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Margin recovery a key positive...

Kansai Nerolac Paints Ltd. (KNPL) is the market leader in industrial paints and the third largest decorative paint company in India.

• During the quarter, the top line grew by 5.1% YoY, led by high single digit volume growth in the decorative paint business.

• Gross margin improved by 537bps YoY to 64.7% owing to moderation in raw material prices. While EBITDA margin improved by 294bps YoY to 15.4% in Q1FY24.

• Within the industrial paint segment, automotive demand stabilised, while the non-auto segment performed well.

• The management is focusing on improving its market share in the decorative business and expects the segment to grow faster than industrial paints.

• KNPL expects margins to stabilise at 14% in the coming years on account of favourable input prices and a revival in rural demand.

• We revised our rating from Accumulate to BUY and value KNPL at 40x on FY25E EPS with a target price of Rs. 388.

Decorative demand in high single digit...

The company reported top-line growth of 5.1% YoY to Rs.2,157cr, supported by high single-digit volume growth in decorative paint demand and healthy demand in industrial paints. Within the industrial segment, automotive demand stabilised, while the non-auto segment performed well. The company is focused on growing its decorative business through new premium product launches and project business, which now accounts for 10% of the total revenue. In the project business, the company’s market share is less than 10%. Geographically, Tier 1 cities contribute 10% to 15% of the total revenue, while Tier 2 to Tier 4 cities contribute 20% to 25%. The decorative segment constitutes 55% of the revenue, and the industrial segment contributes 45% in Q1FY24. The management highlighted that the journey of exiting low-margin paints is progressing well, and they are focusing on adding more premium paints.

Margin recovery on cards...

KNPL’s gross margin improved by 537bps YoY to 35.3%, led by a fall in input prices and traction in rural demand. While EBITDA margin expansion was capped at 294bps YoY to 15.4% due to higher employee costs and other expenses. We expect margins to stabilise in the coming quarters due to benign oil prices and higher demand for premium paints. During the quarter, KNPL received an exceptional gain of Rs671cr on account of the sale of land at Thane, which helped the reported PAT grow by 383% YoY.

Key highlights...

• The growth momentum in automotive and performance coatings is expected to continue.

• A favourable monsoon and a longer festival season are likely to see traction in decorative demand.

• The progress of the monsoon augurs well for rural demand in the coming quarters.

Valuation and Outlook

We expect the revival in decorative paint demand, along with margin recovery, to lead to profitability. Therefore, we revise our rating to BUY from Accumulate on the stock with a target price of Rs. 388, based on a P/E of 40x on FY25E EPS.

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