Paint companies reeling from margin pressure

High crude oil prices, weak rupee may keep affecting earnings, profitability

Stocks of major paint companies — Asian Paints, Berger Paints and Kansai Nerolac (Nerolac) — fell 4.8-7.3 per cent on Tuesday, following weak September quarter (Q2) earnings of Asian Paints and Nerolac that were announced on Monday. The two companies posted 14-16 per cent year-on-year (YoY) drop in net profit, while Berger is expected to report Q2 numbers on similar lines on November 1.

Apart from the broader market correction, expectations of pressure on profitability — in light of rising crude oil prices and a weakening rupee — were already high in the Street. The same is reflecting in the stocks, which are down 23-41 per cent from their recent highs recorded in the past three months.

Yet, the stocks fell on Tuesday. The reason was that the Q2 numbers also point to near-term earnings pressure for the companies on the back of high input costs. Analysts expect the trend in margin weakness to continue in the ensuing quarters too.

“The high inflationary trajectory is unlikely to soften in the near term, amid high prices of crude oil and weak rupee. Though companies have taken price hikes after Q2, we believe this is not sufficient to offset the cost pressure,” says Naveen Kulkarni, head of research at Reliance Securities.

In fact Nerolac — which has more exposure to industrial paints — could see more pain, say analysts.

Prices of key raw materials were elevated in Q2 on the back of high crude oil prices and a weak rupee against the dollar.

As a result, gross margin of Asian Paints and Nerolac contracted 148 basis points to about 40 per cent and 492 basis points to 35.1 per cent, respectively, compared to the year-ago quarter.

What actually impeded the situation is the companies’ inability to fully pass on high input cost pressure to customers even as goods and services tax (GST) on paints was cut from 28 per cent to 18 per cent. Owing to the antiprofiteering law, paint companies could not hike prices to protect their margin profile.

Moreover, Asian Paints and Nerolac failed to restrict other operating expenses, leading to a contraction in earnings before interest, taxes, depreciation and amortisation (Ebitda) margin.

Among the few positives is that lower GST helped push up sales volumes in Q2, which drove the top line.

Asian Paints and Nerolac clocked 12 and 9 per cent volume growth in Q2, respectively, on expected lines.

The ongoing festive season, commissioning of new plants, and shifting of business from unorganised to organised players due to lower GST, should help push up volumes in coming quarters as well.

Unless companies manage to improve pricing or reduce costs, it will be difficult to protect margins. This could keep stock prices under pressure.