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Asian Paints hosted the 1QFY22 results call yesterday (July 20) 6pm IST. PPG Industries Inc. (global second largest paints and coating company by revenue, third largest by market cap) hosted its 2QCY21 results call around the same time – 8am EST.

In our interpretation (from the call), APNT expects raw material inflation to decelerate, whereas, interestingly, PPG US expects raw material inflation to continue for now, and it explains it’s view on impact on auto OEM (some implications for Kansai Nerolac, Akzo Nobel India etc. in our view). PS: We liked a statement by Michael McGarry, CEO of PPG US about owning up (given below).

Verbatim comments (select) from PPG US call:

I would say we're disappointed that the raw material inflation continued at such a high level throughout the quarter, and it just seemed to get worse. And when you bank on your suppliers saying they are going to get to 20 trucks and they get you 10, that doesn't help you. So we own up to this raw material inflation miss and that's our accountability.

Due to supply disruptions we experienced unprecedented levels of raw material and transportation costs that continually elevated as the quarter progressed. This drove raw material inflation to be up a mid to high teens percentage on a year-over-year basis versus our original estimate of a high single digit percentage increase.

Our automotive OEM business was impacted most significantly from supply disruptions….

This impacted our sales by about $100 million or higher than $40 million more than we expected in April. Finally, as we expected, the supply disruptions led to shortages of certain raw materials. We had anticipated an impact the $30 million to $50 million, but the actual impact was closer to $100 million. We are highly confident that the sales related to these production disruptions will be deferred to later quarters, and this will elongate the global automotive OEM recovery.

As I mentioned in April, coming into the year we're expecting an inflationary environment and had prioritized selling price increases across all our businesses. This helped us to achieve solid price increases year-to-date and our pace of price realization is well ahead of the most recent raw material inflation cycle in 2017 and 2018.

Clearly this inflation cycle is much higher than anyone anticipated and we're continuing on a business-by-business basis, working to secure further selling price increase. This includes executing additional pricing actions during the third quarter. As a reminder, the second quarter of 2021 was our 17th consecutive quarter of higher selling prices. Another notable accomplishment during the second quarter was the appointment of our company's first ever Vice President of Global Sustainability.

PPG has been a clear ESG leader in the coatings industry through our market leading sustainable products and we have plans to further improve our overall ESG program. We also expect raw material costs to remain at elevated levels in the third quarter. Our current best estimate is that they will be inflated by as much as 20% compared to the third quarter of 2020 with businesses in our industrial coatings segment experiencing the largest increases due to the raw material mix of those types of coatings.

As a result, all of our businesses are securing additional selling price increases. Due to significant increases we experienced in the second quarter and anticipate in the third quarter, we now fully expect to offset raw material cost inflation in the fourth quarter on 2021 on a run rate basis. As I've said previously, these current disruptions are temporary and we strongly believe there is sufficient capacity available in our supply chain once operating conditions normalize.

But overall I would say raw materials, the only one that we're currently forecasting to be moderating is the oil, and as you saw oil in the past week has started to decline. So solvents would parallel the oil price changes. So that’s the only one we have right now in our model. Akzo Nobel (only paint stock in our coverage rated BUY) is preferred turnaround pick and beyond (though, we reckon that short-term remains cloudy, may be a tad underwhelming). We have ADD rating on Asian Paints, Kansai Nerolac and Indigo Paints and HOLD rating on Berger Paints.

Valuation and risks

We value stocks on DCF methodology (WACC and TG ranging from 10-13%, 3-6% respectively). Key upside risk is better-than-expected gross margins due to correction in input prices. Key downside risk is unexpected irrational competition due to deceleration in general consumption demand. Please refer table 1 for estimates, target prices and ratings.

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