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Goodlass: Exit from expressway?
Dec 14, 2005

Introduction to results
The benefits of improved housing activity and strong growth in automobile sales is reflected in the topline growth of paint majors. Goodlass Nerolac, the second largest player, posted 16% YoY growth in sales in 1HFY06 and a similar increase in PBT. Barring lower other income and higher depreciation charges, the growth in net profit would have been on the higher side.

(Rs m) 2QFY05 2QFY06 Change 1HFY05 1HFY06 Change
Net sales 2,317 2,635 13.7% 4,236 4,901 15.7%
Expenditure 1,935 2,188 13.1% 3,571 4,085 14.4%
Operating profit (EBDITA) 383 447 16.8% 665 817 22.9%
EBDITA margin (%) 16.5% 17.0%   15.7% 16.7%  
Other income 97 81 -16.3% 103 105 2.6%
Interest 2 2 5.3% 3 3 3.0%
Depreciation 50 77 51.8% 96 139 45.5%
Profit before tax 428 450 5.2% 668 780 16.7%
Extraordinary income/(expense) - 2 - - 2 -
Tax 135 144 6.6% 221 259 17.3%
Profit after tax/(loss) 292 307 5.2% 447 522 16.7%
Net profit margin (%) 12.6% 11.7%   10.6% 10.7%  
No. of shares (m) 15.3 25.5   15.3 25.5  
Diluted earnings per share (Rs)* 45.8 48.2   35.1 40.9  
Price to earnings ratio (x)         18.2  
(* annualised)            

What is the company's business?
Goodlass 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 paint, Goodlass has being making a concerted effort to increase contribution from the decorative paint market over the years. It is estimated that the industrial-decorative contribution of the company at the current juncture is at 50:50. Kansai Paints, the Japanese paint major, holds 64.5% stake in the company. India ranks among the top three international markets for Kansai Paints, apart from Japan and the US (Goodlass contributes 11% of Kansai's net sales).

What has driven performance in 2QFY06?
Combo effect: If one considers the paint sector, the total market size was estimated at Rs 77 bn in FY05, of which organised sector accounted for Rs 54 bn (70% of the total market, which in our view is higher by around 5% to 7% as compared to five years back). The organised sector has been able to outpace the total industry growth, resulting in consolidation at the top. Considering the fact that the Indian paint sector has only four strong players, the industry leaders are riding on the housing and auto wave. While this is the macro growth driver, the other factors that have guided Goodlass' topline growth are its sheer dominance in the automotive paint sector and aggressiveness on the decoratives front. We believe that Goodlass has the potential to outpace industry growth in the long-term (the sector is expected to grow by 12% per annum).

Cost savings…
(Rs m) 2QFY05 2QFY06 Change 2HFY05 2HFY06 Change
Raw materials 1,412 1,585 12.3% 2,547 2,924 14.8%
% sales 60.9% 60.2%   60.1% 59.7%  
Staff cost 115 134 16.4% 240 260 8.3%
% sales 5.0% 5.1%   5.7% 5.3%  
Other expenses 408 469 14.9% 785 901 14.8%
% sales 17.6% 17.8%   18.5% 18.4%  

Operating leverage: Despite firm raw material price scenario in the global markets, raw material costs as a percentage of sales is lower in 2QFY06 and 1HFY06. We attribute the same to benefits from economies of scale (both in terms of capacity and relatively better bargaining power with suppliers). However, in our view, further savings from here on is likely to be limited and to that extent, we have a cautious view on the operating margins of the company going forward.

Asian Paints Vs Goodlass: As compared to the trend in FY05, the topline growth of Asian Paints and Goodlass Nerolac (the top two players by market share) are more or less in line. However, on the operating margins front, Goodlass has come a long way as compared to Asian Paints, which to its credit has the chemical division that has been a drag on the overall profitability. From here on, we believe that Asian Paints could outperform Goodlass at the topline level.

What to expect?
At Rs 745, the stock is trading at a price to earnings multiple of 14 times our estimated FY08 earnings. Recently, Goodlass announced a joint venture with Kansai Paints, its parent company, with Goodlass holding 55% stake. This joint venture entered into an agreement to acquire the paints business of Sime Coatings Sdn. Bhd., Malaysia, which is subject to the necessary approvals. The initial investments of the company in the joint venture would be upto Rs 300 m. It remains to be seen how this acquisition unfolds. If we keep this out of the equation, the upside is limited even from a two to three year perspective (without upgrading valuations, which we are not comfortable with).

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