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Kansai: Decorative paints keep margins stable - Views on News from Equitymaster

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Kansai: Decorative paints keep margins stable
Nov 28, 2013

Kansai Nerolac announced the results for second quarter and first half of financial year 2013-2014 (1HFY14). The company has reported 12.2% YoY growth in sales while its net profits have grown by marginal 2.0% YoY. Here is our analysis of the results.

Performance summary
  • Top line increased by 15% YoY in 2QFY14 as against 12.2% YoY during the first half due to a slight pick-up in volume growth due to a slump in the auto industry.
  • Operating margins remain stable in 2QFY14 and decline by a marginal 0.3% from 12.5% in 1HFY13 to 12.2% in 1HFY14.
  • Due to significant fall in other income, the net profits grow by only 2% YoY in 1HFY14.

(Rs m) 2QFY13 2QFY14 Change 1HFY13 1HFY14 Change
Net sales 6,794 7,810 15.0% 14,002 15,708 12.2%
Other operating income 29 107 269.0% 56 128 128.6%
Expenditure 6,034 7,000 16.0% 12,303 13,902 13.0%
Operating profit (EBDITA) 789 917 16.2% 1,755 1,934 10.2%
Operating profit margin (%) 11.6% 11.6%   12.5% 12.2%  
Other income 35 14 -60.0% 102 51 -50.0%
Interest - -   - -  
Depreciation 161 161 0.0% 314 317 1.0%
Profit before tax 663 770 16.1% 1,543 1,668 8.1%
Tax 189 250 32.3% 436 539 23.6%
Effective tax rate (%) 29% 32%   28% 32%  
Profit after tax/(loss) 474 520 9.7% 1,107 1,129 2.0%
Net profit margin (%) 6.9% 6.6%   7.9% 7.1%  
No. of shares (m)         53.9  
Basic & Diluted earnings per share (Rs)*         39.4  
P/E ratio (x) *         26.8  
*Excludes inter-segment and unallocated expenditure

What has driven performance in 1HFY14?
  • Although 45% of the company's sales come from industrial paints, a growing exposure to decorative paints helped Kansai Nerolac remain in good stead during past 6 months. Net sales for Kansai increased 12.2% YoY in 1HFY14. The sales growth was moderate due to sluggishness in demand especially from the industrial segment. Slowdown in the auto sector due to high interest rate environment also impacted the overall topline growth to an extent. While the company has managed to pass on the input cost inflation to retail customers it has not been able to do so for the industrial segment. The second quarter of FY14 nevertheless was evidently better than the first one in terms of volume growth.

    Since the Society of Indian Automobile Manufacturers (SIAM) expects the automobile industry to grow by just 3-5% in FY14, the near term outlook for Kansai Nerolac, a dominant paint supplier to the auto industry, remains muted. Having said that the company expects double digit growth in value terms from the decorative paint segment.

  • Kansai Nerolac's operating margin stood at 12.2% in 1HFY14, compared to 12.5% in 1HFY13. Input cost for the company increased by 13% YoY in 1HFY14.

  • Despite fall in depreciation costs (with change in accounting method from written down value to straight line), the significant drop in other income led to bottomline growing by just 2% YoY in 1HFY14.
What to expect?
At the current price of Rs 1,060, the stock is trading at a price to earnings multiple of 15 times our estimated FY16 earnings. Sluggishness in auto demand due to high interest rates and slowdown in the real estate market is expected to keep the top line growth under check. Also while more capacity is expected to come on stream in FY14, one will have to keep a watch on utilization rates and operating margins.

As far as the margins are concerned, it may be noted that crude prices have corrected in the recent past. However, the depreciation of the rupee may keep margin upsides limited. Also, considering that the company has limited bargaining power in the industrial segment it remains to be seen whether it can extract any benefits out of the fall in raw material prices by holding on to the realizations. While the stock has corrected by more than 15% since we recommended Sell on it in June 2013, we would recommend investors to wait before buying it at more attractive valuations.

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