.5% 4.9%  
Other expenses 503 500 -0.7% 1,856 2,130 14.8%
% sales 21.2% 17.5%   18.4% 17.4%  

'Extraordinary' effect: Bottomline during the fiscal fell by 22% YoY. However, this was on account of the extraordinary income of Rs 504 m that the company received in FY06 on the back of sale of investments in an associate company. Barring this effect, bottomline has grown by a decent 22% YoY, which is in tandem with the topline growth despite the fall in operating margins. This has been on the back of lower depreciation and tax expenses.

What to expect?
The stock currently trades at Rs 688, implying a price to earnings multiple of 16.3 times its trailing 12 month 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. We shall soon update our research report on the company.

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