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Higher raw material prices drag profitability…

About the stock: Kansai is the global leader in industrial coatings (automotive). However, in the last 10 years, it has increased its decorative paint mix to 55% of its total topline. Currently, Kansai is the third largest decorative paint player in India.

* Strong distribution network of ~28,000 dealers across the country with 75-80% penetration of tinting machine

* In the last two years, KNL has increased its total paint manufacturing capacity by 28% to 5.3 lakh tonnes at an investment of ~| 1100 crore

Q2FY22 Results: Delay in passing of higher raw material prices dented profitability but revenue growth was in line with our estimate.

* Favourable base and strong demand for decorative paints helped drive revenue up by 16% YoY to | 1521 crore

* Sharp rise in raw material prices and delay in passing on the same dragged gross & EBITDA margin down by 1040 bps and 925 bps YoY, respectively

* PAT declined by ~41x YoY to | 99 crore, tracking lower margins

What should investors do? Kansai’s share price has grown by ~1.5x over the past five years (from ~| 379 in October 2016 to ~| 560 levels in October 2021).

* We revise our rating from BUY to Hold on the stock

Target Price and Valuation: We value Kansai at | 630 i.e. 48x P/E on FY23E EPS

Key triggers for future price performance:

* We believe the decorative paint will continue to grow ~2x of GDP growth considering, shortening of repainting cycle, growing urbanisation and increased distribution reach of organised players

* Revival in passenger vehicle sales and strong demand momentum in industrial paints would help in a recovery in 45% of KNL’s revenue portfolio

* Focus on improving product mix towards premium products would help drive profitability, going forward

Alternate Stock Idea: We also like Asian Paints in our coverage universe.

* Asian Paints is the market leader in decorative paint and is expanding its product portfolio along with dealer expansion in tier II and tier III cities

* BUY with a target price of | 3425

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