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Foray in paints is return dilutive; however, correction overdone

JK Cement has announced its foray into the paints business last week. The company will invest INR 6bn on the business over 5 years, split into two parts – INR 3bn on capacity building (60,000 kl/annum) and INR 3bn on branding, working capital and accumulated losses for initial years. Our thoughts: a) foray into paints is necessary to sustain long term growth in putty business due to bundling of sales by paint companies, b) we derive comfort from the guidance that the annual investment in paints business will be restricted to 8-10% of standalone EBITDA, c) the company will launch the products only in states of UP and Rajasthan (10% of pan Indian market), with target market share of 7-10%, where it enjoys strong brand loyalty and 70% of dealer chain is common between paints and putty (rest being hardware stores). Assuming the company achieves its market share targets, being a new entrant in the business and conversion of customers from unorganised segment in tier3/4 towns will restrict margins in 12-17% range (500bps lower vs market leader), in our view. We believe the segment will be RoIC dilutive to some extent as we expect RoIC in 7- 11% range (Exhibit 1). However, we believe the current correction in the stock is overdone, notwithstanding the risks associated with paints business, even after factoring in elevated costs. Hence, we upgrade the stock to BUY with a revised TP of INR 2,750 (INR 3,200), as we cut our EBITDA estimates by 10%/5% for FY23/24E to factor in power & fuel/freight cost pressure and reduce target multiple to 12x (vs 13x).

Investment in paints business capped at INR 6bn: JK Cement has taken aboard approval to enter paints business with INR 6bn investment, split into INR 3bn for capacity building (60,000 KL/annum) and INR 3bn for working capital, branding, and accumulated losses in initial years. The plant will be located in Kanpur, UP and will be finalised in 2-3 months’ time. The annual investment will be capped at 8-10% of the standalone EBITDA. Company will split the investment into Equity and Redeemable Preference capital. The company wanted to secure the capital expenditure in the grey cement business (Panna) and then take on a new venture.

Financial metrics: Company will begin the business with revenue of INR 1-1.5bn in first year (FY25) and a consistent growth to INR 7-8bn on a stabilised basis. Company is looking at gross and EBITDA margins of 35-40% and 17-23% for the business (basis the margins being made by incumbents). Current incumbents are making 18-35% of returns on capital employed in the business. However, we believe the company will make return ratios of 7-11% on a stabilised basis, thus being RoIC dilutive.

Paints business to complement the white putty business: JK Cement has taken a decision to enter the business to complement the cement putty business – 70% of the putty sells through paints channel (20-25k dealers and 50-60k retailers in the target markets), strong brand equity and bundling of the products. Paints companies had begun bundling paints with putty over last three-four years, which made it difficult for putty players to sell in the retail channel. Hence, the company has strategized to enter the paints business to complement its putty business.

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