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Paints: Who is the best? - Views on News from Equitymaster
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Paints: Who is the best?
Dec 28, 2004

While it is a commonly known fact that the paint sector has been clocking around 8% to 9% growth per annum over the last five years, if one were to compare the financial performance of the the top rung companies in the sector, there is a marked difference. The second (Goodlass Nerolac) and the third largest (Berger Paints) paint manufacturers have caught up with the market leader, Asian Paints. The table below highlights the the progress of the top three paint majors on various parameters. The valuation ratios are calculated based on the high and low price of the respective year to show the the upgradation in valuation multiple over the last five years.

Parameter Goodlass Nerolac Asian Paints Berger Paints
  FY99 FY04 FY99 FY04 FY99 FY04
Net sales (CAGR - 5 years) 9.6% 13.1% 11.2%
EBDITA margin 10.1% 13.5% 13.9% 15.5% 8.7% 10.1%
Net margin 5.7% 7.6% 8.6% 8.4% 6.5% 6.6%
Return on equity 15.3% 21.9% 25.2% 27.8% 20.1% 23.5%
Return on assets 10.5% 11.1% 11.2% 14.1% 9.1% 13.0%
Working capital/sales 27.9% 12.7% 19.1% 0.8% 36.6% 19.0%
Price to earnings (x) 10.5 14.0 9.3 24.2 8.1 8.9
Price to book (x) 1.6 2.3 2.4 6.6 1.6 2.1
Source: Equitymaster research

As is evident, Goodlass has been the outperformer almost on all fronts in the last five years (barring the topline growth). The expansion in operating margins in the last five years for Goodlass stands at 340 basis points (3.4%) whereas the same stands at 1.6% for Asian Paints and 1.4% for Berger. This expansion in margins is due to two reasons. One, over the last five years, Goodlass has managed to improve its capacity utilisation level (29% in FY99 as compared to 65% in FY04), which has meant that the existing assets are being 'sweated' well. Secondly, the contribution from decorative paint segment has increased in the last five years (decorative command better margins as compared to automotive paints).

Regional limitations and lack of scale in operations (supply chain and sourcing of raw materials) has limited the margin expansion potential for Berger Paints. While Asian Paints has managed to improve operating margins over the last five years, it has to be remembered that the company also has presence in chemicals (penta and pthalic that are also raw mateials in the paint manufacturing process). Due to cyclical reasons, prices of penta has been depressed thus impacting overall margins.

Even at the net level, Goodlass has managed to improve margins by 1.9%, while Berger's margins are almost static. Though Asian Paints' margins seem to have declined at the first look, excluding the impact on extraordinary items in FY99 and in FY04, net margins have actually improved by 1.9%. As far as utilisation of cash is concerned, Asian Paints was the first to kick of the SAP implementation, which is reflected in the lower working capital to sales ratio. The company was also the pioneer in India as far as introducing the dealer tinting machines (Colour World), which reduced the inventory in the system. The graph below shows the cash conversion cycle trend i.e. how fast a company is able to rotate its working capital. Though Goodlass' conversion days are higher, it has to be remembered that the bargaining power in the automotive segment is lower and therefore, the company has to give higher credit days to customers.

As we go forward, we believe that Asian Paints will continue to outperform at the topline level (the faster growth in the last five years was on account of early into the exterior paint segment) due to its innovative skills i.e. the launch of the home solution services, early launch in the wood finishes (FY00) and increased focus on the industrial paint segment. Besides, the company made the next leap last year by acquiring Berger Paints in Singapore and SCIB in Egypt. We believe that the international operations will outperform domestic sales growth in the next five years.

As far as Goodlass is concerned, the strong foothold in the automotive paint segment with Maruti as a key customer will results in the company capturing the long-term growth potential arising from increased auto demand in the country. Also, as the contribution from decorative paint increases, there is a support to overall margins as well (even if automotive margins comes under pressure in the future). Having said that, given the fact that raw material cost accounts for 50% to 52% of sales in FY04, any further rise in crude prices or packaging material prices will impact margins. This is the major concern apart from high dependence on monsoons.

On a balanced scale, from a three to five year perspective, we believe that the Indian paint sector is likely to grow by 8% to 10% per annum with organised players gaining further market share from the current level. Our top picks from the sector will be Asian Paints (for its global acquisitions) and Goodlass Nerolac (for its domestic foothold in the automotive and industrial paint segments combined with possibility of valuation upgradation).

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