Markets
A fall in crude prices is usually good news for paint companies. Not this time.
Summary
- Excitement about potential benefits from falling crude prices may be premature as companies may be tempted to forego most of them to beat the competition and protect their market share.
A softening of crude oil prices is usually good news for paint companies. The industry’s margin prospects tend to get a leg-up as prices of key input chemicals titanium dioxide and crude-based monomers ease in tandem with oil prices, although the impact on earnings comes with a lag. The price of Brent crude hit a three-year low of $68 a barrel earlier this month and is now about $74 a barrel. Still, this time around, the picture is unlikely to be as rosy as it was earlier.
That’s because incumbent paint makers may be tempted to pass on most of the benefits of easing costs to beat the competition and protect their market share. Companies may choose to deploy crude-led additional cost savings for higher dealer discounts and/or reduce prices.
For instance, Asian Paints Ltd has hiked prices at a faster rate than crude oil and has retained the partial benefits of a correction in commodity prices, said ICICI Securities Ltd in a report dated 18 September. “In a normal scenario, we believe a similar trend would have followed in H2FY25-H1FY26, too, if crude oil prices remain lower. However, Asian Paints is likely to pass on most benefits now due to a steep increase in competitive pressures," added the report.
Also read: Kajaria Ceramics had a bumper start to the year. Now it needs demand to catch up
Asian Paints is the market leader in decorative paints and the industry’s trendsetter for pricing decisions. Interestingly, after lowering prices in recent quarters, paint companies raised prices by 1-2% in July. But it should be noted here that new entrant Grasim Industries’s Birla Opus has priced its decorative paint products lower than competitors. So incumbents may want to bridge this gap, capping sharp margin gains.
“Operating margins may only marginally benefit (from low crude oil prices), improving to 16-18% in FY25 (earlier estimates were 15-17%), as high rebates and discounts as well as higher marketing spend to enhance reach and build brands continues," said Poonam Upadhyay, director, CRISIL Ratings.
Market share over margins
Thus, the Street’s excitement about potential benefits from a fall in crude prices may be premature. Over the past month, shares of Asian Paints, Berger Paints India Ltd and Kansai Nerolac Paints Ltd have gained about 4-8%. “The market structure is much worse compared to previous cycles in the paints sector, and in fact lower input prices could perhaps make it easier for new competitors such as Grasim to sustain the competitive intensity in the sector," said a Kotak Institutional Equities report.
Also read: Realty stocks lose some ground as property boom takes a breather
Accordingly, investors may be disappointed if companies choose market share over margins. Further, the value-volume gap that the incumbents have been facing due to price cuts is expected to sustain at least in the near term. The September quarter (Q2) is typically slow for the construction and real estate industries, which hurts demand for discretionary items such as paints.
So, expectations from Q2FY25 earnings of paint companies are low. That said, management commentary on demand outlook will be important. Pricing actions to shore up sales in the upcoming festive season in Q3FY25 will be a litmus test for incumbents. It will also help investors gauge the sector’s earnings trajectory and changing competitive dynamics.
For now, a re-rating of paint stocks is unlikely. So far in 2024, Asian Paints and Kansai have fallen by 3.5% and 8.6%, respectively, while Berger has risen marginally by 2% and the benchmark Nifty50 index is up 19%. Sure, valuations of key paint stocks have come off recent peaks, but the overhang of elevated competitive intensity amid increased supply raises the risk of earnings downgrades and keeps paint stocks under pressure.
Also read: Can NTPC Green Energy IPO power NTPC?
