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Grasim’s entry to heat up competition in paints

* Grasim Industries, an Aditya Birla Group company, has announced its foray into the Decorative Paints business. The company’s ambition to become #2 player and initial capex outlay of Rs50bn (over next 3 years) suggest that the competition is likely to heat up, even as Paints is a tough category to crack.

* Grasim’s cash generation and balance sheet capacity indicate reasonable ability to invest aggressively. Grasim plans to leverage its subsidiary Ultratech’s putty distribution network of 54,000 outlets; 74% of them are also paint outlets.

* Paints has high entry barriers and new entrants have had very limited success over the years. Asian Paints dominates the sector (40%+ value share), thanks to its strong brand, distribution and execution. Also, 25% of category revenue are in the unorganized segment.

* Grasim’s entry may provide impetus to volume growth over the medium-to-long term, but it is also likely to impact margins and profitability of incumbents. Post recent run-up in share prices, we believe that APNT/BRGR/PIDI are richly valued at 53x/73x/56x and may see some correction in the near term. We maintain Sell on BRGR and PIDI. We retain Hold on APNT but reduce Mar’22 TP by 9% to Rs2460, valuing it at 50x FY23E PER.

Grasim plans big and serious entry into paints; to leverage Ultratech’s putty reach: Grasim has announced a serious entry into decorative paints with an ambition of becoming a No. 2 player. The company has announced an investment of Rs50bn over the next three years with an appetite for further investments in future. Management commentary indicated that a detailed business plan is already in place, which aims pan-India presence with expansion at an aggressive pace. It plans to leverage Ultratech’s Birla Putty reach (arrangement would be at arm’s length), given the product leadership in the putty market and reach to 54,000 outlets (2nd largest distribution), 74% of which are also paint outlets.

Success not easy given high entry barriers; but rise in competitive spends is inevitable: Even as paints is a low-tech product category and offers limited product/service differentiation, it has significant entry barriers on account of entrenched brands and distribution networks (latter cemented by deployment of tinting machines in retail outlets) and influence over trade/applicators though training and discount schemes as well as loyalty and incentive reward points. The paints market is dominated by top 3 players (~65% market share), which have a strong brand and execution and retail presence that is difficult to match but also has a large presence of unorganized/regional players as well (almost 1/4th). New players could not make a dent, including Nippon Paints and JSW, due to inability to scale up retail presence. While it may be difficult to displace the top 3 players, Grasim’s foray cannot be overlooked. At the very least, it is likely to drive up sales & marketing spends across the industry, impacting margins of incumbent players over the medium-to-long term. We expect the competition may also spill over to adjacent categories of construction chemicals/waterproofing, impacting PIDI.

Rich valuations to moderate in view of emerging competition: Growth opportunity in Paints remains exciting, driven by favorable demographics, growing urbanization, trends toward rental housing, and premiumization in Tier-3 and rural areas. However, the entry of a well-capitalized entity with aggressive ambition is likely to increase competitive intensity and marketing/channel spends. It may also impact margins of incumbent players (earning 35-40% RoIC), thus emerging as a valuation overhang for paints stocks. Recent run-up in share prices of APNT/BRGR/PIDI has made their valuations expensive at 53x/73x/56x, which we believe should correct. We maintain Sell and UW stance BRGR and PIDI. We retain Hold on APNT, but trim our TP by 9% to Rs2460, applying a lower 50x PER multiple on our FY23E EPS.

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