Paints: The decorative gloss is back

A. Srikanth

THE PAINT industry is getting back its sheen.

Most major companies posted higher revenues and earnings during 1999-2000 and continued to post good growth rates in the first quarter of this fiscal. But this is true largely of the strong which are getting stronger. The weak are getting weaker.

In 1993-94, the top 10 companies accounted for around 85 per cent of the total sales (in value terms) by the organised sector. Of this, the top four companies -- Asian Paints, Goodlass Nerolac, Berger Paints (including Rajdoot Paints which was merged last year) and ICI India -- accounted for around 66.50 per cent. But in 1998-99, the top 10 companies accounted for around 90.50 per cent, and the top four for a 76 per cent share. Surely, the industry is consolidating, in a different way though because there have been few mergers or acquisitions.

Just as the paints market is shrinking, so too are the choices for the investors. They had just four firms to pick from and to shuffle around in their portfolio. And even this has shrunk to just Asian Paints, Goodlass Nerolac and Berger Paints. As the market matures further and dominance increases, players would have to become more selective.

With very little improvement in rural penetration by most companies, much of the growth (14 per cent per annum over the last five years) has come from the urban market expansion. Greater competition, increased cost pressures and frequent disturbances in the demand-supply dynamics have resulted in the weaker companies losing market share to the stronger players.

This only goes to show that from the point of view of investments, the brightening prospects of the paints industry means most for the top four companies than for the others. The relative ranking of the four companies would, however, depend on their current market position and the growth strategies they have chalked out. In particular, their future profitability would depend critically upon the balance between decorative and industrial paints, risk management strategies, measures towards cost reduction, product range, access to technology, quality of service, globalisation, and strategies for acquisitions.

All the top four paint companies, with the exception of ICI India, posted good growth rates in revenues for the year 1999-2000. The average paints revenue growth rate of Asian Paints, Goodlass Nerolac and Berger Paints was around 18 per cent. However, in terms of post-tax earnings, Asian Paints posted the highest growth rate of 26.60 per cent followed by Goodlass Nerolac (17.45 per cent) and Berger (5.25 per cent). The profits of Asian Paints got a boost from the higher revenues (due to increased capacity) from the sale of phthalic anhydride, the realisation of which improved by around 24 per cent in 1999-2000. While ICI's turnover went up marginally by 4.20 per cent, the company posted a loss of Rs. 93.54 crores after adjusting for non-recurring transactions.

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Both Asian Paints and Goodlass Nerolac improved upon their operating profit margins. On the other hand, the margins of Berger Paints and ICI India declined. Overall, while Asian Paints comes out on top, Goodlass Nerolac improved significantly on its previous year's performance. The first quarter performance of these companies (including ICI India) was also good. While the revenue growth was 10-11 per cent, post-tax earnings grew, on an average, at 22 per cent.

Though there are some initial signs of a slowdown, industry sources expect companies to improve on the first quarter performance. The decline in the production of the automobile sector (which accounts for around 35 per cent of the total offtake of industrial paints) could impact the revenues of Goodlass Nerolac, the leader in this segment.

However, the sluggishness in general engineering (which accounts for the balance 65 per cent of the industrial paints offtake) could have an adverse impact on the offtake of all the companies. Since the market for general industrial paints is spread over a large number of segments, there is also the possibility of an evening out. However, given the fact that the general engineering paints segment is still in a nascent stage, the growth rates are not expected to be more than 7-8 per cent.

In this situation, the offtake of decorative paints could be the deciding factor for the medium-term prospects of the leading companies. The decorative paints segment has witnessed steadier growth rates compared to industrial paints. The recent decision by Goodlass Nerolac to refocus on decoratives is a pointer to this fact.

Asian Paints has a stranglehold of the decorative paints segment with a market share of 40 per cent. The company also has the largest reach in terms of the dealer network of 14,500 outlets, almost a-third more than that of Goodlass Nerolac, the second biggest company in the industry. While Berger Paints has a dealer network of around 5,500 outlets, ICI India has 4,500.

Efforts to reach out to the customer directly by installing colour vending machines has begun yielding results. Proof is Asian Paints witnessing much higher growth rates wherever these machines have been installed. On this count too Asian Paints is the leader, with 848 installations compared to Goodlass Nerolac's 550. Both Berger Paints and ICI India have fewer installations.

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While the installation of the colour vending machines has enhanced significantly the availability of shades, both Asian Paints and Goodlass Nerolac have been targetting actively the lower end of the product profile, looking for higher volumes. The fact that the companies are finding it increasingly difficult to pass on price increases on to the consumers is a pointer to the fact that decorative paints segment is becoming more of a commodity business. And in a commodity business, volumes matter more than value. Both the companies have offered low-value exterior paints as an better alternative to cement paints.

While these initiatives could help generate volumes, companies could face cost pressures with the firming up of raw material prices. Since raw materials (solvents, resins, pigments, and additives) account for around 50 per cent of the total cost of production, this could have a significant impact on margins and, consequently, on the bottomline. The depreciation of the rupee could aggravate matters.

In this situation, companies with better cost-management systems could come out winners. All the top four companies have initiated IT-related measures as part of their cost-reduction strategies. Asian Paints spent Rs. 12 crores (??) on IT initiatives in 1999-2000 and plans further investments of Rs. 28 crores this fiscal. It has put in place a supply-chain management system. It also plans to upgrade its communications infrastructure through VSATs, leased and ISDN lines across the country. The company's ERP solution from SAP is scheduled to be implemented in 2001. Goodlass Nerolac has allocated Rs. 40 crores for implementing an ERP programme and to integrate its 60-odd depots around the country.

Given Asian Paints' track record in cost reduction and its early-mover advantage, there is a greater chance of the company improving its operating profit margins compared to other companies. Though the proportion of raw materials for one rupee of sales has been coming down over the last five years, Asian Paints has managed to achieve the highest reduction, followed by ICI India and Goodlass Nerolac. For Asian Paints, this has come down from 52 per cent in 1994-95 to 45 per cent in 1998-99.

Asian Paints also has the advantage of having its own phthalic anhydride plant whose capacity is to be raised from 22,000 tonnes to 24,000 tonnes this fiscal. As the company sells nearly 65-70 per cent of the total production in the open market, the current firm trends in PAN prices could boost the operating profit margins. The company also has captive pentaerythritol and resins plants. Though Goodlass Nerolac also expects lot of savings from its IT initiatives to compensate for the increase in raw material costs, it could be some time before the company actually derives the benefits.

For a business which is increasingly becoming commoditised, it appears that the ad-spend would be one of the important differentiating factors which would enhance `brand recall'. And in the paints industry `brand recall' is more important than individual product recall. Here again, Asian Paints again has done the homework to enhance its `brand recall'. Its ad-spend has gone up from 11.25 per cent per unit of sales in 1994-95 to 14.85 per cent in 1998-99. This is followed by ICI India and Goodlass Nerolac.

Thus, overall, Asian Paints would come on top in the decorative business. There is, however, close competition between Goodlass Nerolac and Berger Paints. Berger Paints has increased its market share after its merger with Rajdoot Paints last year. Though it has a better reach through its manufacturing facilities in the four regions (Goodlass Nerolac's four plants are spread around in Maharashtra and UP), it capacities are far lower compared to that for Goodlass Nerolac. But with the recent refocus in decoratives to take advantage on its brand value, Goodlass Nerolac's hold on the decoratives market to take a leap in the future. The company's ad-spend is slated to double this fiscal.

With the recent increase in capacity from 57,500 tonnes to 1.01 lakh tonnes (with the commissioning of the Lote factory), Goodlass Nerolac would have no capacity constraints. This was one of the important factors which had earlier forced the company to concentrate less on decoratives. The company has also introduced quite a few new products at both the ends of the value spectrum. With the support of Kansai Paints, which now holds 64.52 per cent stake, Goodlass Nerolac plans to introduce new niche premium products. With its increased concentration on water-based emulsions and distempers, where the demand growth rates have been high, the company hopes to have a strong second place in the decorative paints market and at the same time increase the gap between itself and Berger Paints.

Though industrial paints growth rate could get affected by the slowdown in the automobile industry, it still would contribute significantly to the margins of all the companies. In this segment, Goodlass Nerolac has the leadership position with a 45 per cent share of the market. Apart from Kansai Paints, the company also has tie-ups with DuPont, Nihon Parkerising (for pre-treatment chemicals), Nihon Tokushu Toryo (for sealants and underbody coatings), Valspar Corporation (for powder coatings), Ameron Coatings (for high-performance coatings) and Drew Chemicals (for water treatments chemicals).

While Goodlass Nerolac, Berger Paints and ICI India have industrial paints as one of their divisions, Asian Paints has hived off its automotive coatings business into a joint-venture (JV) with PPG, US, the fourth largest company in the world. The JV has helped Asian Paints in many ways. While the main business would benefit from the revenue flows (through dividends) from the JV, it would at the same time help the company to shield the main business from the adverse effects of a fluctuating demand for automotive paints. Since a separate JV offers PPG the necessary protection for its technology, it would be more comfortable in introducing latest products.

Moreover, PPG's global acquisition of ICI's refinish and industrial coatings business would add further strength to the Asian Paints' JV with the company in India. It could at the same time have an adverse impact on ICI India's growth prospects in industrial paints. After the sale of its refinishes to PPG, ICI Plc has been a big loser, as it plunged from the top spot to number five position at the global level.

Berger Paints has presence in all the segments of industrial paints through its tie-ups with Herberts of Germany (which was taken over by DuPont last year) and Nippon Paints of Japan. But it is strongly placed in powder coatings where it has a tie-up with Teodur NV of Holland.

Thus, while Goodlass Nerolac has a leadership position in industrial paints, Asian Paints would come next in the relative ranking before Berger Paints. ICI India could suffer from the lack of access to the latest technology in industrial paints and so has to scout for technology partners.

While all the companies have trying to reduce costs, they have also been actively looking at the acquisitions and globalisation for improving growth. Asian Paints has the maximum global reach through its 10 international subsidiaries. During the previous fiscal, the company established subsidiaries in Oman and Mauritius, acquired controlling stake in the second largest paints company in Sri Lanka. After its recent acquisition of Jenson & Nicholson (Nepal), Berger Paints is looking at acquisitions in Sri Lanka. Again, both ICI India and Asian Paints are seriously looking at Shalimar Paints.

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Overall, from the point of view of investments and future prospects, Asian Paints appears to a very safe bet followed by Goodlass Nerolac. However, the Asian Paints stock currently ruling at Rs. 258 (post 3:5 bonus) and discounted at nearly 22 times appears fully priced. Investors can get into the stock at declines. On the other hand, there is lot of upside potential left in the Goodlass Nerolac stock which rules at Rs. 135 and discounted at just 9.90 times its recent annualised quarterly earnings. The Berger Paints stock has been quite steady at Rs. 94 discounted at around 9.90 times its quarterly earnings. However, the potential for a significant upside appears limited.