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Plans to foray into the Paints business but at a low scale

Will it end up as another ineffective capital allocation after Fujairah?

JK Cement (JKCE) announced its intention to enter the Paints business through a wholly owned subsidiary, according to the notice given to BSE on 5 th Mar’22. The company will invest INR6b over five years.  It was likely that JKCE might explore opportunities in the Paints business too after Grasim announced its foray into this business in Jan’21. Both Grasim and JKCE are manufacturers of White Cement and Wall Putty in India, whose distribution channels overlap with the Paints distribution channel.

Investments of JKCE will be at a much lower scale v/s Grasim (capex of INR50bn) and we believe that its presence will be limited to North/Central regions. Entry in this segment at such a lower scale does not make much business sense at a time when competition is likely to intensify (entry of Grasim at a much bigger scale with nationwide presence and ambition to become the No. 2 player in the industry in terms of profits). We expect Grasim to compete strongly with incumbents given its strong brand recall, large scale, healthy balance sheet and expertise to run the chemicals plant.

Grasim has already received Environmental Clearance for its factories in Punjab and Haryana and we believe that these will be operational in the next 18 months. Further, hardware stores may face challenges for allocating space for tinting machines to another new entrant in such a short time.

Though, JKCE’s management has not shared details of the business yet, we believe that it can set up a plant of 0.12-0.15m kl (assuming 15% of the amount committed for working capital and capex/liter of INR40).

JKCE’s Fujairah plant has already been running into losses and the entire net worth of this subsidiary has been wiped out. JKCE made an investment of INR6.92b in this subsidiary until 31st Mar’21 and it had taken an impairment of INR3.28b until Mar’21 (INR1.67b in FY21 and INR1.61b in FY20). It also provided for INR166.4m for outstanding receivables of earlier years, in FY20

Maintain Neutral due to limited potential upside

We have not factored in the investments in the Paints business into our assumptions as of now and have not ascribed any value to the same. JKCE is in the process of increasing its grey cement grinding capacity by 4mtpa in the central region by 1QFY24E (current capacity: 14.5mtpa).

The stock trades at 13.6x/12x FY23E/FY24E EV/EBITDA. It has traded at an average one-year forward EV/EBITDA of 10.8x for the last seven years.

We value its White Cement/Grey Cement at 14x/13x FY24E EV/EBITDA (v/s 15x/14x earlier, considering entry into unrelated business segment) to arrive at a TP of INR2,925, implying 11% upside potential. We maintain our Neutral rating on the stock.

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