YES Securities initiates coverage on India Paints sector

Top Picks - Asian Paints, Berger Paints

India Paints Sector: Bright prospects for large incumbents despite commodity and competition headwinds.

Notwithstanding multiple headwinds including the worst-ever commodity inflation, intensifying competition from multiple new entrants, and steep valuations, we remain structurally positive on the organized paint companies given the long runway for growth and strong competitive moats. We expect the strong growth trajectory to soar higher on the wings of increasing penetration, market share gains, new value-added product segments and services, and other forays in the home improvement space. While regulatory support-led housing and urbanization boom, shorter repainting cycles and shift from unorganized to organized market would be key volume drivers, some premiumization across categories and sharp price hikes (given the current inflation) would be key value drivers.

Premium valuation multiples are expected to sustain, especially for larger companies with strong pricing power to protect their margins and competitive edge to protect and gain market share. The big names enjoy an extensive dealer/depot and tinting machine network, strong brand equity, and a limited risk of disruption from peers and new entrants. Most of them have braved the pandemic with exceptional ability and agility, delivering enviable volume growth rates coupled with cost efficiency measures to mitigate the sharp dip in gross margins. While margins remain at risk in the near-term, we see the ongoing correction as a prudent opportunity to buy heavyweight names at relatively better entry levels. We expect the sector to significantly outperform the staples space and hence believe the valuation premium is justified. Our preferred pick is the industry leader Asian Paints (BUY, TP Rs 3,715) followed by Berger Paints (ADD, TP Rs 790). We would advise avoiding Indigo Paints (REDUCE, TP Rs 1,693). Among the key risks to our call are the likelihood of further cost inflation, and unhealthy competition from new entrants.

Asian Paints (BUY) - Aggressive strategy to fortify leadership position

CMP (Rs) 3,157, 12m Target (Rs) 3,715, Upside 17.7%

The indisputable market leader with a 42% share in decorative paints, Asian paints (APNT) has demonstrated volume growth of 11% CAGR over FY17-21, outperforming the industry through an aggressive distribution strategy. It is expected to further strengthen its leadership position through product innovation, cost efficiencies, capacity expansion, and better customer reach. APNT has consistently achieved good growth in revenues and margins leading to strong wealth creation in the last decade. We expect revenue growth to clock a CAGR of 22% along with EBITDA margins of 18%-21% for the period FY21-24, on the back of macroeconomic recovery post pandemic and company's strong foothold in the sector. We assume coverage on the stock with a BUY rating and a TP of Rs 3,715 valuing it at 60x FY24EPS.

Berger Paints (ADD) - Industry runner-up with bright prospects

CMP (Rs) 732, 12m Target (Rs) 790, Upside 7.9%

BRGR has a comprehensive portfolio across decorative and industrial segments. It has more than 20 product offerings across exterior and interior decorative paints segments, catering to all price paints across the spectrum. On the industrial application side, it has strong presence across industries. It is a clear No.2 player in decorative paints with a long growth headroom given its capacity, dealer and tinting network at ~40% of Asian Paints and revenue at 30%. BRGR revenues have grown at a steady 8% CAGR during FY15-21. Now with various initiatives and the thrust on R&D, premiumization and product innovation, we expect company's revenue to grow 19.0% CAGR from FY21-24E which would be significantly higher than the last 7-year period. BRGR RoE and RoCE is expected to reach 27.8% and 35.4% respectively in FY24 from current levels of 23.8% and 29.6% respectively on back of higher operating leverage and improving efficiencies. We estimate Revenue and EBITDA CAGR of 19% and 21%. We initiate coverage with a ADD rating and TP of Rs 790 valuing the stock at 55x FY24 EPS; at a marginal 10% discount to our multiple for Asian Paints.

Indigo Paints (REDUCE) - Fine track record, difficult journey ahead

CMP (Rs) 1,625, 12m Target (Rs) 1,693, Upside 4.2%

Indigo Paints has achieved rapid capacity expansion in both liquid paints and putty/cement paints. The liquid paints capacity increased from 46,608 KL in FY18 to 1,01,903 in FY20, while the Putty/Cement paints capacity increased from 48,944 MT in FY18 to 93,118 MT in FY21. The company now commands 2% market share in a highly challenging decorative paints industry. Indigo Paints is the fastest growing company in the paints industry, with promising prospects. It has delivered a revenue CAGR of 21% for the period of FY18-21. EBITDA margins have increased from 6.4% in FY18 to 16.9% in FY21. We expect revenue growth to clock a CAGR of 27% for the period FY21-24 and EBITDA margins to improve to 20% in FY24. While growth will be strong, we still initiate coverage with a REDUCE rating and a TP of Rs 1,693 based on 40x FY24E EPS, a discount to peers, to factor in a much lower scale and presence in large markets and impending rise in competitive intensity.

Source : Equity Bulls

Keywords

India PaintsSector YESSecurities InitiatingCoverage AsianPaints BergerPaints