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Auto-paints shine but high-cost raw material stocks dim margins; Buy

Kansai Nerolac’s posted a broadly in-line performance on adj Q3 FY23 figures (for exceptionals incl. in other income in Q2 FY22). Revenue growth was driven by auto paints; decorative paints slightly declined (volumes likely to be flat) hit by a prolonged monsoon and early Diwali. Margins was squeezed by high-cost stocks, expected to be exhausted gradually in another 1-2 quarters. Thus, dimming margin expectations. Hence, we lower our FY23e-25e 8-10%. The expansion to new businesses (construction chemicals), consistent innovation and portfolio premiumisation, supported by higher brand spends should aid in better decorative paints revenue growth. Also, softer input prices, industrial and automotive paint recovery and attractive valuations keep us positive on the stock. We recommend a Buy, with a TP of Rs560 (37x Sep’24e, a 5% discount to its 10-year average PE) vs. Rs610 earlier.

Auto paints drive revenue. Reported sales rose 1% y/y, driven by auto-paints, helped by easing supply-chain issues (semi-conductor shortages). Decorative paints dipped slightly in Q3 due to an adverse sales mix as volumes were 3-4% more (impacted by the protracted monsoon). Management was optimistic of steady volume growth in auto-paints (barring two-wheelers, slow recovery) We project a ~13% revenue CAGR over FY22-25 on price increases, greater demand for auto & industrial paints and the foray into newer businesses

Margins to lag peers for 1-2 quarters due to high cost inventory. Despite a 3% price hike YTD in decorative paints (and 8-9% in industrial), the gross margin slid 115bps in Q3, due to high-cost inputs stock. We are optimistic of decorative & industrial premium paints, and softening input costs (partly offset by rupee depreciation & higher brand spends) in gradually improving margins in coming quarters. Hence, we build a 14.4% EBITDA margin for FY25, up from 10.2% in FY22.

Key risks: Persistently high input costs, slower-than-anticipated recovery in its automotive-paints category and market-share loss due to keener competition.

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