ADD on Kansai Nerolac - Joined at the hip with Auto - HDFC Securities

Mr. Varun Lohchab, Head Institutional Research & Mr. Jay Gandhi, Institutional Research Analyst, HDFC Securities

Kansai Nerolac (KNPL; #1/#3 in Industrial/Decorative Paints) remains joined at the hip with Auto OEMs, which are likely to see their 2nd straight year of 16-18% volume declines (given Auto slowdown/COVID-19). Meanwhile, it has been beefing up its relatively less cyclical non-auto industrial portfolio. In Decorative, KNPL has outpaced bigger rivals over FY15-19, given its aggressive marketing & distribution push. This trend, however, is unlikely to continue over FY20-23 as KNPL's predisposition would likely be to safeguard margins/restrict A&P spend amidst the demand destruction & until Auto recovery is in sight. We build in Rev/EBITDA/PAT CAGR of 6/9/8% over FY20-23E and initiate coverage on the stock with an ADD recommendation & DCF-based TP of Rs. 500/sh (implying 44x Sep-22 P/E, 12% discount to APNT).

Alpha hinges on Auto recovery pace, thrust on reducing cyclicality: KNPL's high exposure (HSIE:25-28% of sales) to Auto OEMs, which are likely to see their 2nd straight year of 16-18% volume declines will translate into deeper topline cuts (vs APNT/BRGR) in FY21. Meanwhile, KNPL has been subtly pivoting towards relatively less cyclical industrial portfolio such as Auto-refinish, powder, coil, and protective coating). We build in a modest 3.6% CAGR for its industrial business over FY20-23E.

Decorative salience increasing, albeit volumes to marginally lag Top 2: KNPL outpaced APNT/BRGR in decorative segment over FY15-19, given its aggression in both marketing (A&P spends clocked a 23% CAGR vs APNT/BRGR's -2/-5% CAGR over FY15-18) and distribution (5-year active dealers CAGR estimated at 13%+ CAGR). This outperformance is unlikely to repeat itself over FY20-23 as KNPL's predisposition would likely be to safeguard margins from the Auto onslaught by restricting A&P spends. Ergo, we expect KNPL's decorative volumes to marginally lag Top 2 and build in decorative revenue CAGR of 7% over FY20-23E.

Well-covered to play the volume game, margins to improve over FY20-23: Even if overall volumes clock 9% CAGR over FY20-24, we estimate KNPL to hit a capacity utilisation of ~80% by FY24. Hence, KNPL seems well-covered to play the volume game. While demand shock-led benign raw material costs/high GMs are likely to mean-revert, the reversion for KNPL is likely to be less steep vs peers, given the increasing decorative salience. Thus, we build in a 120bp EBITDAM improvement to 16.4% over FY20-23E on the back of higher GMs and higher utilisation-led marginal cost savings.

Ranks low on fundamental anchors, ergo discount to peers: Higher industrial salience (lower GMs, higher capital intensity) warrants a valuation discount to Top 2. That said, increasing decorative salience will help RoICs improve from 10.8% to 14.5% over FY21-23. Swifter Auto recovery could offer higher upside. We initiate coverage on KNPL with an ADD Reco & DCF-based TP of Rs. 500/sh (implying 44x Sep-22 P/E).

Shares of KANSAI NEROLAC PAINTS LTD. was last trading in BSE at Rs.492.7 as compared to the previous close of Rs. 484.3. The total number of shares traded during the day was 2383 in over 250 trades.

The stock hit an intraday high of Rs. 493.55 and intraday low of 480. The net turnover during the day was Rs. 1157411.

Source : Equity Bulls

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