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Paints: Analyzing Grasim’s ‘right to win’ in paint industry and impact on incumbents

Realistic view / our view: Given that Grasim targets a 20% IRR in paints, we do not expect material impact on incumbents. We believe additional media spends and investments in distribution to accelerate industry growth and drive formalisation. We ascribe low probability of a price war as pricing is not the most critical differentiating factor for consumer purchase decision. Industrial paints will be least impacted considering Grasim plans only Decoratives as of now. Apart from commitment of Rs50bn investment over CY20-23, Grasim will also benefit from (1) Birla White and Birla WallCare putty brands and (2) distribution of putty through 54,000 outlets, 70% of these outlets also sell paints. It will also have advantage in cement paints/primer. Relationships with real estate developers may help to gain share in projects business (~10% of paint industry). Creation of stronger brand equity and investment in tinting machines remain two challenges but considering Rs50bn as investment, it can also invest/subsidize tinting machines. Likely consensus view: This event may lead to derating of all paint stocks, particularly the #2-5 players (Berger, Kansai, Akzo Nobel etc.). Top picks are Akzo Nobel (preferred turnaround pick, rated BUY) and Asian Paints (rated ADD). We continue to recommend investors to wait for better entry points in Berger Paints and Kansai Nerolac (both rated HOLD).

* Opportunity in paint industry: Paint industry size is estimated to be ~Rs550bn. The share of organised industry is ~75%. The size of unorganized industry is ~Rs150bn. There is steady formalization of the sector post demonetization, roll out of GST and covid-led lockdown. We believe Grasim is likely to aim market share gain from unorganized/smaller players as well as gain from growth in paint industry. It aims to be a #2 player.

* Paints is tough industry to succeed…: Large players such as Sherwin Williams, Jotun, Nippon have failed to gain market share of more than 2% in Indian paint industry. Indian companies such as JSW paints and Shalimar also have market share of 1-2%. Market leading paint companies (Asian Paints, Berger, Kansai and Akzo) have been able protect their market shares via strong investments in branding, distribution, new products and technology.

* …but recent increase in industry profitability offers scope to new players: The paint industry used to generate EBITDA margin of 12-14% prior to FY10. However, there is steady increase in profitability and the industry’s EBITDA margin is upwards of 18% over FY17-20. Increase in profitability of incumbents allows new players to enter the market and gain share.

* ‘Right to win’ for Grasim: The company will benefit from (1) Birla White and Birla WallCare putty brands, (2) distribution of 54,000 outlets of Ultratech, a group company. Out of these units, 70% outlets also sell paints, (3) relationships with real estate developers. Projects business is ~10% of paint industry revenues and (4) Strong right to win in cement paints and cement primers.

* Likely investment in tinting machines: Grasim plans to invest Rs50bn in decorative paints over next three years. We believe the amount committed for paint business is far higher than requirement of capex and working capital. Capital employed in FY20 of all paint companies (Ex- Asian Paints) is less than Rs50bn. We believe Grasim can also invest/subsidize tinting machines to drive growth.

* Impact on paint industry and companies: Considering Grasim also plans to generate 20% IRR on the investments in paint business, chances of price war are low. However, the profitability of entire sector may move a notch lower. Additional investments in market creation and distribution may accelerate growth of paint industry as well as formalization of the sector. As Grasim plans to enter Decorative paints, we believe there will be negligible impact on industrial paint business. In case of price war (if any), incumbents with high margins / cost structure may suffer more.

* Valuation and risks: We value stocks on DCF. Key upside risk is better-thanexpected gross margins due to decline in input prices. Key downside risk is unexpected irrational competition. Please refer table-4 for revised target prices and ratings.

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