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On right track to resolve issues that led to underperformance vs peers in past 3 years

While Kansai’s Q2FY23 was weaker than consensus and our estimates, we note certain positives as (1) the company has increased its brand building spends. We model the benefits with a lag of 2-3 quarters, (2) recovery in automotive paints will likely ensure superior revenue growth vs peers and lead to benefits of operating leverage and (3) With expected price hikes from Auto OEMs, the EBITDA margins have bottomed out, in our view.

Kansai is focusing on resolving issues that led to its underperformance vs peers. It plans to increase share of voice, premiumize the portfolio, defocus some of the low margin products and expand distribution. While we note Kansai is on right track, we model the restructuring process to impact earnings in near term. With entry of Grasim and multiple large players, our neutral stance on paints remains intact. Maintain HOLD.

* Q2FY23 performance:

Kansai reported revenue, EBITDA and PAT growth of 19.2%, 22.5% and 27.4%, respectively. Gross margin was flat YoY but declined 110bps QoQ. EBITDA margin was up 30bps YoY but declined 210bps QoQ due to higher input prices and increase in brand building efforts. The company has raised prices across decorative and industrial paints and expects to negotiate additional price hikes with Auto OEMs in H2FY23.

* Segment-wise performance:

Industrial paints have reported healthy growth with revival in automotive industry. However, Decorative paints were impacted due to prolonged rainfall. Kansai plans to premiumize the portfolio across both segments and we believe it may have curtailed sales of some low margin paints in Q2FY23.

* Increase in brand building spends:

Kansai has done relaunch of its brand as ‘Kansai Paint+ with Japanese technology’. It has also increased the branding and marketing activities in Q2FY23. We model the benefits of these investments to be realized with a lag of 2-3 quarters.

* Likely weaker Q3FY23: The company expects Q3FY23 to be slightly weaker for decorative paints due to (1) prolonged monsoon, (2) strong base of Q3FY22. Due to price hikes of ~18% in Q3FY22, there was higher inventory build-up in trade and (3) early Diwali. Some sales attributable to Diwali are already booked in Q2FY23.

* Maintain HOLD:

We model revenue and PAT CAGRs of 19.1% and 44.5%, respectively, over FY22-24E. We maintain HOLD with a revised DCF-based TP of Rs500 (implied: 38x FY24E EPS). Key risks: Continued slowdown in Industrials and inflation in input prices. Upside risks: Lower-than-expected competitive pressures.

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