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l Equity Research l

India | Consumer 19 January 2011

India Paint Sector


Sparkling performance

 We expect India’s paint sector to maintain its growth trajectory given favourable macroeconomic factors and
evolving consumer preferences.

 India’s paint industry is likely to report volume growth of 13-15%, the fastest in Asia Pacific, driven mainly by
repainting demand, change in consumer perception and resumption in the capex cycle.

 We expect incumbents to maintain their positions given high entry barriers – a tough to create direct-to-retail
distribution model, low consumer involvement making brand building difficult, negligible contract manufacturing
and high logistics costs that require plants near markets.

 We initiate coverage on Asian Paints (APL) with an OUTPERFORM rating given its faster-than-industry growth,
high margins, quality management and strong balance sheet. Given this, we believe its above-median forward P/E
of 24x is justified.

 We initiate coverage on Kansai Nerolac (KNPL) with an UNDERPERFORM rating as we believe its current
valuation – at a 25% premium to its five-year median P/E – is high given lack of pricing power and margin
sensitivity to input cost fluctuations. We value it at a 25% discount to APL.

BB Mkt cap Price PT Up/Down* Impl. PE EPS (Rs) EPS CAGR PE (x)
code Rec (US$bn) (Rs) (Rs) (%) FY12E 2012E 2013E FY10-13E (%) FY12E FY13E
Asian Paints APNT IN OP 5.8 2,726 3,077 14.1 28.0 109.8 132.8 18.6 24.8 20.5
Kansai Nerolac KNPL IN UP 1.1 900 852 -4.3 20.5 41.5 48.8 16.9 21.7 18.4

Note: OP = OUTPERFORM, UP = UNDERPERFORM, IL = IN-LINE; Prices as at 14 January 2011; *includes dividend yield
Source: Company, Bloomberg, Standard Chartered Research estimates

Sanjay Singh Pratik Biyani


sanjay.singh@sc.com pratik.biyani@sc.com
+91 22 6755 9898 +91 22 6755 9851

Important disclosures can be found in the Disclosures Appendix


All rights reserved. Standard Chartered Bank 2011 http://research.standardchartered.com
THIS REPORT MAY NOT BE DISTRIBUTED INTO THE UNITED STATES
India Paint Sector l 19 January 2011

Contents

Investment summary 3
Stock summary & valuation 4
A structural growth story 7
Decorative paints to grow faster 8
Uptrading in decoratives happening at a fast pace 10
Growth in Industrial paints steady 11

Industry structure − A cosy oligopoly 13


Distribution − Highly challenging as compared to FMCG 14
Brand building relatively more difficult vis-à-vis FMCG 14
Manufacturing – Key barrier, unlike most FMCG categories 16
Different entry different barriers for industrial paints 16

Margins – Steady and improving 17


Volatile raw material costs, but not a major concern 17
Any demand slowdown in a scenario of sharp capacity expansion can hurt margins 18

Annexure − Comparison with international peers 19


Company updates
Asian Paints 22
Kansai Nerolac 35

l Equity Research l 2
India Paint Sector l 19 January 2011

Investment summary
We expect India’s paint sector to maintain its growth trajectory given favourable
macroeconomic factors and evolving consumer preferences. We initiate on Asian Paints
(APL) with an OUTPERFORM rating given its faster-than-industry growth, high margins,
quality management and strong balance sheet. Given this, we believe its above median
forward P/E of 24x is justified. We initiate on Kansai Nerolac (KNPL) with an
UNDERPERFORM rating as we believe its current valuation – at a 25% premium to its five-
year median P/E – is expensive given lack of pricing power and margin sensitivity to input
cost fluctuations.

A structural growth story – India’s paint industry has reported consistent growth over FY05-10
− volume and revenue CAGRs of 13.6% and 17.8%, respectively. Given volume growth is
typically 1.5-2.0x GDP growth and our economist forecasts GDP growth of 8-9% in the medium
term, we expect the paint industry to maintain volume growth of 13-15%. The industry growth
drivers would likely be:

 Repainting demand fuelled by the real estate boom over the past few years

 Changing consumer preferences, from pure aesthetics to value added features

 Resumption in the capex cycle raising demand for industrial paints

High entry barriers favour incumbents – Unlike in the FMCG sector, where many new entrants
(eg, Perfetti, L’Oreal) have been successful, there is not even one such instance in the paint
industry. This is because of the high entry barriers – a tough to create direct-to-retail distribution
channel, low consumer involvement making brand building difficult, negligible contract
manufacturing and high logistics costs implying plants need be close to markets. In addition, with
APL commanding above 50% market share without making ‘abnormal’ margins makes it the price
setter and reduces the relative pricing power of competitors.

Margins steady and improving – Being an oligopolistic industry, margins have been resilient in
the past, but suffered in FY09 due to the increase in crude prices and demand slowdown.
Nevertheless, softening input prices in FY10 and sharp demand recovery saw margins not just
recover but rise to higher-than-historical levels. In 1H FY11, the industry has maintained margins
at these levels despite the sharp rise in input costs. Going forward, we expect margins to remain
steady or improve as up trading happens at a faster pace. In addition, strong volume growth is
likely to lead to operating leverage. However, note that the industry is in capacity expansion
mode and any demand slow down could hurt margins.

Paint companies have consistently outperformed the broader market – All the paints
companies have benefited from the strong fundamental growth in the sector and have
significantly outperformed the Sensex in the past 10 years.

Fig 1 – Paint companies have outperformed the broader market in the past 10 years
Asian Paints Kansai Nerolac Berger Paints BSE Sensex
10-yr volume CAGR (FY00-10) 14.1 11.1 12.6 -
10-yr sales CAGR (FY00-10) 16.7 12.2 14.7 -
10-yr PAT CAGR (FY00-10) 17.7 14.5 14.1 -
5-yr stock return CAGR w/o dividend 36.0 17.3 16.7 15.0
10-yr stock return CAGR w/o dividend 31.5 37.0 29.4 16.7
Source: Bloomberg

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India Paint Sector l 19 January 2011

Stock summary and valuation


APL is our preferred pick (OUTPERFORM; Price target: Rs3,077)
 APL is best-placed to ride on the structural growth of the paints sector in India. We expect its
market leadership, comprehensive product portfolio, nation-wide dealer network and
continuous launch of innovative products/services to support higher-than-industry growth. We
estimate 17.8% consolidated sales CAGR over FY10-13E.

 Supported by the rapid shift to premium products and strong operating leverage, we expect
APL to maintain higher-than-historical margins in the medium term, leading to strong
consolidated EPS CAGR of 18.6% over FY10-13E.

 At FY12E P/E of 24.8x, APL trades at a premium of 27% to its historical five-year median,
which we feel is rational especially given the sharp improvement in return ratios (RoE has
improved from 32.1% in FY05 to 52.5% in FY10). We initiate coverage with an
OUTPERFORM rating and price target of Rs3,077 (valuing it at a forward P/E of 24x).

 We note that as per our Standard Chartered Category Attractiveness model (Refer to our India
Consumer Sector report), decorative paints stands among the top-5 categories (when
weighed against top-25 FMCG categories) indicating high growth and stable profitability even
when compared with FMCG categories. In our relative valuation model, APL rates as the third
best company in our consumer universe on the back of high growth, sustainable margins,
good RoE and dividend payout. Hence, it deserves to trade in line with peers like ITC & HUL
and thus we value it at forward P/E of 24x.

Fig 2 – APL: P/E bands


3,500 32x
3,000 28x
2,500 24x
20x
2,000
Rs

16x
1,500
1,000
500
0
Mar-06

Mar-07
Apr-05

Aug-07

Aug-08

Aug-09

Jan-10

Jul-10

Jan-11
Sep-05

Sep-06

Feb-08

Feb-09

Source: Company data, Bloomberg, Standard Chartered Research

Fig 3 – APL: One-year forward P/E chart


35
30
25
PE (x)

20
15
10
5
May-07

May-08

May-09
Nov-07

Nov-08
Apr-05

Apr-06

Jun-10
Oct-05

Oct-06

Dec-09

Dec-10

One year forward P/E Median P/E


Source: Company data, Standard Chartered Research

l Equity Research l 4
India Paint Sector l 19 January 2011

Fig 4 – APL: Premium over Sensex


100

80
60

% 40

20

-20

May-07

May-08

May-09
Nov-07

Nov-08
Apr-05

Apr-06

Jun-10
Oct-05

Oct-06

Dec-09

Dec-10
Premium to sensex Five-year median
Source: Company data, Standard Chartered Research

KNPL − Valuations expensive (UNDERPERFORM; Price target: Rs852)


 Strong growth in auto sales enabled KNPL to post over 20% volume growth in the past 18
months; we expect FY11E volume growth to be equally strong at 20%. Nevertheless, we
expect volume growth to slow to 14.5% in FY12 and FY13E, due to a high base and likely
moderation in auto sales. We estimate KNPL would post 18.2% sales CAGR over FY10-13E.

 KNPL has delivered stable EBITDA margins at ~14-15% in FY04-08 except in FY09, when it
declined to 11.5% due to a rapid increase in crude prices and a demand slowdown. We
expect KNPL to maintain EBITDA margin at ~15% over FY11-13E, however, note that
margins are vulnerable to any sharp increase in input prices or a demand slowdown. Our EPS
CAGR estimate over FY10-13E is 16.9%.

 We value KNPL at a forward P/E of 18x, a discount of 25% to APL’s target multiple, compared
with its 18% five-year median discount to APL due to growth moderation. At FY12 P/E of
21.7x, valuations are dear, and hence we initiate with UNDERPERFORM and price target of
Rs852.

Fig 5 – KNPL: P/E bands


1,200
28x
1,000 24x
800 20x
Rs

16x
600
12x
400

200

0
Mar-06

Mar-07
Apr-05

Aug-07

Aug-08

Aug-09

Jan-10

Jul-10

Jan-11
Sep-05

Sep-06

Feb-08

Feb-09

Source: Company data, Bloomberg, Standard Chartered Research

l Equity Research l 5
India Paint Sector l 19 January 2011

Fig 6 – KNPL: One-year forward P/E chart


30

25

20
PE (x)
15

10

May-07

May-08

May-09
Nov-07

Nov-08
Apr-05

Apr-06

Jun-10
Oct-05

Oct-06

Dec-09

Dec-10
One year forward P/E Median P/E
Source: Company data, Standard Chartered Research

Fig 7 – KNPL: Discount to Asian Paints


60

40

20
%

-20

-40
May-07

May-08

May-09
Nov-07

Nov-08
Apr-05

Apr-06

Jun-10
Oct-05

Oct-06

Dec-09

Dec-10
Discount to APL Five-year median
Source: Company data, Standard Chartered Research

Risks
 Paint demand is highly correlated to economic growth; hence a slowdown from current levels
of GDP growth could be detrimental to the sector. In addition, companies’ plans to raise
capacity could create supply-side pressure and impact margins.

 Deferral or delays from government/ private companies in infrastructure capex could reduce
uptake for industrial coatings.

 In the near-term, possible withdrawal of excise stimulus and continued increase in raw
material costs will make it difficult for paint companies to transfer the entire increase to
consumers immediately, as they have already taken ~10-11% price hike since May ’10. Hence,
margins might be impacted.

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India Paint Sector l 19 January 2011

A structural growth story


India is the fastest India’s strong economic growth has propelled the paint industry to double-digit growth over the
growing paint market past few years and has made it Asia Pacific’s fastest growing paint market. India is also the
in Asia Pacific second largest coatings market in Asia-Pacific ex-Japan (16% share), behind leader China.
Despite fast growth, India’s per capita paint consumption is still abysmally low at 1.5kg/year
compared with 4.5kg and 7.0kg for Asia Pacific and the World, respectively.

Fig 8 – Paints growth in various countries Fig 9 – Per capita paints consumption

25 25

kg consumed per person


20 20
CAGR 04-08 (%)

15
15
10
10
5
5
0 1.5
0
-5

Malaysia
Japan

Australia

Indonesia

India
Vietnam
Korea

China

Thailand
India

Indonesia

Malaysia

Japan
Vietnam
China

Thailand

Korea

Australia

Avg. Asia Pacific Avg. World

Source: PPG Presentation 2009, Standard Chartered Research Source: PPG Presentation 2009, Standard Chartered Research

Paint volume growth India’s paint industry size is estimated to be Rs190bn (~2m kilolitre by volume), nearly double the
likely to be 13-15% size of the largest FMCG category (at Rs113bn, biscuits is the largest FMCG category). Despite
over FY11-13E the large size, the paint industry has posted strong sales CAGR of 17.8% over FY05-10. Volume
growth of the top-five organised players stood at 13.6% during the same period. There is a high
correlation between GDP growth and paint volume growth – paint volume has increased 1.6x (on
an average) real GDP growth. Given estimated GDP growth of 8.5-9.0% over FY11E-13E, we
expect industry volume to post CAGR of 13-15% over the same period. This makes paints one of
the fastest-growing categories, even when compared with other large high-growth FMCG
categories. In addition, India’s low per-capita consumption compared with Asian peers implies
ample scope for growth and, hence, this robust volume increase is structural in nature.

Fig 10 – Paints market size by value Fig 11 – Volume growth 1.5-2x GDP growth

200 18
180 16
14
160 12
CAGR 04-10: 17.8%
140 10
%

8
Rs bn

120
6
100 4
80 2
0
60
FY03
FY04

FY05

FY06
FY07
FY08

FY09
FY10

FY11E

FY12E
FY13E

40
FY05

FY06

FY07

FY08

FY09

FY10

Real GDP growth Paint volume growth

Source: Company data, Standard Chartered Research estimates


Source: Industry, Asian Paints Annual Reports
Note: Total volume growth of top-five paint companies in organised
sector

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India Paint Sector l 19 January 2011

Fig 12 – Growth in paints versus top 10 FMCG categories in the past five years
Paint category 40 35
33

CAGR FY05-10 (%)


growing faster than
30
many FMCG 24 23
20 22 21
categories 18 18
20 15 15
14 14 14 14 12 11
9
10 5
4 4
0
0
Namkins

Packaged
Hair Oils
Edible

Detergent
Biscuits

Creams

Paints

Pastes

Soaps
Washing

Toilet
Tooth
Powder
Oils

Skin

cakes

Tea
Value Volume
Source: Industry, Company data, Standard Chartered Research

Share of unorganised According to the India Paints Association (IPA), ~65% of the paint market is organised. The
players to decline organised market is highly concentrated and a classic example of an oligopoly, where entry
further from the barriers are high and the ‘top-5’ players capture most of the market, while the unorganised
current 35% market is highly fragmented with over 2,000 players. While organised players have a nationwide
manufacturing presence, their unorganised peers are mainly regional and deal in low-value
products. Introduction of VAT, decline in excise duty and preference for better quality products
have resulted in slower growth for the unorganised players, resulting in increasing share for their
organised counterparts. Introduction of goods and service tax (GST), high growth in emulsion and
premium products, volatility in raw material prices and increasing brand awareness should result
in a further decrease in the share of unorganised players.

Decorative paints to grow faster


The paint market can be divided into two broad product segments – decorative and industrial.
Unlike in most developed countries, where the decorative paints to industrial paints ratio is 50:50,
in India decorative paints form the bulk of the market, both in value and volume terms.

Fig 13 – Product segmentation – Decorative paints form the bulk of the market

Industrial Industrial
33% 24%

Decorative
67%
Decorative
76%

Source: Industry data, Standard Chartered Research

Repainting accounts Demand for decorative paints is derived from two sources – repainting and new construction.
for ~70% of Repainting accounts for ~70% of demand, while the remaining is from new civil construction with
decoratives demand a lag of 12-18 months between construction and painting.

We expect the paint industry to register 13-15% volume CAGR through FY11-13E, with
decorative paints growing at a higher rate than industrial paints. Decorative paints are set for
higher growth, given in-place demand drivers, which are 1) robust economic growth resulting in
higher disposable income, 2) real estate boom in the past few years, translating into increase in
demand for repainting, 3) continued growth in real estate, 4) launch of ‘affordable housing’, 5)
change in perception towards painting, 6) shift in demographic profile resulting in increase in
number of households and 7) various innovations by large players. In addition, apart from overall
volume growth, we expect significant up-trading – from distemper to interior emulsions, cement
paints to exterior emulsions and low-end emulsions to premium emulsions.

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India Paint Sector l 19 January 2011

Robust economic growth will continue to be the macro driver


Our economist estimates strong GDP growth of 8.5-9% over FY11-13E, driven by strong growth
in private consumption. Inflation, though likely to be high at 8.2% in FY11E, is likely to soften
gradually to 6.5% and 5.0% in FY12E and FY13E, respectively. Given the high correlation
between GDP and paint volume growth, we expect decorative paints to grow on the back of
strong economic momentum.

Real estate boom in the past few years, with focus on affordable housing
Real estate boom in Notwithstanding temporary hitches, the real estate sector is likely to play a significant role in the
the past few years country’s economic growth. Rapid urbanisation leading to strong demand for new residential units
should lead to strong (current space shortage is close to 19.4m units, largely in the middle and low-income groups) and
demand for re-
painting repainting of existing stock built in the housing boom of the past five years will increase usage of
decorative paints. To address the shortage, the government and the developers are focusing on
affordable housing projects. Availability of low ticket-size home loans at cheaper rates is also
increasing demand for affordable housing. This will increase consumption of low-cost emulsions
going forward.

Growth in IT and ITES and financial services will require additional commercial space. With
organised retail growing steadily and discussions on FDI relaxation taking place, it is estimated
that need for retail space will grow multi-fold. These factors will be direct demand boosters for the
paint industry.

Fig 14 – Tata’s affordable housing projects


Tata Housing’s Value Homes project in Boisar,
Mumbai was over subscribed 7x the flats
available for sale. In Dec’10 it launched
another value homes project in Vasind near
Mumbai.
It plans to invest Rs25bn in value homes
segment by 2011.
Source: Company data, Standard Chartered Research

Exterior emulsions Perception change from aesthetic to protective coating


fastest-growing sub- Perception about paints is changing rapidly – from being the most delayed decision in the
segment within household to being a core part of home décor, from being perceived as an aesthetic product to
decorative paints being aware about the protective nature of paints. This rapid change in perception is likely to help
drive demand in semi-urban households. This is probably one of the key reasons for the
significantly higher growth in tier 2 and 3 towns. Rise in advertising by paint companies for
protective exterior coatings with long durability has led to increasing consumption of exterior
emulsions and made it one the fastest growing paint categories.

Favourable demographic profile


Average household Increase in number of households owing to urbanisation and nuclearisation of Indian families is
size in urban area has driving demand for housing. Average household size in urban areas has decreased from 5.5 in
decreased from 5.5 in
1991 to 4.3 in 2007 1991 to 4.3 in 2007. Also, the proportion of the population in the earning age bracket (20–59
years) is expected to increase 200-300bps by 2015E. This will further boost housing demand.

Launch of various innovative offerings


Various paint companies are creating new avenues of demand for paints by launching innovative
products and services. They are not only changing perception toward paints but also making it
convenient for the consumers. Some examples of various innovative offerings are:

 Painting was considered to be a messy affair involving a lot of pre-planning. However, hassle-
free painting services with other colour selection-related help offered by players like APL and
Berger are increasingly making the painting experience convenient

 Introduction of ‘samplers’ – small-size, low-cost cans (Rs60/200ml) – by APL to help


consumers visualise the real look of the wall

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India Paint Sector l 19 January 2011

 Royale Play brand of APL is positioned as a lifestyle brand to be used in creating various
special effects & texture on walls

 Nerolac tying up with Walt Disney to target children by painting cartoon characters on the wall

 Launch of various metallic colour shades such as gold and silver by APL and Nerolac

 Launch of ‘Surprise your Spouse’ initiative by APL whereby the company helps to re-design a
particular wall in the house in a day.

Uptrading in decoratives happening at a fast pace


Emulsions In the past few years, water-based emulsions, comprising nearly one-third of the market, have
increasingly been increasingly substituting lower-end paints such as distempers, cement paints and enamels.
substituting lower-end
As per our interactions with industry sources, growth in emulsions has been significantly higher
paints
than that of other paints. High durability, better looking finish in a wider colour range, more
environmental-friendly and increasing affordability due to availability of economy emulsions at a
relatively lower cost have been driving the shift to emulsions.

Premium & luxury While the trend of higher growth in emulsions continue, our industry interactions point towards a
emulsions growing at new trend – higher-end emulsions like Royale & Apex Ultima have been growing at a much faster
a rapid pace pace than the overall category. This trend could be attributed to marketing attention being
focussed on premium emulsions. In the past five years, market leader Asian Paints has heavily
advertised its luxury emulsion brands Royale and Apex Ultima with minimal ad-campaigns for its
other brands. Also, improving affordability, increasing awareness about the protective nature of
paints and the fact that the cost of painting has not increased in proportion to the asset value
could have added to this trend. We note that material cost for painting an apartment of 1000 sq ft
carpet area with the most premium paint is ~Rs16,500, which works out to 0.1-0.5% of the asset
value. According to industry experts, premium products (>Rs200 per litre) contribute only ~20%
to industry volumes indicating that there is a significant scope for up trading.

Fig 15 – Decorative paints segmentation Fig 16 – Geographic segmentation

Wood Primers,
thinners East
finishes
11% 14%
Cement 5% West
paint Enamels 32%
4% 33%
Putty North
4% 26%
Distemper
13% Emulsions
(interior) South
Emulsions
17% 28%
(exterior)
14%

Source: Indian Small Scale Paints Association, IPA, Standard Source: Industry data, Standard Chartered Research
Chartered Research

Fig 17 – Price segmentation Fig 18 – Paint material costs


Material cost
Price range (Rs/lt) Vol. contribution
Paint type Rs/sqft
> 200 20%
100 - 200 40% Luxury Emulsion 3.7
<100 40% Premium Emulsion 2.5
Economy Emulsion 1.8
Distemper 1.6
Source: Industry data, Standard Chartered Research Source: Asian Paints, Standard Chartered Research

l Equity Research l 10
India Paint Sector l 19 January 2011

Growth in Industrial paints steady


The industrial paints segment is dominated by the organised sector owing to its high technology
orientation. In developed markets, industrial paints contribute 50% of the overall industry, but in
India, it forms one-third of the industry in terms of value and we don’t see it changing significantly
in the near term as we expect decorative growth to be marginally higher than industrial.

All industrial segments to contribute to growth


Automotive paints form ~45% of the industrial paints segment. Performance coatings, the next-
largest segment (25% of industrial paints segment) derives its demand from industrial plants and
machinery setups. Consumer durables and auto-ancillary products use powder coatings, where
as coil coatings are used in industrial construction, electrical equipments and interiors of trains &
buses.

As demand for industrial paints is mainly derived in nature, the segment’s growth is dependent on
various industries such as automobiles and consumer durables as well as infrastructure spending
on roads, power plants, marine development, etc. With robust growth in domestic sales of
automobiles, increasing auto exports and rising investments in infrastructure projects, demand for
industrial paints is expected to grow at a healthy pace.

Auto sector – On a high base, moderation in growth rates expected


Economic growth in the past few years has attracted global auto companies to Indian markets.
India has emerged as a favourite investment destination and is slowly transforming into an export
hub for global auto manufacturers. Volume in auto sector has revived handsomely post the poor
show due to global economic slowdown in FY09. Growth in domestic sales of passenger vehicles
(PVs) was 29.4% in FY10 and is expected to be an impressive ~25% in FY11E. This revival in
growth has resulted in strong performance of auto paint companies like Kansai Nerolac (auto
paints comprises ~35% of overall sales).

However, on a high base, growth rates for the automotive sector are expected to moderate. Our
auto analyst expects PVs to grow at 16% and 14% in FY12E and FY13E, respectively.

Fig 19 – Industrial paints segmentation Fig 20 – Growth in automobile-segments

40
Other
industrial 30
coatings 20
15%
10
Powder Auto
%

coatings paints 0
15% 45%
-10
-20
-30
FY06

FY07

FY08

FY09

FY10

FY11E

FY12E

FY13E

Protective
coatings
25% PV CV Two-wheeler

Source: Industry, Standard Chartered Research Source: SIAM, Standard Chartered Research estimates

Strong growth in consumer appliances to increase demand for powder coatings


Powder coatings, a technologically intensive segment, is amongst the fastest-growing industrial
coatings segments. On the back of increasing affordability, price rationalisation, easier financing
and wider distribution, we expect growth rates of white goods to be strong going forward.
Moreover, expected revival of capex cycle augurs well for powder coatings.

l Equity Research l 11
India Paint Sector l 19 January 2011

Fig 21 – Growth expected in white goods Fig 22 – Consumer durable ind. growth

50
Product Value growth
40
FY03-08 FY08-13E
TV 3 7-9 30

Refrigerator 8 9-11 20

%
Washing m/c 12 10-12 10
AC 16 14-16 0
-10
-20

Apr'05

Apr'06

Apr'07

Apr'08

Apr'09

Apr'10
Oct'05

Oct'06

Oct'07

Oct'08

Oct'09

Oct'10
Source: Industry, Standard Chartered Research Source: CSO, Standard Chartered Research

Significant investments in infrastructure projects


Other industrial paint segments such as performance coatings, coil and marine coatings are
expected to surge on the back of strong investment in infrastructure projects such as power, ports
and roads. The projected investment in the infrastructure sector is expected to double to US$1trn
over 2007-12 compared with US$514bn during 2002-07. All the sectors like ports, roads, railways
and airports are expected to witness significant investments.

l Equity Research l 12
India Paint Sector l 19 January 2011

Industry structure − A cosy oligopoly


Top five players have Decorative paints’ low technological requirement had historically attracted various small players
maintained market foraying into the segment. As per industry estimates, there are over 2,000 players in the
share despite entry of unorganised segment. Various international players such as Jotun, Nippon and Sherwin Williams
foreign players
have also entered the Indian market in the past few years. Despite this, APL has not only
maintained leadership position, but also gained market share; the other top-four players have
also largely maintained their share. No new player has been able to garner any scale mainly
owing to the high entry barriers in distribution, brand building and manufacturing. APL has been
able to improve its leadership position on account of its nationwide distribution network,
exhaustive product portfolio, and strong brand equity.

APL has established APL has established itself as a ‘price setter’ in the industry; hence, it has not only passed-on raw
itself as a ‘price setter’ material cost hikes to the consumer, but has also taken judicious price cuts when input costs
have reduced. Thus, despite sharp increase in input costs, industry margins have not only been
stable, but have also risen marginally. The margin improvement has been better for APL because
of the sharp improvement in its product mix (due to up trading as discussed earlier) and ability to
derive significant benefits from economies of scale. Also, APL has ensured that on a ‘like-to-like’
basis it does not make ‘abnormal’ margins; hence, other large players have not attempted to gain
market share via price cuts. Thus, the industry works as a cosy oligopoly.

Fig 23 – Market share of organised players (top-5)


Overall Decorative
Industrial
Akzo Shalimar
Akzo
Nobel 3.2% Others
Nobel
9.7 9.0%
10.0%
Kansai Shalimar
Kansai Nerolac 10.0%
Nerolac Asian 11.0% Kansai
18.1 Paints Nerolac
Asian Berger
51.7 48.0%
Paints 13.0%
Berger
59.0%
Berger 20.0%
16.8 Asian
Paints
20.0%

Source: Industry, Standard Chartered Research

Fig 24 – International players have not been able to gather momentum


Nippon Paints
Nippon, Asia’s largest coatings maker, entered India in 2006, commencing operations in the
South by investing Rs800m to build a manufacturing unit in Chennai. It has opened two new
plants and plans to invest another Rs2.5bn over the next three years to double capacity of
the Chennai plant. It is also looking for land to setup one more unit with an investment of
Rs1bn in North India. In the past four years, it has only been able to have 500 dealers with
presence in seven states and intends to have a pan-India presence by 2012.
Jotun India
Part of the Norway-based paints major, the Jotun Group set up shop in India in 2005 – It
invested Rs1.25bn to set up a manufacturing unit in Pune, with 50m litre capacity of wet paint
and 10,000te of powder coating. It currently has a small network of >175 dealers. It initially
planned to gain market share of 8% by ’10, but, with turnover of ~Rs2.5bn in CY08, this
seems unlikely.
Sherwin Williams
Sherwin Williams started operations in India by acquiring the paints unit of the Nitco Group
in ’06 for ~Rs2bn. It opened its first store in February ’09 in Bangalore. It also operates
through a network of 3,000 Nitco dealers. Since the acquisition, it has not been able to
significantly scale up its presence.
Source: Standard Chartered Research

l Equity Research l 13
India Paint Sector l 19 January 2011

Distribution − Highly challenging as compared to FMCG


Unlike FMCG, distribution is direct to retail
Paints distribution Unlike in the FMCG sector, the paint industry has no wholesale distributors who break bulk or
chain does not have help manage credit to retailers. Most FMCG companies do not give credit to wholesale
any wholesaler
distributors, even though the latter may give credit to retailers. However, in paints, the distribution
chain does not have any wholesale distributors, as the number of retailers, at ~ 40,000 is much
lower than the ~ 7 m FMCG stores. Hence, any company planning a pan-India presence needs to
directly deal with thousands of retailers and manage credit with them (on average, the industry
gives a credit of three weeks to retailers). Compared with this, any FMCG company has to
directly deal with only 500-1,500 distributors. Thus, it is probably easier to set up FMCG
distribution than distribution in paints.

Unlike FMCG, paint retailers are not inclined to introduce new products; hence,
distribution for a new paint company is difficult
Distribution in paints High consumer involvement in FMCG categories leads to consumers demanding for new brands/
extremely difficult products from retailers after being exposed to advertising for these brands/ products in the media.
Also, because of low space & capital requirement retailers are not hesitant to stock new FMCG
brands/ products. Provided there is sufficient brand pull, the presence of a passive distribution
network through third-party wholesale dealers enables distribution of FMCG products even if a
company is not able to create an active distribution network. However, in paints, despite
increased advertising spends by various companies to increase brand awareness, consumer
decisions of buying paints continues to be highly influenced by painters, contractors and
dealers/retailers signifying higher involvement of influencers. Also, paint being a bulky product
tends to occupy significant shelf space, thereby discouraging retailers to introduce new brands.
Thus, low consumer involvement and high retailer involvement and non-existence of third-party
wholesale channel makes distribution in paints extremely difficult.

Tinting machines required to sell emulsions act as significant barrier


Tinting machine Most large outlets that sell emulsion paints have tinting machines that are used to generate the
requires significant desired shade. However, tinting machines require significant space (25- 35 sq ft), thereby leading
space at the retail to lack of space for a retailer to keep more than 1-2 tinting machines. Thus, it is extremely difficult
outlet
for a new company to set up new tinting machines in existing outlets. This has become a
significant entry barrier.

Brand building relatively more difficult vis-à-vis FMCG


Brand building in FMCG entails differentiated positioning (Bingo! versus Lays, Fair & Handsome
versus Fair & Lovely), high spend on advertising and sampling, etc. However, in paints, traditional
avenues of brand building are not easily available. We believe that there is no significant
positioning difference between large paints players. Also, paint companies’ relationship with
painter associations and architects is critical in establishing a stronghold as the latter largely
influence paint usage. Hence, brand building is a much more complex and time-consuming
process.

l Equity Research l 14
India Paint Sector l 19 January 2011

Fig 25 – Why many new companies have been successful in establishing themselves in
FMCG but there has been no such success story in Paints?

In the past 10-15 years many new companies have been able to establish themselves firmly
in various FMCG categories. While distribution in FMCG is difficult, many companies have
been able to build a distribution network from scratch. This was possible mainly on the back
of launch of superior & differentiated brands/ products. For example, Perfetti entered India in
the ‘90’s and very quickly became the undisputed leader in the highly competitive
confectionary category – while it had no distribution to begin with, it achieved its leadership
status through unconventional advertising and superior products. Similarly, L’Oreal was
successful in achieving leadership position in the hair colour market and significant shares in
other categories through superior & differentiated brands/ products. While there are many
such success stories in FMCG, we do not find a parallel example in paints.

The key reason that describes this anomaly is the fact that while most FMCG categories tend
to have high consumer and low retailer involvement, decorative paints tend to have low
consumer and high retailer involvement. Due to high consumer involvement in FMCG,
consumers tend to seek superior/ differntiated offerings and lap up new brand/ product
offerings if they find it to be relevant (most recent examples being Fair & Handsome and
Bingo!). Low space and capital requirement backed by sufficent consumer demand makes
the retailer stock up new FMCG brand/ products, signifying low retailer involvement. In
contrast, consumer involvment is limited in decorative paints and mainly restricted to overall
cost the consumer is willing to incur and the corporate brand the consumer prefers while
significant influence is wielded by painters, contractors and dealers. Significant outlay of
space (due to many SKUs and need for tinting machine) and capital requirement makes
decorative paints a high involvement category for retailers and hence they are reluctant to
keep many brands of paints. Also, they tend to lose out on volume discounts offered by
companies, hence in most cases they tend to stock just one or two brands.

Lower consumer involvement makes it difficult for paint companies to come up with a
differentiated or ‘niche’ offering. However, we see this changing especially at the premium
end – this is also reflected in the advertising of companies where there has been a shift from
corporate advertising to specific premium brands (For example, while earlier most APL
advertising used to be on the ‘har ghar kuch kehta hai’ theme, the company is now focussing
on specific premium products like Royale and Apex Ultima).

Fig 26 – Consumer vs retail involvement of various FMCG categories


Consumer involvement

Auto
High

Personal care

Packaged food Consumer


Durables

Paints
Low

Homecare

Staples

Low High
Retailer involvement
Source: Standard Chartered Research

l Equity Research l 15
India Paint Sector l 19 January 2011

Manufacturing – Key barrier, unlike most FMCG categories


Requires manufacturing units in close vicinity to markets
Paints have high Paints have a high volume-to-value ratio and are thus expensive to transport, requiring a
volume-to-value ratio
manufacturing presence in close vicinity to markets – unlike in other FMCG categories such as
and requires
manufacturing near personal products and cigarettes, where the product can be manufactured in a few locations and
markets then distributed across the country. Hence, any new player planning a pan-India presence also
requires manufacturing presence across the country. This results in high initial capital outlay,
which acts as a natural barrier.

Unlike some FMCG manufacturing, outsourcing in paints is limited to low end


Some FMCG categories such as biscuits, alcohol and detergents outsource manufacturing.
Outsourcing is limited
only to low-end paints However, in paints, because of the high capex and technological access, outsourcing of product
manufacturing is limited to certain low-end paints. The top-four players purchased nearly 29% of
their total sales volumes; the rest of it was manufactured in-house. Most organised players have
installed their own manufacturing units to maintain product quality.

Fig 27 – Plant locations of major paint companies

Source: Company data;


Plants in Khandala (Asian Paints), Hosur (Kansai Nerolac), Hindupur (Berger) are expected to be commissioned in next 2-3yrs

Different entry different barriers for industrial paints


Entry barriers in industrial paints are completely different versus decorative paints. High
technology and customised requirements in industrial paints have made global tie ups important.
For example, Kansai Nerolac’s (KNPL) global tie up with Suzuki is an entry barrier for other
players. Also, in certain cases, the paint company has to work closely with major customers and,
replacing a long-term relationship could be major hindrance as it could disturb production. For
example, a large number of Kansai Nerolac’s engineers work closely with Maruti Suzuki.
Replacing such a large relationship can be challenging and acts as a barrier. However these high
entry barriers come at the cost of low bargaining power. Passing on increased cost pressures to
institutional customers becomes difficult in an inflationary environment but cost benefits in the
event of softening of input prices need to be passed on.
l Equity Research l 16
India Paint Sector l 19 January 2011

Margins – Steady and improving


Volatile raw material costs, but not a major concern
Industry raw material The paint industry is raw-material intensive (~60% of sales) and requires >300 constituents.
intensive (~60% of Nearly 45% of the raw material is linked to crude and, hence, is volatile in nature. Despite high
sales) material costs and volatile nature, paint companies have successfully transferred cost to
consumers in the past. According to our Paints RM Index, CAGR in input costs over FY05-10 has
been ~8.5%; however, paint companies have been able to manage stable EBITDA margins
during this period.

The margin correction in FY09 was not only due to the sharp rise in crude prices but also due to a
Margins higher than
historical combination of factors like sharp drop in demand, passing of excise benefits to inventory carried
by retailers, etc. With demand recovery and softening input prices, margins have not only
recovered but have also increased compared to historical levels mainly because 1) Strong
volume growth has led to economies of scale and 2) Uptrading has led to a better product mix.

Our Paints RM index The recession experienced in 2008-09 resulted in the closure of various titanium dioxide and
has increased 18% monomoer manufacturing units in Europe. Due to this global demand supply imbalance, prices
from Jan’10 to Nov’10 shot up and availability has become an issue. However, these capacities might come up again
once the situation in these global economies improve. Our Paints RM index has increased 18%
from Jan ’10 to Nov ’10. Strong pricing power has enabled the industry to pass on these costs to
consumers - the industry has hiked prices four times in a staggered manner by a cumulative
~11% in FY11 – this should enable the industry to maintain margins. We might witness another
round of price hikes in the next quarter on the back of rising crude prices and possibility of
withdrawal of stimulus package. Hence, while we are cautious, we are not overly concerned by
raw material inflation. However, we note that it would be difficult for the industry to pass on the
input cost increases to industrial consumers in general and automotive companies in particular.

Fig 28 – SCSI Paints RM Index Fig 29 – Industry EBITDA margins


180 20

17.1
170 18
14.5

14.5
14.2

160
14.0

14.0

16
13.7
13.1

13.2

150 14
11.8
140 12
130 10
%

120
8
110
6
100
4
90
2
80
0
Apr-04

Apr-05

Apr-06

Apr-07

Apr-08

Apr-09

Apr-10
Oct-04

Oct-05

Oct-06

Oct-07

Oct-08

Oct-09

Oct-10

FY01

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

Source: Industry data, Standard Chartered Research Source: Company data, Standard Chartered Research

l Equity Research l 17
India Paint Sector l 19 January 2011

Demand slowdown in current expansion mode can hurt margins

Significant ramp up in Capacities of the top four organised players have increased at a CAGR of 9% over FY05-10.
capacities of major However, strong demand in the sector has resulted in ambitious expansion plans for various paint
paint companies companies. As per announced plans, the capacity of the top four companies is expected to nearly
double in the next four years. This implies a capacity CAGR of ~20%. We believe if economic
growth is robust and resultant demand remains strong then this capacity can be absorbed easily.

A demand shock can However, any global shocks or slowdown in the Indian economy can create serious supply-side
create supply side pressure. In this event, companies will be more focussed on pushing volume rather than sitting
pressure on idle capacity or very poor utilisation. This can seriously impact margins for the industry.

Fig 30 – Manufacturing capacity of top-four paint companies

Manufacturing
capacity expected to 2,500
double in the next
three to four years 2,000
Thousand tonnes

1,500

1,000

500

0
FY05 FY06 FY07 FY08 FY09 FY10 FY13-14E
Source: Company data, Standard Chartered Research
Note: Capacity of top four paint companies including Asian Paints, Kansai Nerolac, Akzo Nobel India, Berger Paints

l Equity Research l 18
India Paint Sector l 19 January 2011

Annexure − Comparison with international peers


Fig 31 – Operational parameters and valuations of international paint companies
CAGR EBITDA margins
Mcap RoE (%) Div. P/E (x) EV/EBITDA (x)
(CY10-12E) (%)
yield
Name (US$m) Sales EBITDA EPS CY11E CY12E CY11E CY12E CY11E CY12E CY11E CY12E
(%)
Paint companies
Kansai Paint 2,701 5.3 6.4 7.5 13.0 13.1 8.2 8.3 1.3 14.7 13.6 6.4 6.0
Nippon Paint 2,067 3.2 1.8 10.4 10.8 10.6 10.5 10.3 1.2 11.5 10.3 8.0 7.9
Akzo Nobel 14,463 4.9 7.4 12.5 14.0 14.3 9.9 10.4 3.3 12.3 11.1 6.3 5.9
Sherwin Williams 9,096 6.8 11.9 15.9 12.5 13.2 33.1 38.6 1.8 16.5 14.3 10.0 8.9
Valspar 3,441 1.3 6.4 13.0 14.3 15.5 14.9 14.6 1.8 12.3 10.8 7.5 7.1
Average 4.3 6.8 11.9 12.9 13.4 15.3 16.4 1.9 13.5 12.0 7.6 7.2
Source: Bloomberg; Prices as of 13 January 2010
Kansai and Nippon has March YE, Valspar has October YE

l Equity Research l 19
India Paint Sector l 19 January 2011

l Equity Research l 20
India Paint Sector l 19 January 2011

Company Section

l Equity Research l 21
India Paint Sector l 19 January 2011

Asian Paints Limited (APL)


High margins here to stay; initiate with OUTPERFORM

 We initiate coverage on APL with an OUTPERFORM OUTPERFORM (initiating coverage)


rating and 12-month price target of Rs3,077. PRICE (as at 14 January 11) PRICE TARGET
 APL is well-placed to ride the structural growth in India’s
paint sector. We expect APL to post higher-than-industry Rs2,726 Rs3,077
growth with consolidated sales CAGR of 17.8% over Bloomberg code Reuters code
FY10-13E. APNT IN ASPN.BO
 Supported by rapid growth in premium products and
strong operating leverage, we expect APL to maintain Market cap 12 month range
higher-than historical margins in the medium term, Rs261,478m (US$5,811m) Rs1,761 - 2,977
leading to strong consolidated EPS CAGR of 18.6%
EPS est. change - - - -
over FY10-13E.
 Robust growth, higher margins and improved return
ratios are likely to keep APL’s valuations at a premium.
Higher-than-industry growth rate – We expect APL to not Year end: March 2010 2011E 2012E 2013E
Sales (Rs m) 66,045 75,679 90,032 107,889
only ride the structural growth in the paints category but also EBIT (Rs m) 12,139 13,700 16,292 19,671
post above industry growth mainly supported by 1) strong EBITDA (Rs m) 12,276 14,005 16,693 20,174
brand equity built in premium emulsions in the past couple Pretax profit (Rs m) 11,855 13,518 16,105 19,484
Earnings (Rs m) adjusted 7,642 8,813 10,533 12,738
of years coming into play and 2) unmatched distribution Diluted EPS (Rs ) adjusted 79.7 91.9 109.8 132.8
network in Tier 2 & 3 towns where growth is likely to remain Diluted EPS growth (%) adj. 92.8 15.3 19.5 20.9
DPS (Rs ) 27.0 35.1 45.9 56.2
high. We expect it to post robust standalone sales CAGR of DPS growth (%) 54.3 30.0 30.8 22.4
22.8% over FY10-13E. Note that management is planning EBITDA margin (%) 18.4 18.3 18.3 18.5
aggressive capacity expansion – doubling capacity in the EBIT margin (%) 18.2 17.9 17.9 18.1
Net margin (%) 11.3 11.4 11.4 11.6
next four years. Div payout (%) 39.6 44.6 48.8 49.3
Book value/share (Rs ) 178 229 285 353
High margins for the medium term – APL’s current Net gearing (%) -29 -30 -35 -34
ROE (%) 52.5 45.1 42.7 41.6
standalone EBITDA margin of >19% is significantly higher ROCE (%) 42.0 38.2 37.2 37.2
than historical margins (15-16%). Nevertheless, we expect FCF (Rs m) 6,374 5,179 7,019 6,862
EV/Sales (x) 3.9 3.4 2.9 2.4
APL to maintain current levels in the medium term given an
EV/EBITDA (x) 20.9 18.3 15.4 12.7
improving product mix (premium emulsions growing at a fast PBR (x) 15.3 11.9 9.5 7.7
pace), higher operating leverage and economies of scale. In PER (x) 34.2 29.7 24.8 20.5
Dividend yield (%) 1.0 1.3 1.7 2.1
addition, management action (it hiked prices a cumulative
Source: Company, Standard Chartered Research estimates
11% in FY11 despite the high margin) indicates comfort with
current margins. Share price performance
3,000
Valuations still in a rational zone – At FY12E P/E of 2,800
2,600
24.8x, APL trades at a premium of 27% to its historical five- 2,400
2,200
year median, which we feel is rational especially given the 2,000
1,800
sharp improvement in return ratios (RoE has improved from 1,600
32.1% in FY05 to 52.5% in FY10). Our 12-month price Jan‐10 Apr‐10 Jul‐10 Oct‐10 Jan‐11
target of Rs3,077 is based on forward P/E of 24x.
Asian Paints Limited BSE SENSEX 30 INDEX (rebased)
Risks – Adverse movement in raw material prices coupled Share price (%) -1 mth -3 mth -12 mth
with complete withdrawal of stimulus benefits and any Ordinary shares 0 1 45
demand slowdown in an environment where capacities are Relative to Index 5 8 35
Relative to Sector - - -
expected to increase sharply. Major shareholder Promoter (52.3%)
Free float -
Average turnover (US$) 6,457,158
Source: Company, Bloomberg

Sanjay Singh Pratik Biyani


sanjay.singh@sc.com pratik.biyani@sc.com
+91 22 6755 9898 +91 22 6755 9851

l Equity Research l 22
India Paint Sector l 19 January 2011

Investment argument and valuation


Growing faster than industry
APL has consistently Growth in paints is structural in nature and volume is normally in the mid-teens. Asian Paints
registered higher-than (APL) has not only successfully leveraged the strong category growth but has also consistently
industry growth in the outperformed the industry. Over FY05-10, APL posted 15.8% volume CAGR compared with the
past five years
organised industry’s 13.6%; gross sales CAGR was a robust 19.8%. We expect APL to continue
posting higher-than-industry growth supported by 1) strong brand equity, 2) comprehensive
product portfolio with strong presence in premium emulsions, 3) unmatched distribution network
especially in Tier 2 & 3 towns where the growth has been higher in recent times and 4)
successful launch of new products and innovative services. We estimate gross sales CAGR of
22.8% over FY10-13E; however, expected withdrawal of excise benefits could result in lower net
sales CAGR of 20.7%.

Fig 1 – APL vs. Industry volume growth Fig 2 – APL − Standalone sales & growth
17.8

17.5
19 110 30

16.4
16.6
15.6

15.6
14.4

16 90 25
13.2

13.8

13.4
13.1
11.4

13 70 20

Rs bn
11.0
%

%
9.1

10 50 15
8.7

8.3

7 30 10

4 10 FY04 5
FY05
FY06
FY07
FY08
FY09
FY10
FY11E
FY12E
FY13E
FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

Industry APL Net sales (LHS) YoY growth (RHS)


Source: Company data, Standard Chartered Research Source: Company data, Standard Chartered Research estimates

Strong brand equity with focus on decorative paints


Improved market APL’s successful marketing campaigns over the years have made it the leading player in the
share from 44% in decorative segment with nearly three times the market share of the nearest competitor. It has
FY05 to 52% in FY10 also been able to reposition the paint category from a commodity product to a branded product
with aesthetic and protective values. Consistently increasing ad-spend has worked in its favour –
its market share improved from 44% in FY05 to 52% in FY10 in the overall paints market. APL’s
market share in decorative paints, which contributes ~76% of total market volume, is even higher
at ~60%. Decorative paints contribution to APL’s standalone sales is greater than 95%.

Fig 3 – APL − Market share Fig 4 – APL − Adspends-to-sales increased


54 5.5
51.7
50.5

52 5.0 4.9 4.8


4.6 4.6
50 4.5
46.9

4.0 4.0 4.0


48
45.9

4.0 3.7 3.7


45.7

45.5

3.6
%
%

44.9
44.7

3.3
44.0

46 3.5

44 3.0

42 2.5

40 2.0
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

Source: Company data, Standard Chartered Research


Source: Company data, Standard Chartered Research
Market share amongst top five paint companies

l Equity Research l 23
India Paint Sector l 19 January 2011

Comprehensive product portfolio − Exterior and premium emulsions growing faster


APL has the most comprehensive product portfolio among paint companies. It has products
ranging from low-end distemper to specialty premium paints with brands varying across price
points in each paint type. For example, in enamels it has Gattu at the economy end and Apcolite
at the premium end; in interior emulsions it has the highest-selling and attractively priced
economy brand Tractor and hugely successful Royale in the premium end.

Advertising focus in Its premium emulsion brands Royale (interior) and Apex Ultima (exterior) are growing at a much
past five years on faster pace than other emulsions, enamels or distempers. A strong advertising push for premium
premium emulsions
brands might have urged consumers to up trade – in the past five years Royale and Apex Ultima
were the most advertised APL brands on television, while only a couple of campaigns were run
for its economy brands Tractor (emulsion) and Utsav (distemper). This is also a departure from its
marketing campaigns in the past – earlier the company used to focus on the “corporate umbrella
brand” with its highly memorable ‘Har ghar kuch kehta hai’ campaign.

Unmatched distribution network − Strongest in tier 2 & 3 cities


Strong and wide APL has a wide and formidable distribution network of 26,000 dealers across India, nearly twice
network of 26,000 the size of its nearest competitor (Berger Paints), which has 14,000 dealers. The number of
dealers tinting machines had risen over eight times in the past 10 years to ~17,000 by Nov ’10, compared
with 6,000 machines for the second-largest player. It has benefited from its strong presence in
tier 2 and 3 cities, as smaller towns have posted faster growth than large towns.

Fig 5 – APL’s tinting machines Fig 6 – Competitors tinting machines


20,000 30,000
25,000
16,000
20,000
12,000 15,000

8,000 10,000
5,000
4,000
0
APL

KNPL

Nobel
Akzo
Berger

India
0
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY11*

Tinting m/c Dealers

Source: Company data, Standard Chartered Research Source: Company data, Standard Chartered Research
* Tinting machines installed till Nov’10

Launch of innovative products/services


APL has been at the forefront of making painting a convenient and colourful experience by
introducing innovative products, services and retail initiatives.

 In FY08, APL made shade selection easier by introducing small 200ml ‘samplers’ that made
colour visualisation convenient – now one could paint a wall to check the shade rather than
look at a shade card

 It has been highly successful in marketing its premium brand Royale and has regularly
introduced paints with a variety of special effects and textures in the premium segment

 Small but useful services on its website such as a calculator to estimate cost of painting,
online consultations with experts to select paints, shades, etc

 It launched a retail signature store ‘Colour with Asian Paints’ in 2009 which doesn’t sell paints,
but where consumers can view and experience the finish of different paints

 It runs the highly successful ‘Home Solutions’ service where it takes care of the whole painting
process and in effect takes the ‘pain’ out of painting.

l Equity Research l 24
India Paint Sector l 19 January 2011

Higher-than-historical margins here to stay


Over FY04-08, APL was able to maintain EBITDA margin in the tight range of 15-16%. In FY09,
however, margin fell to 13.1% as demand slowed and input costs rose. In FY10, as inputs costs
softened and product mix improved, gross margin bounced back 580bps yoy. EBITDA margin
rose higher – up 660bps yoy to 19.7% – supported by higher operating leverage, evident in
declining other cost-to-sales.

We expect APL to maintain EBITDA margin above 19% (higher than historical level of 15-16%) in
EBITDA margin likely the medium term given 1) management’s intent to maintain margins at these levels reflected in
to remain above 19% recent price increases, 2) improving product mix, 3) operating leverage from strong volume
growth and 4) economies of scale benefits. This also helps APL to command higher margins than
competitors.

Fig 7 – APL: Standalone RM cost-to-sales Fig 8 – APL: Standalone EBITDA margin


66 22

19.7

19.4

19.4
19.3
61.5

64
20
62
59.1
58.9
58.2
57.8

57.6

57.6

16.2
18
57.3
60
56.8

15.5

15.2

15.2
55.7

15.0
58

%
%

16
56

13.1
54 14
52
12
50
48 10
FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY04

FY05

FY06

FY07

FY08

FY09

FY10
FY11E

FY12E

FY13E

FY11E

FY12E

FY13E
Source: Company data, Standard Chartered Research estimates Source: Company data, Standard Chartered Research estimates

Fig 9 – APL: Standalone adspends-to-sales Fig 10 – APL: Standalone other cost-sales


5.5 26
22.9
22.8

4.9 4.8 4.7 4.7 4.8


22.0

21.9

5.0 24
21.3

4.6
20.7

19.8
4.5 22
4.0 19.1
4.0 4.0
18.8

18.3
4.0 3.6 20
%

3.5 18
3.0 16

2.5 14
2.0 12
FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY04

FY05

FY06

FY07

FY08

FY09

FY10
FY11E

FY12E

FY13E

FY11E

FY12E

FY13E

Source: Company data, Standard Chartered Research estimates Source: Company data, Standard Chartered Research estimates

Significant price increases, despite margins at all-time high


Raising prices four Despite EBITDA margin being at an all-time high of 19.7% in FY10, APL has increased product
times in FY11 shows prices by a cumulative of 11% in FY11 in response to increase in input costs, especially titanium
management’s intent
dioxide (Standard Charetered RM index up 23% yoy in Nov ’10). This has helped APL to post
standalone EBITDA margin of 19.9% in 1H FY11, demonstrating management’s intent to
maintain margins at these levels.

Improving product mix with high growth in premium emulsions


Most of Asian Paints’ marketing campaigns are currently targeted at premium emusions like
Royale and Apex Ultima. Industry interactions indicate that premium emusions are growing faster
than other segments. We note that APL’s EBITDA margin and gross margin expansion (since
FY08) have been higher than those for other players, indicating that APL’s margin expansion
could partly be attributed to improvement in product mix.

l Equity Research l 25
India Paint Sector l 19 January 2011

Economies of scale offer significant advantages


Benefits from APL’s current manufacturing capacity is ~440,000 tonnes, double that of the second-largest
economies of scale decoratives player. APL plans to increase capacity to ~1m tonnes over the next three to four
and higher capacity years. In addition, the new plants are much larger than existing plants, offering it significant
utilisation
benefits from economies of scale. We expect this to help APL maintain higher-than-histroical
margins. APL’s high capacity utilisation of ~90% compared with peers’ 70% result in higher asset
turnover and better return on capital employed (RoCE) than competitiors.

Fig 11 – EBITDA margin of paint companies Fig 12 – RoCE of paint companies


25 60
19.8

47.7
16.3

50

15.5
20 14.1

12.5
13.2

33.0
11.5

11.9
40

10.5
10.1

10.4
15

21.1
20.6
%

20.3
8.4
30

16.3
16.2
10

14.1
20
5
10
0 0

Nobel
Nerolac

Akzo
Berger
Paints
Asian

Paints

India
Kansai

Nobel
Nerolac

Akzo
Berger
Paints
Asian

Paints
Kansai

India
FY08 FY09 FY10 FY09 FY10

Source: Company data, Standard Chartered Research Source: Company data, Standard Chartered Research

International business − Grim economic scenario


Rationalisation of The global slowdown and divestment of some international businesses resulted in muted sales
international growth of 6.7% (adjusted for 15 months’ sales) in FY10. However, the divestment of loss-making
operations improved international subsidiaries in Malaysia, Hong Kong, China and Thailand in FY10 improved the
profitability
profitability of the international business – from a loss of Rs175m in FY09 to a profit of Rs480m.

Fig 13 – International sales and growth Fig 14 – International EBIT margin


18 30 16 15.0 14.9
14.2 14.6
15 14
25
12
12
20 10
Rs bn

8.4
%

9 7.7
%

8
15
6 6
3 10 4 2.9

0 5 2 0.4
FY04
FY05
FY06
FY07
FY08
FY09

FY11E
FY12E
FY13E
FY10*

0
FY06

FY07

FY08

FY09

FY11E

FY12E

FY13E
FY10*

International sales (LHS) YoY growth (RHS)


Source: Company data, Standard Chartered Research estimates Source: Company data, Standard Chartered Research estimates
* FY10 results for overseas business includes result for 15 months. * FY10 results for overseas business includes result for 15 months
YoY growth numbers are adjusted for it.

l Equity Research l 26
India Paint Sector l 19 January 2011

Fig 15 – International sales breakup FY10* Fig 16 – International EBIT breakup FY10*
South
South
Pacific
South Pacific
7% Middle South
East Asia 7% Middle
East East Asia
8% East
54% 8% 66%

South Asia South Asia


15% 13%

Caribbean
6%
Caribbean
16%

Source: Company data, Standard Chartered Research Source: Company data, Standard Chartered Research
* FY10 results for overseas business includes result for 15 months * FY10 results for overseas business includes result for 15 months

Conditions in APL’s largest international markets, the Middle East and the Caribbean, continue to
remain uncertain and challenging. Sales in the Caribbean region declined 11% yoy in 1H FY11,
where as in the Middle East it was flat. Growth in Asian markets was strong at 21.9% yoy, while
the South Pacific region posted a modest 7.7% yoy in 1H FY11. Overall, international sales grew
3.2% in 1H FY11.

We expect international market conditions to improve and estimate growth of 7.2% in FY11E
followed by mid-double digit growth in FY12-13E. We expect international margins to be in the
range of 14-15% going forward.

Industrial paints − Capex growth yet to pickup


Deferral in capex Industrial paints’ growth has been largely driven by strong growth at its automotive JV (Asian
spends impact non- PPG Industries). Non-auto industrial paint demand has not yet picked up due to deferral of capex
auto industrial paint spends. An extended monsoon has also led to delays in projects and maintenance demand. APL,
demand
however, saw some up-tick in non-auto industrial paint demand in 2Q FY11 over 1Q FY11. We
estimate sales growth of 15% in FY11E, which we expect to improve further in FY12-13E.

Fig 17 – Industrial sales Fig 18 – Second in industrial paints


6 35 Others
30 9%
5
25
4 Shalimar
20
10%
Rs bn

3 15
Kansai
2 10 Nerolac
5 Berger 48%
1 13%
0
0 -5
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY11E
FY12E
FY13E

APL +
PPG
20%
Net Sales (LHS) YoY growth (RHS)
Source: Company data, Standard Chartered Research estimates
Source: Company data, Standard Chartered Research
APICL: Asian Paints Industrial Coatings Ltd.

Valuations in a rational zone - initiate with Outperform


Given long-term structural growth prospects and oligopolistic nature of the industry, we find the
paint category highly attractive, even when compared with other FMCG categories. As discussed
earlier, we expect APL to deliver higher-than-industry volume growth for some time to come. We
also expect APL to maintain higher-than-historical margins, which will enable it to post strong
EPS CAGR of 18.6% over FY10-13E.

APL is currently trading at FY12E P/E of 24.8x, 27% premium to its five-year median P/E of 19.6x.
While valuations may appear expensive compared with the historical median, we note that over
FY05-10, APL has consistently seen earnings upgrades and hence the historical median might

l Equity Research l 27
India Paint Sector l 19 January 2011

not give the true picture. Also, increasing EBITDA margin and improving return ratios (RoE
increased from 32.1% in FY05 to 52.5% in FY10) enable APL to trade at higher valuations. We
believe APL will continue to command premium valuations on the back of strong growth, superior
margins, stable cash flows and excellent return ratios. Our one-year price target of Rs3,077 is
based on forward P/E of 24x.

Fig 19 – APL − P/E bands


3,500 32x
3,000 28x
2,500 24x
20x
2,000
Rs

16x
1,500
1,000
500
0
Mar-06

Mar-07
Apr-05

Aug-07

Aug-08

Aug-09

Jan-10

Jul-10

Jan-11
Sep-05

Sep-06

Feb-08

Feb-09
Source: Company data, Bloomberg, Standard Chartered Research

Fig 20 – APL − One-year forward P/E chart


35
30
25
PE (x)

20
15
10
5
May-07

May-08

May-09
Nov-07

Nov-08
Apr-05

Apr-06

Jun-10
Oct-05

Oct-06

Dec-09

Dec-10
One year forward P/E Median P/E
Source: Company data, Standard Chartered Research

Fig 21 – APL − Premium over Sensex


100

80
60
%

40
20

-20
May-07

May-08

May-09
Nov-07

Nov-08
Apr-05

Apr-06

Jun-10
Oct-05

Oct-06

Dec-09

Dec-10

Premium to sensex Five-year median


Source: Company data, Standard Chartered Research

APL stock performance has been strong since the last market peak
APL has outperformed the broader indices on a consistent basis. Since the market peaked in
Jan ’08, APL stock has jumped 140% versus a flat BSE Sensex. Given the sharp outperformance
over the past few years, we expect stock returns to be moderate from a one-year perspective.

l Equity Research l 28
India Paint Sector l 19 January 2011

Fig 22 – APL stock performance vis-à-vis broader indices


APL FMCG Index BSE Sensex
1 year 44.9 28.7 7.3
3 year 34.4 14.2 -3.1
5 year 36.0 16.7 15.0
10 year 31.5 13.5 16.7
Source: Bloomberg
Note: For periods greater than a year, the returns are annualised

Risks
 Further increase in prices of raw materials like titanium dioxide or crude combined with
complete withdrawal of stimulus benefits could force APL to absorb some of the costs as it
has already increased prices four times in FY11. This could lead to short term margin squeeze.

 APL plans to more than double its manufacturing capacity in the next three to four years,
implying a capacity increase CAGR of ~19% over the next four years. Any economic
slowdown (due to global shocks or otherwise) which can potentially disrupt domestic demand
can cause margins to slide as APL will be more focussed on volume growth.

l Equity Research l 29
India Paint Sector l 19 January 2011

Financials
We estimate consolidated sales, EBITDA & EPS CAGR for APL to be at 17.8%, 18.0% & 18.6%
respectively over FY10-13E.

APL’s cash flows are strong and similar to any FMCG company. Its average operating cash flow
in the past five years have been at 95% of reported net profit. Relatively high capex results in
FCF post capex as proportion of reported net profit to be lower at 55-60%. Dividend payout is at
40-50% and its RoE is a healthy >40%.

Fig 23 – APL: Sales & sales growth Fig 24 – APL: RM cost to sales
120 35 65

62.5
60.8
100 30 63

60.3

59.2
80 25 61

58.7

58.1
58.0
57.8

57.7
Rs bn

56.9
59

%
60 20

%
40 15 57

20 10 55

0 5 53
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY11E
FY12E
FY13E

51

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11E

FY12E

FY13E
Net sales (LHS) YoY growth (RHS)
Source: Company data, Standard Chartered Research estimates Source: Company data, Standard Chartered Research estimates

Fig 25 – APL: A&P as % of sales Fig 26 – APL: Other costs as % of sales


25.5

5.0 30
4.6

24.5
4.5

4.5

4.5
4.5
4.4

22.7

22.6

21.3

20.8
4.5 25

20.2

19.4

19.2

18.7
4.0

4.0 20
3.6

3.6
3.6
%

3.5 15

3.0 10

2.5 5

2.0 0
FY04

FY05
FY06

FY07

FY08

FY09

FY10

FY04

FY05

FY06

FY07

FY08

FY09

FY10
FY11E
FY12E

FY13E

FY11E

FY12E

FY13E

Source: Company data, Standard Chartered Research estimates Source: Company data, Standard Chartered Research estimates

Fig 27 – APL: EBITDA margin Fig 28 – APL: PAT & PAT growth
22 14 100
18.5
18.4

18.3
18.3

20 12 80
18
14.9

10
16 60
13.1

13.2

13.0
13.0

Rs bn

%
12.3

8
14 40
%

6
12
20
10 4
8 2 0
6 0 -20
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY11E
FY12E
FY13E

4
FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11E

FY12E

FY13E

PAT YoY growth (RHS)


Source: Company data, Standard Chartered Research estimates Source: Company data, Standard Chartered Research estimates

l Equity Research l 30
India Paint Sector l 19 January 2011

Fig 29 – APL: Cash flow as % of PAT Fig 30 – APL: Return ratios


160 60

130 50

100 40
%

%
70 30

40 20

10 10

-20 0

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11E

FY12E

FY13E
FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11E

FY12E

FY13E
Operating Cash Flow FCF post capex RoE RoCE
Source: Company data, Standard Chartered Research estimates Source: Company data, Standard Chartered Research estimates

Fig 31 – APL: Income statement (Rs m)


Year end: March FY09 FY10 FY11E FY12E FY13E
Net Sales 53,941 66,045 75,679 90,032 107,889
- of which Standalone 42,630 51,021 62,031 74,403 89,751
- of which subsidiaries 11,312 15,023 13,648 15,629 18,138
Other operating income 691 765 855 954 1,067
Total Revenue 54,632 66,809 76,533 90,986 108,956
Raw materials consumed 33,706 37,580 43,694 52,197 62,729
Gross Profit 20,926 29,230 32,839 38,789 46,227
- Gross Margin (%) 38.3 43.8 42.9 42.6 42.4
Other operating expenses 14,232 16,954 18,833 22,096 26,053
EBITDA 6,694 12,276 14,005 16,693 20,174
- Growth (%) 1.7 83.4 14.1 19.2 20.9
- EBITDA margin (%) 12.3 18.4 18.3 18.3 18.5
Depreciation & Amortisation 744 836 1,187 1,481 1,775
Gross Interest 263 285 183 186 186
Other Income 517 699 882 1,079 1,272
Recurring PBT 6,204 11,855 13,518 16,105 19,484
Add: Extraordinaries 21 715 0 0 0
Less: Taxes 2,030 3,730 4,215 4,998 6,043
- effective tax rate (%) 32.7 31.5 31.2 31.0 31.0
Less: Minority Interest 216 483 491 574 703
Net Income (Reported) 3,978 8,357 8,813 10,533 12,738
Recurring Net Income 3,964 7,642 8,813 10,533 12,738
- Growth (%) -4.8 92.8 15.3 19.5 20.9
- Net margin (%) 7.2 11.3 11.4 11.4 11.6
Source: Company, Standard Chartered Research estimates

l Equity Research l 31
India Paint Sector l 19 January 2011

Fig 32 – APL: Balance sheet (Rs m)


Year end: March FY09 FY10 FY11E FY12E FY13E
Cash & Bank balance 2,104 1,058 2,716 5,309 6,529
Inventory 7,690 9,559 10,182 13,211 14,653
Sundry Debtors 5,719 5,425 6,889 7,569 9,483
Loans and Advances 1,978 1,746 1,899 2,066 2,251
Other Current Assets 497 646 713 786 867
Total Current Assets 17,987 18,435 22,398 28,941 33,783
Sundry Creditors 7,337 10,171 10,091 14,018 14,817
Other Current Liabilities 2,775 3,626 4,209 4,910 5,750
Provisions 1,810 3,150 3,518 4,003 4,556
Current Liab. & Prov. 11,921 16,947 17,818 22,931 25,124
Net Current Assets 6,066 1,488 4,580 6,010 8,659
Investments 784 6,243 6,243 6,743 7,243
- of which Strategic 10 10 10 10 10
- of which Marketable 774 6,233 6,233 6,733 7,233
Net Fixed Assets 9,051 12,801 14,713 18,281 21,585
- of which CWIP 921 4,072 4,072 4,120 4,200
Goodwill 506 367 367 367 367
Total Assets 16,407 20,899 25,904 31,401 37,855

Equity Share Capital 959 959 959 959 959


Reserves & Surplus 11,073 16,141 21,026 26,423 32,877
Net Worth 12,032 17,100 21,985 27,383 33,836
Borrowings 3,086 2,292 2,356 2,356 2,356
Deferred Tax Liability 533 562 562 562 562
Minority Interest 756 945 1,000 1,100 1,100
Capital Employed 16,407 20,899 25,904 31,401 37,855
Source: Company, Standard Chartered Research estimates

Fig 33 – APL: Cash Flow statement (Rs m)


Year end: March FY09 FY10 FY11E FY12E FY13E
Reported Net Income 3,978 8,357 8,813 10,533 12,738
Depreciation & Amortisation 147 -208 1,187 1,481 1,775
Others -322 -932 -392 -505 -568
Operating Cash flow 3,804 7,217 9,608 11,508 13,945
Working Capital Changes -1,712 2,698 -1,329 558 -2,003
Capital Commitments -2,280 -3,541 -3,100 -5,048 -5,080
Free Cash Flow -189 6,374 5,179 7,019 6,862
Investing Activities 2,499 -4,760 882 579 772
Inc (Dec) in Borrowings 334 -794 64 - -
Dividend paid -1,908 -2,188 -4,033 -4,531 -5,710
Extraordinary Items 21 715 - - -
Chg. In Cash & Bank balance 997 -1,045 1,658 2,593 1,220
Add: beginning balance 1,107 2,104 1,058 2,716 5,309
Closing balance 2,104 1,058 2,716 5,309 6,529
Source: Company, Standard Chartered Research estimates

l Equity Research l 32
India Paint Sector l 19 January 2011

Fig 34 – APL: Ratios


Year end: March FY09 FY10 FY11E FY12E FY13E
Per Share Data (Rs)
Recurring EPS 41.3 79.7 91.9 109.8 132.8
Reported EPS 41.5 87.1 91.9 109.8 132.8
Dividend per share (DPS) 17.5 27.0 35.1 45.9 56.2
Book Value per share (BV) 125.4 178.3 229.2 285.5 352.8
Growth Ratios (%)
Net Sales 23.8 22.4 14.6 19.0 19.8
EBITDA 1.7 83.4 14.1 19.2 20.9
Recurring EPS -4.8 92.8 15.3 19.5 20.9
Valuation Ratios (x)
P/E 66.0 34.2 29.7 24.8 20.5
P/BV 21.7 15.3 11.9 9.5 7.7
EV / EBITDA 38.4 20.9 18.3 15.4 12.7
EV/ Net Sales 4.8 3.9 3.4 2.9 2.4
Operating Ratio (%)
Raw Material/Sales 62.5 56.9 57.7 58.0 58.1
SG&A/Sales 12.7 12.8 12.9 12.9 13.0
Effective Tax Rate 32.7 31.5 31.2 31.0 31.0
NWC / Total Assets 24.1 2.1 7.2 2.2 5.6
Inventory Turnover (days) 50.2 47.7 47.6 47.4 47.1
Receivables (days) 34.9 30.8 29.7 29.3 28.8
Payables (days) 51.8 48.4 48.9 48.9 48.8
D/E Ratio (x) 0.30 0.17 0.13 0.11 0.09
Return/Profitability Ratio (%)
RoCE 27.7 42.0 38.2 37.2 37.2
RoNW 36.3 52.5 45.1 42.7 41.6
Dividend Payout Ratio 49.5 39.6 44.6 48.8 49.3
Dividend Yield 0.6 1.0 1.3 1.7 2.1
Source: Company, Standard Chartered Research estimates

l Equity Research l 33
India Paint Sector l 19 January 2011

Company profile
Asian Paints is the world’s 10th largest decorative paints company and India’s largest with a 52%
market share. Decorative paints contribute >95% of standalone sales and command a market
share of 60% share, nearly three times the nearest competitor. It has a comprehensive product
portfolio ranging from mass-end distempers to premium emulsions at varied price points and a
strong distribution network of 26,000 dealers (with nearly 17,000 having tinting machines). It
plans to double its manufacturing capacity in the next three to four years from 440,000 tonnes in
FY10.

It has a market share of 20% in industrial coatings and offers auto paint products through its
50:50 JV with PPG Industries. Non-auto industrial paints are offered through its wholly-owned
subsidiary Asian Paints Industrial Coatings Ltd. (APICL). International operations contribute ~15-
20% to its consolidated sales and it has a presence in various Middle East, Asian and Caribbean
countries.

Fig 35 – Shareholding pattern as of Dec’10

Others
21.7%

Promoter
DIIs
52.3%
11.4%

FIIs
14.6%

Source: BSE

Fig 36 – Management profile


Name Designation Background
Mr. Choksi is one of the promoters of the company and has
been Non-Executive Chairman since April 2009. He has also
Ashwin Choksi Chairman served as MD from 1984 to 2008, post joining the company in
1965. He holds a Master’s degree in Commerce from the
University of Mumbai, India.
Mr. Dani is the co-promoter and has been engaged with the
company since 1968. He has also served as MD for the
company for a short period from Dec’08 to Apr’09. He holds
Ashwin Dani Vice Chairman a B.Sc. from the Institute of Science and from U.D.C.T.
Bombay. He also holds a Masters Degree in Polymer
Science from Ohio and Diploma in Colour Science from New
York.
He has been in the company for the past 37 years and has
worked in various capacities in sales, materials,
P.M. Murty MD & CEO manufacturing plants and human resources. He is a B.Sc. in
Math and Post Graduate in Management from IIM, Calcutta
of 1971 batch.

Source: Company

l Equity Research l 34
India Paint Sector l 19 January 2011

Kansai Nerolac Paints Ltd (KNPL)


Growth slowdown; initiate with UNDERPERFORM

 We initiate coverage on KNPL with an UNDERPERFORM (initiating coverage)


UNDERPERFORM rating and price target of Rs852 PRICE (as at 14 January 11) PRICE TARGET
 Given a high base and cooling auto sales growth, we
estimate KNPL’s volume growth could slow to 14%/15% Rs900 Rs852
in FY12/FY13 from above 20% over the past 18 months Bloomberg code Reuters code
 We expect margins to be steady leading to EPS CAGR KNPL IN KANE.BO
of 16.9% over FY10-13E
Market cap 12 month range
 Our price target of Rs852 is based on a forward P/E of
Rs48,520m (US$1,078m) Rs509 - 1026
18x, which is at a justifiable 25% discount to APL given
KNPL’s cyclical business and lower return ratios. EPS est. change - - - -

Volume growth likely to slow – In the past 18 months, Year end: March 2010 2011E 2012E 2013E
Sales (Rs m) 17,064 21,061 24,315 28,207
KNPL’s volume has grown at a strong 20%, driven mainly by EBIT (Rs m) 2,398 2,846 3,262 3,833
robust auto demand and stable growth in decoratives. EBITDA (Rs m) 2,637 3,122 3,579 4,245
Nevertheless, we expect volume growth to moderate to Pretax profit (Rs m) 2,386 2,826 3,241 3,811
Earnings (Rs m) adjusted 1,647 1,950 2,236 2,629
14%/15% in FY12/FY13 given a high base and a likely Diluted EPS (Rs ) adjusted 30.6 36.2 41.5 48.8
moderation in auto sales growth. Diluted EPS growth (%) adj. 66.9 18.4 14.7 17.6
DPS (Rs ) 7.5 9.5 11.0 14.5
DPS growth (%) 25.0 26.4 15.5 32.3
Margins likely to remain stable, but prone to risks – EBITDA margin (%) 15.5 14.8 14.7 15.0
Despite gross margin dipping 580bps in the past five years, EBIT margin (%) 14.1 13.5 13.4 13.6
Net margin (%) 9.5 9.2 9.1 9.2
strong volume growth and resultant operating leverage led Div payout (%) 28.5 30.5 30.8 34.6
to operating margin remaining stable at 14-15% over FY05- Book value/share (Rs ) 143 169 197 229
10 (except in FY09 when a sharp and rapid increase in input Net gearing (%) -43 -38 -39 -37
ROE (%) 23.1 23.2 22.7 22.9
prices combined with a demand slowdown reduced it to ROCE (%) 20.6 20.9 20.8 21.2
11.5%). We expect KNPL to broadly maintain margins over FCF (Rs m) 731 365 964 872
EV/Sales (x) 2.7 2.2 1.9 1.6
FY10-13E (with a marginal drop in FY11E). However, we
EV/EBITDA (x) 17.3 14.6 12.7 10.7
note margins can face downward pressure if demand slows PBR (x) 6.3 5.3 4.6 3.9
and/or input prices increase sharply. PER (x) 29.5 24.9 21.7 18.5
Dividend yield (%) 0.8 1.1 1.2 1.6
Source: Company, Standard Chartered Research estimates
Valuations expensive, initiate with UNDERPERFORM –
Strong performances in FY10 and 1H FY11 saw the stock Share price performance
outperform the Sensex by ~50% in CY10. At FY12E P/E of 1,100
21.7x, KNPL trades at a 25% premium to its five-year 1,000
900
median, which we believe is high given a likely slowdown in 800
volume growth. We value it at a forward P/E of 18x leading 700
600
to 12-month price target of Rs852 (implying ~5% downside). 500
Initiate with UNDERPFERFORM. Jan‐10 Apr‐10 Jul‐10 Oct‐10 Jan‐11
Kansai Nerolac Paints Limited
Risks – Continued momentum in auto sales with volume
growth of >20% can impact topline growth & consequently BSE SENSEX 30 INDEX (rebased)
improve earnings. Also, any sharp crude price decline can Share price (%) -1 mth -3 mth -12 mth
Ordinary shares -1 -10 67
expand margins in near-term, but will not be sustainable in Relative to Index 3 -4 56
the longer run. Relative to Sector - - -
Major shareholder Promoter (69.3%)
Free float -
Average turnover (US$) 177,751
Source: Company, Bloomberg

Sanjay Singh Pratik Biyani


sanjay.singh@sc.com pratik.biyani@sc.com
+91 22 6755 9898 +91 22 6755 9851

l Equity Research l 35
India Paint Sector l 19 January 2011

Investment argument and valuation


We initiate coverage on KNPL with an UNDEPERFORM rating and price target of Rs852.
Given a high base and cooling auto sales growth, we estimate KNPL’s volume growth
would slow to 14%/15% in FY12/FY13 from above 20% over the past 18 months. In our
view, the stock looks expensive at current valuations. Our 12-month price target of Rs852
is based on 18x on one-year forward earnings, at a justifiable 25% discount to Asian
Paints’ given KNPL’s cyclical business and lower return ratios.

Volume growth likely to slow


In the past 18 months, KNPL’s volume has grown at a strong 20%, driven mainly by robust auto
demand and stable growth in decoratives. We now expect volume growth to moderate to
14%/15% in FY12/FY13 given a high base and a likely moderation in auto sales growth.

Industrial segment growth dependent on auto demand growth


KNPL is the leader in automotive paints and powder coatings, and has successfully riden on the
growth in these sectors.

Auto paints contribute The company has a dominant 60% market share in the auto paint category, which accounts for
70% to KNPL’s 70% of its industrial paint revenue. Given this, auto demand growth plays a major role in KNPL’s
industrial paint sales
industrial paint growth. Currently, KNPL is enjoying the upswing in auto demand – KNPL’s net
sales grew 24.1% in FY10 and 22.8% yoy in 1H FY11 (PV volume rose 29.4% yoy in FY10 and
27% in 1H FY11). We expect 20% volume growth in FY11. But our auto analyst expects auto
volume growth to cool to 16%/14% in FY12/FY13 from 29.4% in FY10 and 25% in FY11.

KNPL is also dominant in the auto-refinish market, where OEMs have a major say in which
company’s products are used for repainting, though the actual decision depends on the
authorised service station. KNPL’s strong relationship with OEMs has made it dominant in this
segment.

The flip side of this auto sector dominance is that KNPL is prone to cyclicality in sales/earnings
given its high dependence on the sector (~35% of total sales). Other paint companies are not as
cyclical given most of their sales come from the stable decoratives segment.

Fig 1 – KNPL: Industrial sales breakup Fig 2 – KNPL vs PV volume growth

34 30
Others
29 25

24 20
Rs bn

Powder 19 15
%

coating 14 10

9 5

4 0
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY11E
FY12E
FY13E

Auto

Net sales (LHS) YoY growth (RHS)

Source: SIAM, Company data, Standard Chartered Research


Source: Company data, Standard Chartered Research
estimates

Leadership position in automotive paints


KNPL has built an KNPL has a competitive advantage in automotive paints. Most global automobile OEMs prefer
unassailable position paint suppliers who have global tie-ups with their parent. Given Kansai’s relationships and
in automotive paints
technology, KNPL has built for itself an almost unassailable position in automotive paints. Barring
Hyundai Motors, KNPL is the supplier to all leading automotive industry leaders. It supplies 95%
of Maruti Suzuki’s paint requirements. Though the entry barriers are high given the collaborative

l Equity Research l 36
India Paint Sector l 19 January 2011

nature of the business, this is a low margin business that can easily be impacted when there are
steep fluctuations in raw material prices.

Differentiates itself through better service quality – KNPL has around 40 of its 200 technical
support personnel on customers’ shop floors helping them manage their paint lines. An efficient
supply chain that reduces inventory at the customers’ end, quick response to client needs, cutting
painting cycle time and overcoming myriad material and finish-related issues on the spot are
critical in adding value to the customer. Despite auto manufacturers’ high bargaining power,
KNPL’s competence in addressing these critical issues gives it a competitive advantage over
other players.

Automotive paints Technological edge – Continuously changing painting trends in the automotive industry
require a high level of necessitate the development of compatible paint formulations and paint processes. KNPL has
technological forged strong technological collaborations to deliver superior products to its customers which, we
intervention
believe, will keep the company at the edge of innovation. Through its various strategic
collaborations, KNPL offers a total painting system to auto makers in India with a range of
products such as Pretreatment Chemicals, Electro Deposition Primers, Intermediate Coats/primer
Surfacers, Solid & Metallic Top Coats and Clear Coats Touch-up Paints.

Fig 3 – Technological collaborations give KNPL an edge


Collaborating company Country Products Remark
ED Primers, Automotive &
Kansai Paint Co., Japan Japan Owns 69.3% equity in KNPL
Industrial Coatings
Nihon Parkerizing, Japan Japan Pre-Treatment Chemicals -
Oshima Kogyo, Japan Japan Heat Resisting paints -
Ameron/PPG, US USA High Performance Coatings -
Source: Company, Standard Chartered Research

Growth in other industrial coatings to be strong


Powder coatings will witness robust growth driven by strong performance of white goods industry
and also shift from liquid paints to powder coatings in auto ancillary industries. Increased
participation of KNPL in various infra projects and rising investments in infrastructure
development will also increase demands for performance coatings and other industrial paints.

Higher focus to drive growth in decorative paints


KNPL is the third- KNPL is the third-largest player in the decorative paint segment and has a strong dealer network
largest player in of 12,000, out of which 5,000 have tinting machines supplied by the company. In the past few
decoratives years, the company has been riding the strong category growth witnessed in decorative paints. In
addition, it has taken various initiatives to bolster its decoratives segment and increase the
proportion of its emulsion sales from the current ~30%.

KNPL’s initiatives:

 Enhanced branding efforts by increasing advertising of its emulsions brand Impressions

KNPL has taken many  Leveraging its technology expertise in the decorative segment by introducing innovative
initiatives to bolster its products – Impressions tile guard, Impressions marble finish, Impressions texture coating and
decoratives portfolio Suraksha Plus

 Positioning its paints as environmental friendly. KNPL is the only company to have launched a
campaign to educate consumers about its ‘lead free’ range of paints

 Setting up experience centres where consumers can experience the paints through
application on walls

 Organising meetings with paint influencers – contractors and painters. KNPL introduced
‘Nerolac Style Icon’ awards for architects and interior designers in ’07

l Equity Research l 37
India Paint Sector l 19 January 2011

Improved efficiency of its distribution system


KNPL has instituted a host of measures to correct credit systems in its distribution network to
make it more efficient and to prepare it to handle higher volume and growth. While this has led to
loss of market share in FY09, it is positive in the longer run as it will help KNPL control its working
capital requirements.

Fig 4 – KNPL: Overall market share Fig 5 – Distribution networks of companies


24 30,000

21.5
20.9

20.9

20.9

20.6
20.5
22 25,000

19.2

18.1
20 20,000

17.2
18 15,000
%

16 10,000

14 5,000

12 0

APL

KNPL

Nobel
Akzo
Berger

India
10
FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10
Tinting m/c Dealers

Source: Industry data, Standard Chartered Research Source: Company data, Standard Chartered Research

Margins likely to be stable


Strong volume growth, lower prices of crude-linked raw materials and excise benefits helped
KNPL post EBITDA margin of 15.5% in FY10. Strong margins and a low base (earnings declined
18% in FY09) helped KNPL post strong earnings growth of 67% in FY10. Continuing momentum
in auto sales has supported higher sales growth of 23% yoy and kept margin steady at 15.6% in
1H FY11 (despite a 210bps yoy decline in gross margin). We expect FY11E net sales to grow
23.4% yoy. However, the recent increase in input costs is likely to soften margins in the next few
quarters and result in FY11E EBITDA margin of 14.8%. We expect earnings growth to be 18.4%
in FY11, lower than net sales growth.

Margins likely to be The institutional nature of buyers in auto paints result in relatively lower pricing power, hence
maintained at ~15% making it difficult for KNPL to completely transfer sharp and adverse increases in raw material
prices. Furthermore, as most of KNPL’s raw materials are crude linked, its margins tend to
depend on the movement of crude prices, especially when crude price movements are rapid.
However, a gradual increase in input prices can be partly passed through. Hence, part transfer of
increase in raw material prices and stable volume growth expected in auto sales is likely to
enable KNPL to maintain margins at ~15% in FY12-13E, in our view. We expect recurring EPS
growth to be healthy at 14.7% and 17.6% in FY12E and FY13E, respectively.

Margins vulnerable to Fig 6 – Adverse price increase in raw materials impacted margins in FY09
rapid movement in 20
crude prices 150
18 130
110
(US$/bl)

16
90
%

14 70
50
12
30
10 10
Jun-04

Jun-05

Jun-06

Jun-07

Jun-08

Jun-09

Jun-10
Sep-04
Dec-04
Mar-05

Sep-05
Dec-05
Mar-06

Sep-06
Dec-06
Mar-07

Sep-07
Dec-07
Mar-08

Sep-08
Dec-08
Mar-09

Sep-09
Dec-09
Mar-10

Sep-10
Dec-10

Quarterly EBITDA margins (LHS) Crude prices (RHS)

Source: Company data, Standard Chartered Research; Margins for Dec-10 are our estimates

l Equity Research l 38
India Paint Sector l 19 January 2011

Valuations dear; initiate with UNDERPERFORM


KNPL enjoys a strong competitive position in automotive and industrial paints and has favourable
growth prospects in decorative paints, but it is prone to the cyclicality linked with the automotive
sector. At present, KNPL trades at FY12E P/E of 21.7x versus the five-year median P/E of 17.4x.
An excellent performance in the past 18 months, driven by strong volume growth in auto paints,
has reduced the moving five-year discount to APL from 27% last year to 18% currently.

We value KNPL at a However, given the expected slowdown in growth, inherent cyclicality in auto sales and higher
forward P/E of 18x, vulnerability of margins to crude prices, we believe current valuations are expensive and expect
25% discount to our the discount to APL to increase. Hence, we initiate with an UNDERPERFORM rating and a 12-
target multiple for APL
month price target of Rs852 based on a forward P/E of 18x (25% discount to our target multiple
of 24x for APL).

Intrinsic value of land and cash per share provide strong support
KNPL has significant landbank in various parts of the country. While some land tracts are no
longer used for manufacturing, there are other valuable land tracts where production continues.
We value the total ready-for-sale land (Thane, Lower Parel and Vatva) at Rs4bn and the value of
land at the Chennai plant at Rs3bn. Net cash and cash equivalent per share amounts to Rs62.
Hence, the total intrinsic value of land (ready-for-sale) and cash stands at Rs136/share. However,
the company has no plans to sell/ develop the existing land at present and hence, we do not
factor in the land value in our price target. Any move to appropriate value from its landbank can
be a positive trigger for the stock.

Fig 7 – KNPL: P/E bands


1,200
28x
1,000 24x
800 20x
Rs

16x
600
12x
400

200

0
Mar-06

Mar-07
Apr-05

Aug-07

Aug-08

Aug-09

Jan-10

Jul-10

Jan-11
Sep-05

Sep-06

Feb-08

Feb-09

Source: Company data, Bloomberg, Standard Chartered Research

Fig 8 – KNPL: One-year forward P/E chart


30

25

20
PE (x)

15

10

5
May-07

May-08

May-09
Nov-07

Nov-08
Apr-05

Apr-06

Jun-10
Oct-05

Oct-06

Dec-09

Dec-10

One year forward P/E Median P/E


Source: Company data, Standard Chartered Research

l Equity Research l 39
India Paint Sector l 19 January 2011

Fig 9 – KNPL: Discount to APL


60

40

20
%
0

-20

-40

May-07

May-08

May-09
Nov-07

Nov-08
Apr-05

Apr-06

Jun-10
Oct-05

Oct-06

Dec-09

Dec-10
Discount to APL Five-year median
Source: Company data, Standard Chartered Research

Fig 10 – KNPL stock performance vis-à-vis broader indices


KNPL FMCG Index BSE Sensex
1 year 67.3 28.7 7.3
3 year 28.6 14.2 -3.1
5 year 17.3 16.7 15.0
10 year 37.0 13.5 16.7
Source: Bloomberg
Note: For periods greater than a year, the returns are annualised

Risks
 Continued momentum in auto sales for a longer period and volume growth surprises >20%
compared to our auto analyst’s estimate of 14-16% in FY12/13, can result in higher-than-
expected paint volume growth for KNPL.

 Erratic movement in crude. For example, a sharp and rapid decline in crude can increase
near-term margins for a few quarters and can create a spurt in stock prices. However, high
margins will not be sustainable in the long run as KNPL will have to pass on any input cost
benefits to its institutional auto buyers.

l Equity Research l 40
India Paint Sector l 19 January 2011

Financials
We estimate net sales, EBITDA & EPS CAGR for KNPL to be at 18.2%, 17.2% & 16.9%
respectively over FY10-13E.

KNPL’s cash flow has been relatively more volatile compared to APL, but has been strong with
operating cash flow at 97% of reported net profit in the past five years. Low dividend payout at
30-35% has resulted in swelling reserves. KNPL’s reserve as a proportion of share capital is at
26 times compared to 17 times for APL in FY10. As a result, return ratios RoE and RoCE are
lower compared to APL at 23.1% and 20.6%, respectively, in FY10.

Fig 11 – KNPL volume growth to be healthy


25

20.0
22.9
17.9
20

14.5

14.5
12.7
12.5

11.6

15
%

10

5.6

4.1
5

0
FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11E

FY12E

FY13E
Source: Company data

Fig 12 – KNPL: Sales & Sales growth Fig 13 – KNPL: RM cost to sales
34 30 67

65.4

64.6

64.6
64.4
29 25
63.7

65 63.4

62.8
24 20
63
Rs bn

60.9
%

60.5

19 15
60.1

61
14 10
59
9 5
57
4 0
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY11E
FY12E
FY13E

55
FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11E

FY12E

FY13E

Net sales YoY growth (RHS)

Source: Company data, Standard Chartered Research estimates Source: Company data, Standard Chartered Research estimates

Fig 14 – KNPL: A&P as % of sales Fig 15 – KNPL: Other costs as % of sales


6 24
22.1

20.3
20.3

5 22
4.4

19.7
19.3
19.2
4.0

3.9

3.9

3.9
3.9

20
3.6

17.8

4
3.4
3.2

16.9
3.1

16.8

16.5
%

18
3
16
%

2
14
1 12
0 10
FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY04

FY05

FY06

FY07

FY08

FY09

FY10
FY11E

FY12E

FY13E

FY11E

FY12E

FY13E

Source: Company data, Standard Chartered Research estimates Source: Company data, Standard Chartered Research estimates

l Equity Research l 41
India Paint Sector l 19 January 2011

Fig 16 – KNPL: EBITDA margin Fig 17 – KNPL: PAT & PAT growth

15.6

15.5
16 3.0 80

15.0
14.9

14.8

14.7
15 2.5 60

14.1
14.0
2.0 40

13.5
14

Rs bn

%
1.5 20
13
%

1.0 0

11.5
12
0.5 -20
11
0.0 -40

FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY11E
FY12E
FY13E
10
FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11E

FY12E

FY13E
PAT YoY growth (RHS)

Source: Company data, Standard Chartered Research estimates Source: Company data, Standard Chartered Research estimates

Fig 18 – KNPL: Cash flow as % of PAT Fig 19 – KNPL: Return ratios


250 35
200 30

150 25
%

20
100

%
15
50
10
0
5
-50 0
FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11E

FY12E

FY13E

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11E

FY12E

FY13E
Operating Cash Flow FCF post capex RoE RoCE

Source: Company data, Standard Chartered Research estimates Source: Company data, Standard Chartered Research estimates

Fig 20 – KNPL: Income statement (Rs m)


Year end: March FY09 FY10 FY11E FY12E FY13E
Net Sales 13,745 17,064 21,061 24,315 28,207
Exports 42 52 64 74 85
Domestic 13,704 17,012 20,997 24,242 28,122
Raw Material cost 8,996 10,718 13,567 15,714 18,215
Gross Profit 4,749 6,346 7,494 8,601 9,992
Gross Margin (%) 34.6 37.2 35.6 35.4 35.4
Other operating expenses 3,175 3,709 4,372 5,022 5,747
EBITDA 1,575 2,637 3,122 3,579 4,245
% growth -15.6 67.4 18.4 14.6 18.6
% margin 11.5 15.5 14.8 14.7 15.0
Depreciation & Amortisation 376 443 501 585 684
Gross Interest 18 12 20 22 22
Other Income 222 204 225 268 272
Recurring PBT 1,402 2,386 2,826 3,241 3,811
Add: Extraordinaries - 9 - - -
Less: Taxes 416 740 876 1,005 1,181
Effective tax rate 29.7 30.9 31.0 31.0 31.0
Net Income (Reported) 986 1,655 1,950 2,236 2,629
Recurring Net Income 986 1,647 1,950 2,236 2,629
% growth -17.7 66.9 18.4 14.7 17.6
% margin 7.1 9.5 9.2 9.1 9.2
Source: Company, Standard Chartered Research estimates

l Equity Research l 42
India Paint Sector l 19 January 2011

Fig 21 – KNPL: Balance sheet (Rs m)


Year end: March FY09 FY10 FY11E FY12E FY13E
Cash & Bank balance 762 411 439 685 750
Inventory 1,706 2,474 2,719 3,277 3,678
Sundry Debtors 2,096 2,324 3,100 3,162 4,103
Loans and Advances 417 411 527 608 705
Other Current Assets - - - - -
Total Current Assets 4,981 5,620 6,784 7,731 9,236
Sundry Creditors 2,300 2,940 3,522 3,939 4,716
Other Current Liabilities 142 103 103 103 103
Provisions 838 937 1,099 1,218 1,475
Total Current Liab. & Prov. 3,281 3,980 4,724 5,259 6,294
Net Current Assets 1,700 1,640 2,060 2,472 2,942
Investments 2,944 4,015 4,115 4,515 4,915
of which Strategic/Group 4 4 4 4 4
of which Marketable 2,941 4,012 4,112 4,512 4,912
Net Fixed Assets 2,731 3,058 3,891 4,627 5,477
of which CWIP 356 164 404 460 526
Total Assets 7,375 8,713 10,067 11,615 13,334

Equity Share Capital 269 269 539 539 539


Reserves & Surplus 6,275 7,459 8,543 10,091 11,810
Net Worth 6,544 7,728 9,082 10,630 12,349
Borrowings 936 1,100 1,100 1,100 1,100
Deferred Tax Liability -106 -115 -115 -115 -115
Capital Employed 7,375 8,713 10,067 11,615 13,334
Source: Company, Standard Chartered Research estimates

Fig 22 – KNPL: Cash flow statement (Rs m)


Year end: March FY09 FY10 FY11E FY12E FY13E
Reported Net Income 986 1,655 1,950 2,236 2,629
Depreciation & Amortisation 318 440 501 585 684
Others -224 -213 -234 -278 -281
Operating Cash flow 1,081 1,882 2,217 2,544 3,032
Working Capital changes 881 -384 -517 -258 -627
Capital Commitments -512 -767 -1,334 -1,321 -1,533
Free Cash Flow 1,450 731 365 964 872
Cash Flow Investing Activities -600 -867 125 -132 -128
Inc(Dec) in Borrowings -43 164 - - -
Dividend paid -378 -378 -471 -596 -688
Chg. In Cash & Bank 428 -351 28 246 65
Add: beginning balance 334 762 411 439 685
Closing balance 762 411 439 685 750
Source: Company, Standard Chartered Research estimates

l Equity Research l 43
India Paint Sector l 19 January 2011

Fig 23 – KNPL: Ratios


Year end: March FY09 FY10 FY11E FY12E FY13E
Per Share Data (Rs)
Recurring EPS 18.3 30.6 36.2 41.5 48.8
Reported EPS 18.3 30.7 36.2 41.5 48.8
Dividend per share (DPS) 6.0 7.5 9.5 11.0 14.5
Book Value per share (BV) 121.4 143.4 168.5 197.2 229.1
Growth Ratios (% YoY)
Net Sales 4.1 24.1 23.4 15.5 16.0
EBITDA -15.6 67.4 18.4 14.6 18.6
Recurring EPS -17.7 66.9 18.4 14.7 17.6
Valuation Ratios (x)
P/E 49.2 29.5 24.9 21.7 18.5
P/BV 7.4 6.3 5.3 4.6 3.9
EV / EBITDA 28.9 17.3 14.6 12.7 10.7
EV / Net Sales 3.3 2.7 2.2 1.9 1.6
Operating Ratios (%)
Raw Material / Sales 65.4 62.8 64.4 64.6 64.6
SG&A / Sales 10.6 10.7 10.5 10.7 10.8
Effective Tax Rate 29.7 30.9 31.0 31.0 31.0
NWC / Total Assets 12.7 14.1 16.1 15.4 16.4
Inventory (days) 45.7 44.7 45.0 45.0 45.0
Receivables (days) 56.1 47.3 47.0 47.0 47.0
Payable (days) 52.0 56.0 56.0 56.0 56.0
D/E Ratio (x) 0.1 0.1 0.1 0.1 0.1
Profitability Ratios (%)
RoCE 14.1 20.6 20.9 20.8 21.2
RoNW 15.8 23.1 23.2 22.7 22.9
Dividend Payout 38.4 28.5 30.5 30.8 34.6
Dividend yield 0.7 0.8 1.1 1.2 1.6
Source: Company, Standard Chartered Research estimates

l Equity Research l 44
India Paint Sector l 19 January 2011

Company profile
Kansai Nerolac is the second largest paints company in India and leader in industrial coatings. It
is a subsidiary of Kansai Paint Japan (69.3% stake), which acquired entire stake of Tata Forbes
group in 1999.

Its industrial range of products includes auto paints, powder coatings, general industrial and high
performance coatings. It commands a market share of ~60% in auto paints and is a supplier to all
leading auto companies, except Hyundai.

In decorative paints, it is the third largest players (after Asian Paints and Berger Paints) and has
a market share of 11%. It sells its products under its brand of Nerolac through a dealer network
of 12,000 across India. It is strongest in the northern region, which comprises ~40% of the sales

Fig 24 – Shareholding pattern

Others
19.7%

DIIs
5.3%
FIIs
5.7%
Promoter
69.3%

Source: BSE

Fig 25 – Management profile


Name Designation Background
Jamshed Jiji Irani is a Promoter of Tata Steel Limited and
Dr. JJ Irani Chairman also serves as special director of HDFC Ltd. since January
2008. He has been Chairman since July 2003.

Mr. Bharuka has been the MD of Kansai Nerolac Paints Ltd


HM Bharuka MD since April 2004 and has a varied experience of around 24
years in various facets of management in the Paints Industry.
Source: Company

l Equity Research l 45
India Paint Sector l 19 January 2011

Disclosures appendix
Global disclaimer
The information and opinions in this report were prepared by Standard Chartered Bank (Hong Kong) Limited, Standard Chartered Bank Singapore Branch,
Standard Chartered Securities (India) Limited and/or one or more of its affiliates (together with its group of companies, “SCB”) and the research analyst(s)
named in this report. SCB makes no representation or warranty of any kind, express, implied or statutory regarding this document or any information contained
or referred to in the document.

The research analysts responsible for the content of this research report certify that:

The view expressed and attributed to the research analyst or Analysts in the research report accurately reflect their personal
opinion(s) about the subject securities and issuers and/or other subject matter as appropriate; and
No part of his or her compensation and other benefits was, is or will be directly related to the specific recommendations or views
contained in this research report. On a general basis, the efficacy of recommendations is a factor in the performance appraisals
of analysts.
Our ratings are under constant review.

Additional information with respect to any securities referred to herein will be available upon request.

THIS RESEARCH HAS NOT BEEN PRODUCED IN THE UNITED STATES AND MUST NOT BE SENT OR TAKEN OR TRANSMITTED INTO THE UNITED
STATES OR DISTRIBUTED DIRECTLY OR INDIRECTLY IN THE UNITED STATES.

Disclosures Appendix

Where “disclosure date” appears below, this means the day prior to the report date. All share prices quoted are the closing price for the business day prior to
the date of the report, unless otherwise stated.

Company Asian Paints Limited

As at the disclosure date, the following applies:

Asian Paints Limited - current rating is: OUTPERFORM

3,000
2,800
2,600
2,400
2,200
2,000
1,800
1,600
Dec 09 Jan 10 Feb 10 Mar 10 Apr 10 May 10 Jun 10 Jul 10 Aug 10 Sep 10 Oct 10 Nov 10 Dec 10 Jan 11

Source: FactSet prices / SCB ratings and price targets

Company Kansai Nerolac Paints Limited

As at the disclosure date, the following applies:

Kansai Nerolac Paints Limited - current rating is: UNDERPERFORM

1,100
1,000
900
800
700
600
500
Dec 09 Jan 10 Feb 10 Mar 10 Apr 10 May 10 Jun 10 Jul 10 Aug 10 Sep 10 Oct 10 Nov 10 Dec 10 Jan 11

Source: FactSet prices / SCB ratings and price targets

l Equity Research l 46
India Paint Sector l 19 January 2011

Company Hyundai

As at the disclosure date, the following applies:

SCSK is a liquidity provider for the equity-linked warrants of Hyundai Motor and beneficially owned 3,499,940 units of call warrants (KRA741106074) as of 17
January 2011.
SCSK is a liquidity provider for the equity-linked warrants of Hyundai Motor and beneficially owned 3,499,990 units of call warrants (KRA741145080) as of 17
January 2011.
SCSK is a liquidity provider for the equity-linked warrants of Hyundai Motor and beneficially owned 3,500,000 units of call warrants (KRA741147086) as of 17
January 2011.
SCSK is a liquidity provider for the equity-linked warrants of Hyundai Motor and beneficially owned 3,499,990 units of call warrants (KRA741177083) as of 17
January 2011.
SCSK is a liquidity provider for the equity-linked warrants of Hyundai Motor and beneficially owned 3,497,160 units of put warrants (KRA741278089) as of 17
January 2011.
SCSK is a liquidity provider for the equity-linked warrants of Hyundai Motor and beneficially owned 3,499,990 units of call warrants (KRA7411500A9) as of 17
January 2011.

Recommendation Distribution and Investment Banking Relationships

% of covered companies currently assigned % of companies assigned this rating with which
this rating SCB has provided investment banking services over
the past 12 months
OUTPERFORM 63.5% 14.2%
IN-LINE 28.1% 11.0%
UNDERPERFORM 8.4% 3.3%

Research Recommendation

Terminology Definitions
The total return on the security is expected to outperform the relevant market index by 5% or more
OUTPERFORM (OP)
over the next 12 months
The total return on the security is not expected to outperform or underperform the relevant market
IN-LINE (IL)
index by 5% or more over the next 12 months
The total return on the security is expected to underperform the relevant market index by 5% or
UNDERPERFORM (UP)
more over the next 12 months

SCB uses an investment horizon of 12 months for its price targets.

l Equity Research l 47
India Paint Sector l 19 January 2011

Country-Specific Disclosures

If you are receiving this document in any of the countries listed below, please note the following:

United Kingdom and European Economic Area: Standard Chartered Bank is authorised and regulated by the Financial Services Authority. This
communication is not directed at Retail Clients in the European Economic Area as defined by Directive 2004/39/EC. Nothing in this document constitutes a
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l Equity Research l 48

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