Paint companies fret about oil prices. But there are bigger worries ahead.

While rising crude oil prices are a concern, analysts believe this could be a temporary issue for domestic paint companies. In the medium to long term, the industry faces more pressing challenges, including increasing competition and stagnant profit margins.

“A change in market structure will guide paint stock prices in the long run while crude oil prices will dictate more sporadic movements (in the stocks), like what we saw last week," Ajay Thakur, research analyst at Anand Rathi Institutional Equities, told Mint.

“Paint stocks were overbought when oil prices went below $70 (per barrel) a couple of weeks back, just before the Israel-Iran conflict. Those who bought them tracking oil price movements are getting out now," Thakur said.

If Brent crude prices rise beyond $80 per barrel and sustain there for some time, paint stocks will fall further, he added.

On Tuesday, Brent crude was down almost 2% from previous close at $79.69 per barrel.

Paint companies depend on key raw materials like titanium dioxide and crude-based monomers. A rise in their input costs compresses profit margins when they are unable to pass on the same to consumers in the form of product price hikes.

Intense competition

Meanwhile, heightened competition has narrowed the scope of price increases, especially after the Birla group’s entry into the paint industry under the Birla Opus brand. This has kept overall profit margins in the paint industry stagnant at around 14-20% since the last few quarters.

“Paint has become more like the cement industry now," Dharmesh Kant, head of equity and derivative research at Chola Securities told Mint. “Companies are vying for market share rather than going after (profit) margins due to an increase in competition, in light of capacity addition by all players. It's a volume game from here on."

Nuvama Institutional Equities expects the Ebitda margins of Asian Paints and Berger Paints India to contract 70 basis points and 60 bps sequentially to 18.2% and 16.3%, respectively, in the quarter ended September. It expects Indigo Paints’ margins to increase only 20 bps sequentially for the same period, according to its consumer sector preview note for Q2FY25 earnings. Ebitda stands for earnings before interest, taxes, depreciation, and amortization.

Interestingly, after lowering prices in recent quarters, paint companies raised prices by 1-2% in July. Still, analysts expect a broader fall in their profitability in Q2, as companies have been fighting tooth and nail for market share amid subdued demand in the industry.

“Existing players have gone for higher advertisement spendings and deeper (dealer) discounts to protect their market shares. However, volume growth might be a tad slower (in Q2) than in Q1, at 6-8% (on-year growth)," Thakur said. “An erratic and heavy monsoon (season) dampened demand for exterior paint works. However, due to a slight price increase in July/August the revenue prints can be slightly better than Q1 which saw a price cut."

Overvaluation concerns

Analysts have tempered their expectations regarding Q2 earnings and expect further downside in paint stocks with some believing the sector might be overvalued right now.

“Current valuations (of paint manufacturers) are not supported by the growth in their profit or revenue. There has been a slowdown in profit growth due to margin pressure which makes the industry overvalued," Gaurav Garg, research analyst at brokerage firm Lemonn Markets Desk said. “The median PEG (price-earnings to growth ratio) of the industry is nearly 2.8 which is considered overvalued."

Despite such downside risks, industry experts expect paint stocks to consolidate around current levels in the medium to long run until further clarity on the industry’s market structure emerges.

“The competition will intensify in FY26-27 once some new entrant ramps up its production and is able to expand its operations meaningfully," Aniruddha Kekatpure, head of research at Edelweiss Mutual Fund told Mint. 

"The stock prices of the incumbent players will be determined by the level of competitive intensity, changes in the market share of new competitors and the resultant impact on margin profile of the incumbents."

But it will not be easy for new entrants to gain market share either, because the brand recall and product portfolio of top players like Asian Paints, Berger Paints, Kansai Nerolac Paints and Akzo Nobel India are much stronger and diversified than the newcomers. However, if the competition gets too heated and margins start to shrink, existing players might consider mergers or buy-outs to expand their market share, according to experts.

Also Read: A fall in crude prices is usually good news for paint companies. Not this time.

Recently, Asian Paints, the market leader, expressed interest in acquiring a part of Akzo Nobel India’s business after it informed exchanges that its Dutch parent Akzo Nobel NV is exploring joint venture and divestment options for its South Asian business.

“Investors should be cautious of how the change in market structure pans out in the paint industry. We have recommended "hold" positions on all the paint stocks right now," Thakur said.