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Berger: Too much in the price?
Jun 20, 2005

Performance Summary
Berger Paints, the third largest paint manufacturer in the organised segment, announced its FY05 results recently. On the back of new product launches and expansion of network, the topline grew by 23% YoY in FY05. While operating margins were marginally lower on a YoY basis, net profit grew by 18%. But for the extraordinary expenses, net profit actually grew by over 30% in FY05.

(Rs m) 4QFY04 4QFY05 Change FY04 FY05 Change
Net sales 1,658 2,037 22.9% 6,758 8,317 23.1%
Expenditure 1,483 1,807 21.8% 6,028 7,458 23.7%
Operating profit (EBDITA) 175 230 31.5% 730 859 17.7%
EBDITA margin (%) 10.6% 11.3% 10.8% 10.3%
Other income 27 25 -8.2% 52 54 3.7%
Interest 5 7 34.7% 28 36 30.0%
Depreciation 36 32 -10.0% 139 157 12.6%
Profit before tax 161 216 34.0% 615 720 17.1%
Extraordinary income/(expense) - (42) - (1) (57) -
Tax 41 38 -9.4% 174 142 -18.6%
Profit after tax/(loss) 120 136 14.0% 440 521 18.4%
Net profit margin (%) 7.2% 6.7% 6.5% 6.3%
No. of shares (m) 199.5 199.5 199.5 199.5
Diluted earnings per share (Rs) 2.9 3.5
Price to earnings ratio (x) 17.2

What is the company's business?
Berger Paints is the second largest paint manufacturer in India with an overall market share of 18.0% to 19.0% (Source: Company). It is India's second largest decorative paint manufacturer (11.1%) and also the third largest industrial paint manufacturer (13.9%). Over two-thirds of its turnover comes from decorative paints and the balance from industrial paints. The company benefits from a better product mix, brand popularity and has a strong distribution network. It has a strong presence in the northern and eastern markets.

What has driven performance in FY05?
Itís a balanced growth: Growth in the topline was led by encouraging performance by both industrial and decorative segments. Berger, as compared to its key competitors viz. Asian Paints and Goodlass Nerolac, is much stronger in the industrial paints segment. The company's topline growth was much higher than our expectations (in fact, this is the case with other paint majors as well). The growth in the topline should also be viewed with respect to the new capacity at Jammu, which was fully operational during the fiscal. Having said that, we believe that both the industrial and decorative paints divisions of the company have grown by over 15% in FY05.

Raw material pressure on margins: As has been the case during the course of the fiscal, raw material prices continued to trade firm (titanium dioxide prices prices have gone by almost 8% in FY05 whereas xylene is up 20% YoY). This is reflected in the raw material cost to sales increasing from 63% in FY04 to 66% in FY05. Though operating margins lower on a YoY basiss, if one considers trend in the last four quarter, there is stability. With petrochemical prices showing some signs of softness of late, we expect raw material related pressure to subside marginally in the second half of FY06 and to that extent, our operating margins are higher in FY06.

Cost break-upÖ
(Rs m) 4QFY04 4QFY05 Change FY04 FY05 Change
Raw materials 951 1,199 26.0% 4,274 5,474 28.1%
% sales 57.4% 58.8% 63.2% 65.8%
Salaries 99 114 14.2% 393 466 18.5%
% sales 6.0% 5.6% 5.8% 5.6%
Others 368 399 8.3% 1,438 1,695 17.9%
% sales 22.2% 19.6% 21.3% 20.4%
Change in stock 64 96 49.5% (77) (177) 129.8%
% sales 3.9% 4.7% -1.1% -2.1%

Tax rate falls: Net profit in FY05 has increased by 18% YoY. However, if one were to exclude the extraordinary expense, the growth in net profit is higher at over 31%. This is largely due to lower tax rate (effective tax rate in FY05 was at 20% as against 28% in FY04). During our interaction with the company, the management had indicated that tax benefits from the Jammu plant will reduce the overall tax rate.

Berger Vs Asian Paints Vs Goodlass: The graphs below highlight the comparative topline and operating margin performance of Berger against its key competitors. While Berger Paints compares favorably at the topline level, it is a laggard in margins. This is because of the various reasons viz. inadequate economies of scale, concentrated regional presence and relatively higher contribution from industrial paints segment that has a lower margin. But as we go forward, we believe that the company will be able to improve margins owing to better sourcing strategy (third-party purchases) and improved economies of scale.

What to expect?
The stock currently trades at Rs 60, implying a price to earnings multiple of 13.1 times our FY07 estimated earnings. The company declared a dividend of Rs 1.4 per share (2.3% dividend yield). We have assumed around 12% CAGR in the topline over the next three years with an upside to operating margins and to that extent, we believe that we are fairly comfortable with our assumptions. Even with these growth prospects however, the valuations are significantly higher and therefore, we recommend investors to sell the stock.

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