Paints: A pleasant picture for now

Anup Menon

THE PAINTS industry was on the right track in the first half of 2000-01.

Except for ICI (India), the performance of most paint majors was fairly good. The stock market also took notice and the overall performance of the major players was stable, if not outstanding.

The improvement in the economy over the last year-and-a-half has led to more investments in housing and infrastructure leading to higher offtake of decorative paints. Similarly, the auto industry went through a good phase with increased offtake.

However, the question is whether the growth rates can be sustained. If we go by the data from economic research outfits, the broad economy is set to slow down. Though this will have a negative impact on the industry per se, it is not likely to be apparent in the performance of the industry this fiscal. The first two quarters of 2001-02 should give a much better perspective of the industry's long-term prospects.

Consolidation

The size of the organised paints industry is estimated at around Rs 3,000 crore. Over the last decade, the industry has been going through a consolidation, with the stronger companies pulling through the recessionary period. This has resulted in four players -- Asian Paints, Goodlass Nerolac, Berger Paints and ICI (India) -- cornering a sizeable chunk of the market.

These four players control over 70 per cent of the paints market. The stock market too has taken notice and trading interest in the industry has been largely centred around these companies. The future will see keen competition among these players. Hence, their performance can be considered a good proxy for the industry as a whole.

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Good earnings performance

Except ICI (India), the other three majors posted good growth rates in the first half of 2000-01. The turnover growth was also reasonably good during this period. For instance, on an average the sales growth for Asian Paints, Goodlass Nerolac and Berger Paints works out to around 17 per cent. In contrast, the turnover of ICI (India) declined by around 10 per cent.

In terms of operating profits, Goodlass leads the way with a 44 per cent improvement over the previous half. Berger Paints and Asian Paints follow, with growth rates of 25 per cent and 21 per cent respectively. A look at the post-tax earnings indicates that Goodlass Nerolac recorded a 71 per cent growth over the previous half, followed by Berger Paints (25 per cent) and Asian Paints (24 per cent). For ICI (India), this was a 48 per cent fall in post-tax earnings.

The high post-tax earnings and the operating profits growth of Goodlass Nerolac can be partially attributed to a substantial rise in `other income'. Post-adjustment of other income, the growth rates of operating profits and post-tax earnings for Goodlass Nerolac work out to around 31 per cent and 52 per cent respectively -- more or less in line with expectations. Therefore, it is reasonable to expect that the stock market should have reacted favourably. But did it?

Stock market performance

The market has taken notice of the performance of the paints companies. For instance, except for ICI (India) most other stocks have remained more or less stable over the last year and a quarter. They may not have given sterling performances, but the wealth erosion was minimal.

The least risky option among the paint companies is probably Asian Paints. The company rewarded shareholders with a 3:5 bonus in fiscal 2000. A comparison of the stock prices between September 1999 and September 2000 shows that they appreciated by around 9 per cent to Rs 220. Berger Paints witnessed similar trends, with the stock gaining around 9 per cent in the same period. As expected, the poor financial performance affected the ICI (India) stock price. The stock lost around 66 per cent between September 1999 and September 2000.

Industry split

The paints industry can be broadly classified into the industrial and decorative paints segments. All the major players have interests in both segments, with varying degrees of market share and focus. For instance, in the decorative paints segment, Asian Paints is the market leader with a share of more than 40 per cent. Goodlass Nerolac is a distant second with around 14 per cent share in the market. The dominant position in the decorative paints market has helped Asian Paints maintain its position as the overall industry leader.

A strong market presence in the decoratives segment reduces the overall volatility of cash flows for the company. Its importance in the overall product mix is accentuated by the fact that Goodlass Nerolac, a leader in the industrial paints segment, has decided to seriously expand its presence in the decoratives segment. The high concentration on the industrial paints segment has led to increased volatility in the company's growth rates. Among the steps it took to improve its presence in the decorative paints segment is the tie-up with US-based Good Year Chemicals, which will help bring durability into Goodlass's decorative paints range.

But why increase the focus on the decorative paints segment? The growth rates in the decorative paints segment has been fairly stable at 5-7 per cent. This segment is expected to grow at 10 per cent in the near future. On a comparative basis, the growth rates in the decorative segment are more stable compared to its industrial counterpart. Why is this so?

More stable user profile

The answer lies in the consumer profile of decorative paints. The demand for decorative paints depends on the state of the economy, and especially on the construction activity. Goodlass Nerolac expects about 25 per cent of its decorative paints revenues to come from new housing projects. Construction activity picks up when the economy is going through a good phase. In addition to the country's large population base, the product caters to a much larger market compared to industrial paints. In the last couple of years, there has been increased thrust on construction activity, leading to improved offtake in paints. Apart from fresh construction activity, re-painting also relates positively to offtake. These factors lead to steadier growth rates.

Industrial Paints: Grey patches in growth prospects

Industrial paints are the other major segment in the industry. It finds application in the automotive, white goods and engineering segments. Goodlass Nerolac is the market leader in the segment with a market share of around 43 per cent. The automotive sector, which accounts for around 35 per cent of the overall industrial paints offtake, is a major consumers. The other 65 per cent of the revenues is derived from the general engineering and white goods sectors, among others.

The industrial paints growth rate has been much higher than that of the decoratives segment. In the past, the segment has grown at around 18 per cent. However, given its customer profile, the volatility in earnings is likely to be higher. Over the last three months the automobile sector has been slowing down. This could negatively impact the performance of the companies, especially that of Goodlass Nerolac, which derives around 60 per cent of its industrial paints revenues from the automotive industry.

Sectors such as general engineering and white goods depend on the economy's performance. The most recent estimates of GDP growth rates indicate a possible slowdown. This is likely to affect companies deriving a substantial chunk of their revenues from industrial paints. Given the current economic scenario, the near-term growth prospects from the industrial paints segment may not be all that impressive.

In this backdrop, the performance of the companies in the paints business would also depend on their ability to optimise the product mix. On the one hand is the industrial paints sector, where growth prospects are much higher and accompanied by volatility, and on the other hand is the decoratives segment, which is likely grow at a steady pace. In this case, the companies would have to try and work out an optimal product mix to maximise their profits.