Can new players give Asian Paints and Berger Paints a run for their money?

Ever since Grasim has made an announcement of doubling its investment in the paint business to Rs 10,000 crore, stocks of existing paint companies have been on the edge. Do existing paint companies stand to lose as a big company with deep pockets and high capabilities is ready to make a grand entry?

Some experts are calling it a Jio moment of the paint industry. But Grasim hasn’t done any better either, over the past 7-8 months. Is it going to grab market share silently or start a price war? And how should you approach paint stocks now?

Hopefully, this post clears the air!

First things first, when Jio entered the telecom market with its aggressive pricing plans, the sector was already reeling under pressure. Incumbents were staring at dwindling profits and years of accumulated debt due to intense competition. Jio changed the rules of the game and disrupted the sector.

Unlike telecom, which functioned more like a utility sector, the paint business is a proxy on domestic consumption demand. It is less capital intensive as well. The leading paint companies in India are highly profitable and their debt positions are comfortable too.

Snapshot of the Indian paint industry

• The Indian Paint Industry is valued at approximately Rs 70,000 crore and is expected to touch the milestone of Rs 1 lakh crore over the next few years.
• In pre-pandemic times, the organized sector had a market share of 67% which is likely to have increased over the last two years.
• Decorative paint is the dominant segment and accounts for 74% of the industry’s revenues.
• India has a per capita consumption of about 4.1 Kgs, which is lower than the average consumption of 4.7 Kgs in the Asia Pacific region. The average consumption of developed nations in the region has been around 9.7 Kgs.
• Asian Paints enjoys a 50% share of the organized market and Berger Paints accounts for 17%. In other words, the top two players make up 2/3^rd of the organized domestic market.

The paint business doesn’t have very high entry barriers but setting up a distribution network is a Herculean task, especially if any company wants to take on the industry leader. Asian Paints has a dealer network of 70,000, spread across the country.

How big a disrupter Grasim would be:

Grasim has guided for completing its project of setting up a capacity of 1,332 MLPA (Million Litres Per Annum) by Q4FY24.  Asian Paints has an operational capacity of 1,730 MLPA at present.

Moreover, Grasim is aiming to tap the distribution network of UltraTech’s white cement division. UltraTech, a Grasim subsidiary, has a distribution network of 54,000 for its white cement business, of which, 37,800 dealers would sell Grasim’s paints as well.

So far, no companies have even come close to Asian Paints and Berger Paints because setting up a pan-India distribution network hasn’t been easy. But conglomerate players don’t face this challenge.

According to latest company disclosures, Asian Paints had gross fixed assets (i.e. fixed assets such as land, buildings, plant and machinery, etc. unadjusted for accumulated depreciation) of Rs 6,997 crore.

If we exclude the value of land, since it may not reflect the market value, the gross assets are worth Rs 6,552 crore. This is approximately an amount required to get the manufacturing scale of Asian Paints.

On this backdrop, Grasim’s capex of Rs 10,000 crore for its paint business appears substantial.

The company has already spent Rs 579 crore on land acquisition and has completed the process of possession and registration at 5 sites. Registration at one site is yet to be completed. It has already issued engineering contracts for all 6 sites and civil work has begun at two sites—Panipat and Ludhiana.

How should stock market investors read these developments?

The bright prospects of the paint sector have been attracting new players for a while now.

Smaller standalone players are still sitting on a very small market share despite years of existence. However, the entry of conglomerates is going to make giants at least take notice of the changing business landscape now. Besides Grasim, JSW is another group that is eyeing a large slice of the paints business.

In fact, JSW Paints has time and again said that industry leaders have been playing anti-competition tactics to discourage retailers from distributing JSW Paints’ products. In fact, its complaint made the Competition Commission of India (CCI) order a probe against Asian Paints in 2020.

Is that a precursor of what’s coming in the future?

After the recent fall, Asian Paints and Berger Paints are now trading close to their 5-year average valuations on trailing twelve month basis. They still look expensive. But they have always been expensive.

Now what is likely to change?

The focus of new entrants is decorative paint and NOT industrial paint. Therefore, the incumbents, such as Kansai Nerolac Paints, are less likely to feel the heat of new entrants.

Speaking about decorative paint, the unprecedented rise in raw material prices has been putting a lot of pressure on the sector. Although the leaders in the sector have so far managed to take price hikes to negate the impact on their margins. Will they enjoy the same pricing power in future?

Well a lot depends on how conglomerates such as JSW Paints and Grasim approach the competition. Unless new players start a price war, the untapped market in India is big enough to accommodate all pan-India organized players, old and new.

That means, unorganized players stand to lose the most since rising cost pressure is likely to hit them the hardest. Smaller standalone/regional paint companies with limited financial strength could be the next in the firing line.

In summary

Stock returns come through two means—valuation expansion (i.e. when P/E multiple of a company rises) and when earnings rise and prices play catch up. So far existing leaders have witnessed both.

Going forward, valuation expansion looks possible only if the existing players manage to beat the other industry players on growth and profitability. New players have the potential to give existing players a run for their money.

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