Paints Sector: Inflation and intensifying competition pose double threat, says ICICI Securities

Domestic brokerage firm ICICI Securities, in its latest report, underscores the potential inflationary impact looming over crude oil derivatives used in paints as geopolitical tensions drive a surge in crude oil prices. The report suggests a high likelihood of inflation extending to other crucial commodities like titanium dioxide (TiO2) and vinyl acetate monomer (VAM).

While Asian Paints has managed to expand its paint margins significantly over FY19–24 despite volatile crude oil prices, the current inflationary pressure poses a challenge, particularly amidst heightened competitive activity in the sector, said the brokerage. 

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The brokerage noted that this inflationary environment may erode both the pricing power of paint companies and their available budget for brand expenditures, including above-the-line (ATL) and below-the-line (BTL) marketing initiatives.

Considering that Birla Opus Paints (BOP) has priced its paints 17% lower than those of market-leading paint companies, ICICI Securities believes there is limited room for the incumbents to raise prices. Additionally, it anticipates pressure to introduce more competitive trade and consumer schemes.

With a ceiling on realisation and the uptick in commodity prices, the brokerage foresees weaker gross margins, potentially leading to reduced resources to counter heightened competitive activity. This could result in a reduction in the budget allocated for advertising expenditures and increased trade and consumer spending.

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ICICI Securities currently maintains a 'Hold' rating on Akzo Nobel and Indigo Paints with a price target of ₹2,520 and ₹1,380, respectively. Conversely, it has a 'Reduce' rating on Asian Paints and Berger Paints, with price targets of ₹2,600 and ₹520, respectively. The brokerage has an 'ADD' rating on Kansai Nerolac, with a target price of ₹290 per share.

Drawing parallels from HUL-P&G detergents battle

The brokerage draws parallels to the detergent market dynamics from 2003 to 2007, where pricing pressures compelled market leaders to navigate between margin protection and market share retention, akin to the current scenario in the paint industry.

Between 2003 and 2007, P&G, a challenger in the market, slashed the prices of its detergent brands, prompting HUL, the market leader, to follow suit. Faced with input inflation, HUL found itself at a crossroads, compelled to decide between safeguarding margins and maintaining market shares.

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When forced to choose between margins and market shares, HUL decided to sacrifice margins to protect market share. Consequently, its EBIT margins for soaps and detergents took a severe beating, declining from 29.6% in December 2003 to 15.6% in December 2006, the brokerage stated. 

HUL’s PAT declined 32% in CY04 YoY. It took three more years for HUL to recoup the absolute profits lost in CY03. The stock price also largely remained flat and underperformed the benchmark indices during this period, ICICI Securities noted. 

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Disclaimer: The views and recommendations given in this article are those of individual analysts. These do not represent the views of Mint. We advise investors to check with certified experts before taking any investment decisions.