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Third straight quarter of market share gains in decorative paints

Akzo’s revenue growth (49.7%) was higher than peers like Kansai (46.2%) and Indigo (43.6%) and it has likely gained market shares in decorative paints for third consecutive quarter. We remain structurally positive on Akzo as the fruits of the efforts in past three years are visible now. It has (1) reported strong growth in smaller towns and rural markets which was largely led by distribution expansion, (2) its steady launches in luxury and premium decorative paints helped report strong growth in Q1FY23 and (3) new product like Dulux Smartchoice economy emulsion is performing well especially in smaller cities/ towns.

Ahead, we model (1) the distribution 2.0 strategy to expand reach to ~35,000 outlets from 20,000 currently to continue to drive growth, (2) new launches like waterproofing as well as floor paints have positive channel feedback and it should translate to strong consumer off-take and (3) recovery in industrial paints due to sustained revival in Government projects, higher capex and infrastructure spending leading to superior growth of Coatings segment.

We shall track the execution and ramp-up very closely, which are very important for the narrative (and potential stock rerating). We stay believers. Stock trades at 20.8x FY24E (>50% discount to APNT), providing significant margin of safety. ADD; TP Rs2,050.

* Q1FY23 results: Akzo reported revenue, EBITDA and PAT growth of 49.7%, 33.8% and adjusted PAT growth of 30.3%, respectively YoY. Akzo has minor price hikes in Q1FY23 in low single digits in line with peers. Gross margin declined 341bps due to higher input prices, partially offset by higher revenues of luxury and premium products. EBITDA margin declined 154bps (lower than GM decline) due to operating leverage and cost-saving initiatives. Akzo’s revenue growth was higher than Kansai and Indigo which indicates it has gained market shares for 3rd consecutive quarter.

* Segment-wise performance: In our view, Akzo reported volume growth of 30-35%, adjusting for effective price hike of ~25%. It has done well in luxury and premium paints. Volume off-take was strong in metros and tier 1 cities. The incessant efforts to expand distribution helped Akzo report healthy growth in smaller cities and rural markets. Major sub-segments of Industrial coatings did well in Q1FY23. There was strong growth in automotive, Marine, Protective and powder coatings.

* Benefits of distribution expansion: Akzo benefitted in decorative paints as it reported strong volume growth in smaller cities and rural markets. While the impact of inflation is higher in these regions, distribution expansion allowed company to report strong growth. After expanding distribution to 20,000 outlets and 15,000 tinting machines, Akzo now plans to expand distribution 30,000-35,000 dealers. It will continue to add ~2,000 tinting machines each year.

* New products progressing well: Dulux Smart Choice economy emulsion has done extremely well. The floor paints are still in roll out stage but early channel feedback remain positive. The company has rolled out digital communication to strengthen its waterproofing solutions. It has rolled out story of ‘Parul and Painter’ which speaks about Dulux AquaTech waterproofing brand as ‘Must Hai, Best Hai’

* Strong potential in Industrial paints in next two years: We note the revival in Government projects, real estate and construction activity remains strong. It augurs well for Industrial coatings segment of Akzo. As paint are generally used in later stage of infrastructure paints, we model strong volume CAGR in low double digits for Industrial paints over FY22-24.

* Reiterate ADD: We stay believers. Retain ADD with a revised DCF-based TP of Rs2,050. Akzo is trading at lowest valuation (20.8x FY24E) among its peers in paint sector providing significant margin of safety, in our view. Key risks are execution-linked challenges and demand deceleration.

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