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Steep (input inflation, competition, valuation) = our inability (and unwillingness) to have a constructive view

Berger’s revenue growth (27.7%) was lower than market leader Asian Paints revenue growth of (32.6%). However, Berger reported least EBITDA margin decline (333bps) amongst its peers Asian Paints (1090bps), Kansai (937bps) and Indigo (690bps). We believe key reasons were likely higher price hikes than market leader and lower ad-spend. While we remain structurally positive on (1) Berger’s strong positioning in value-for-money paints, (2) established distribution network especially in East India, (3) aggressive growth strategy and innovation and (4) high probability of market share gains in ancillary segments such as waterproofing and putty, we believe the premium valuations are unjustified (78x FY23E). Also increase in competitive intensity coupled with steep input inflation are likely to hurt industry profit pool in H2FY22 and FY23. Maintain REDUCE rating with DCF based TP of Rs670.

* Q2FY22 results: Berger reported consolidated revenue, EBITDA, PAT growth of 27.7%, 5.6% and 0.9%, respectively. (Two-year revenue and EBITDA CAGR was 18% and 18.7%, respectively). We believe volume growth was ~20% YoY. Recovery in industrial paints, healthy volume growth and price hikes were chief reasons for 27.7% revenue growth. Gross margin declined 449bps YoY due to higher input prices but EBITDA margin declined 333bps due to cost saving initiatives. (Lower adspend in our view) Standalone business reported revenue and EBITDA growth of 26.1% and 0.8%, respectively but PAT declined 0.5%, YoY.

* Margin decline less than peers: Berger’s Q2FY22 EBITDA margin decline (333bps) was lower than peers due to (1) price hikes higher than market leader, (2) market share gains in economy paints and operating leverage and (3) likely reduction in ad-spend. EBITDA margin decline for peers was as follows: Asian Paints (1090bps), Kansai (937bps), Indigo (690bps).

* Industry profit pool likely to shrink: While input price index is up almost 60% YoY, we believe the paint industry and Berger is behind the curve in passing on entire input inflation as (1) they are gaining market shares and would like to continue that instead of just focusing on margins. Market share gain is more DCF accretive and (2) there will be some signal to the new competitors. We model the paint industry profit pool to be under pressure in H2FY22 and FY23.

* Maintain REDUCE: We model Berger to report revenue and PAT CAGRs of 19.2% and 17.2% YoY respectively over FY21-24. RoE is expected to be stable ~23% over FY21-24. However, we believe the stock price upside is limited at current valuations (78x FY23E) and hence maintain REDUCE rating with a DCF based target price of Rs670. Key upside risk is higher-than-expected market share gains in paints and steep correction in input prices.

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