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Buy Grasim Industries Ltd For Target Rs.1,2250

Paint is ‘Green’ – a pan-India brand makes foray; upgrade to Buy

* Grasim Industries’ entry into the paints business signals the company’s diversification into a high-growth, high-RoCE segment from cyclical and non-core (fertilizer) business segments. Grasim had already announced divestment of the fertilizer business earlier.

* Brand strength and strong distribution network (70% overlap between white cement/putty and paints dealers) of Birla White and strong balance sheet of Grasim positions the company well for reasonable success in the paints business. We believe that Grasim is likely to pose a serious competition to incumbents in the paints business in the long run.

* The planned Rs50bn initial capex in paints partly alleviates investors’ concerns about further investments in Vodafone Idea (VIL). Success in paints would ensure stable cash flows to the standalone entity and hence, likely higher valuation multiples for Grasim. We believe that weakness in the stock price, if any, due to this news should be bought into.

* Our channel checks indicate VSF prices are up 20% vs. Q3 average; after an increase of 20% qoq in Q3FY21. We upgrade Grasim to BUY from Hold, based on 1) 5% increase in TP of UTCEM after Q3 results, and 2) 5% premium to SoTP value for entry into the paints business. Management targets 20% IRR from the Paints business.

Foray into paints business to provide stable cash flows in the long run: On Friday, Grasim announced its foray into the paints business with a planned capex of Rs50bn over the next 3 years. Paints business offers high and steady growth potential as well as high profitability, and Grasim aims to become the No.2 player in the industry. Grasim already enjoys leadership position in its other two businesses (VSF and Chemical) and is in the process of increasing capacities in both. During Q2FY21 results, the company had announced divestment of the fertilizer business for Rs26.49bn. This deal is expected to be completed in 6-9 months. Paints companies reported EBITDA margins of 14-22% and RoCE of 18-33% in FY20, compared with 7-11% margins in the fertilizer business during FY18-20. We forecast Grasim may achieve meaningful scale in the paints business, with a volume market share of 6% and value share of 7% by FY28E.

We upgrade Grasim to Buy: Grasim’s large capex plan shows its commitment to being a serious player in the paints industry. Management targets to achieve an IRR of 20% in this business. We think we are not highly optimistic in our assumptions as new entrants in the paints industry have found it difficult to build market share quickly; nonetheless, the distribution network of Birla White and strong brand identity of Birla group may help Grasim achieve a higher scale sooner than previous entrants. UTCEM (subsidiary company) already has presence in the white cement & wall putty segment with a distribution network of 54,000 dealers and over 70% overlap between paints and white cement/putty dealers as per management. Grasim has a strong balance sheet and we expect the company to become net cash positive in FY23E (considering the proceeds from divestment of fertilizer business), which would support investment requirements of the paints business. VSF prices too are on an upswing post Oct’20 and would help profitability of the standalone entity. We upgrade Grasim to Buy from Hold and raise the TP to Rs1,225 from Rs1,105. Our TP includes a 5% premium to underlying SoTP to capture the potential upside from its paints foray. Key risks are: 1) decline in VSF prices and 2) lower-than-expected market share gains in the paints industry.

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