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Berger Paints: Visit Note - Views on News from Equitymaster
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Berger Paints: Visit Note
Aug 9, 2005

We met with the company last week in Kolkata to understand the growth prospects of the paint industry over the next three years and where is Berger Paints placed with respect to its competitors to capitalize on the opportunity? Here are the key takeaways. What is the company’s business?
Berger Paints is the second largest paint manufacturer in India with an overall market share of 19.0% (Source: Company). It is India’s second largest decorative paint manufacturer (11.1% market share in volume terms) and also the third largest industrial paint manufacturer (13.9% market share in volume terms). Over two-thirds of its turnover comes from decorative paints and the balance from industrial paints. It 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. The company also has a plant in Pondicherry for meeting southern market demand. Berger caters to the automotive sector through its subsidiary Berger Automotive Coatings to OEMs like Escorts, Hero Honda, Bajaj, M&M and Fiat (meeting 20% to 80% of requirements on case-to-case basis). While topline has grown at a CAGR of 14.2% over the last six years, net profit has risen at similar rate and this topline performance is higher than the industry growth rates. But it has to be remembered that this growth was on account of acquisition of Rajdoot Paints in FY98-99.

FY05 – A roundup…
Compared to the industry growth of 8% to 9% in FY05, Berger’s topline grew at a faster pace of 13%. Margins were lower on account of higher raw material expenses. The decorative to industrial paint mix in FY05 was 65:35 with the market share in the decorative segment at 18% to 19% in FY05 in value terms. Market share in industrial paints was 20% to 25% in value. The total number of dealers stands at a strong 11,000 (as compared to 9,500 three years ago).

In the industrial paint segment, the company’s market share in road marking paints in FY05 was 30% to 35% (market size is estimated at Rs 2 bn to Rs 2.5 bn). In FY05, Berger was able to increase prices, but in line with competition (not being a price leader).

Why margins trail competition?
Despite similar product quality, comparable distribution network, Berger’s margins have trailed Asian Paints and Goodlass Nerolac historically for the following reasons:

  1. Relatively weaker presence in the western region as compared to competitors. Prices in this region are higher by around 5% to 10%, depending on product range.

  2. Lack of SAP, which the company believes is critical to keep raw material costs and working capital low. The company is moving towards implementing SAP across supply chain. Since there are more than 300 raw materials used in manufacturing, having an efficient supply-chain is critical to lower cost.

  3. More importantly, the company’s brand is not strong in the off-the-shelf segment as compared to Asian Paints and Goodlass Nerolac. The company plans to increase adspend and marketing in the next three years to make it more ‘visible’.

Key benefits going forward…

  1. Implementation of VAT will lower raw material costs to sales in FY06. It is a one-off benefit for FY06 due to the change in tax structure.

  2. The Jammu plant is fully operational and therefore, the effective tax rate will fall in FY06.

New initiative…

  1. Setting up of a plant in Gurgaon, which will manufacture plastic paint coatings for auto ancillary products. Capacity at 1,000 metric tonnes (MT) per month and scheduled to be completed by Mid-2007. Technical agreement with Nippon.

  2. This business is expected to grow by 15% to 20% per annum over the next three years, as it is a niche segment. The company hopes to ramp up capacity, depending on the demand scenario going forward.

Jammu plant – Current status…

  1. Total capacity of 12,000 MT for only liquid paints i.e. water-based and solvent-based, which are decorative paints. Manufacturing of water-based paints already started and solvent-based expected to commence soon.

  2. Powder coatings – capacity of 600 MT per month initially. Expected growth of 10% to 15% per annum. A niche high-value add segment within industrial paints. The key growth driver being the fact that more consumer durables manufacturers are shifting to powder-based coatings from normal paints for environmental reasons.

The basic idea is to sell insurance through its dealership network (like banc assurance). In our view, the rationale to invest money in this business is vague.

Estimated capital expenditure of Rs 250 m to 300 m every year. Gurgaon plant would require Rs 100 m to Rs 120 m.

What is our view?
The stock currently trades at Rs 58 implying a price to earnings multiple of 13.1 times our estimated FY08 earnings. We had recently recommended a ‘Sell’ on the stock at Rs 62 owing to two key reasons. Firstly, valuations at even 15 times FY07 expected earnings adequately reflect the medium-term growth prospects. Secondly, with crude prices trading firm, operating margins will come under pressure (though not in FY06 owing to VAT related benefits). In our view, at these valuations, Asian Paints and Goodlass are much better plays in the paint sector with a two to three year perspective.

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