july 18, 2012 paints thematic -...

July 18, 2012

Paints Thematic INITIATING COVERAGE

Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit Capital may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.

Please refer to disclaimer section on the last page for further important disclaimer.

Analyst contacts

Rakshit Ranjan, CFA Tel: +9122 3043 3201 [email protected]

Shariq Merchant Tel: +91 22 3043 3246 [email protected]

Asian Paints BUY

CMP: `3,658

Target Price `4,218

Mkt cap: `356bn/US$6,360mn

52-wk H/L: `4,191/2,250

3M ADV: `370mn/US$6.6mn

Upside (%) 15

EPS (FY13): `131.3

Variance from consensus (%) 5

Berger Paints SELL

CMP: `131

Target Price `138

Mkt cap: `46bn/US$814mn

52-wk H/L: `153/78


Upside (%) 5

EPS (FY13): `6.1

Variance from consensus (%) (3)

Valuation metrics (x) Asian Paints FY12 FY13E FY14E

P/E 35.5 27.9 22.5

EV/EBITDA 21.9 17.3 13.9

ROE (%) 40.1 41.0 41.3

Berger Paints FY12 FY13E FY14E

P/E 25.2 21.6 18.7

EV/EBITDA 14.6 12.5 10.7

ROE (%) 24.3 24.3 23.7

Striking the right balance Volume demand for paint products in India is expected to grow at around 11% YoY in FY13 v/s 14% CAGR over FY04-FY12. Benefits to raw material costs from depreciation in crude oil prices are likely to be offset by the negative impact of INR depreciation. With increasing consumer involvement in decorative paints and given steady acceleration of growth in premium products, we expect Asian Paints to continue to win market share from peers given its focused management team and efficient supply chain. Berger is likely to remain a distant second as it attempts to cover lost ground in the premium decorative products market. We initiate coverage on Asian Paints with a BUY and on Berger with a SELL.

Whilst other paint companies have focused on a range of strategies (including product quality, segments and dealer/painter incentives), none except Asian Paints has consistently gained market share over the past several decades.

Our discussions with market participants reveal that focus on efficient supply chain management in a large distribution network remains the formula for success in the decorative paints industry due to: a) the voluminous nature of the products implies low shelf space is available on shop floors and a large network of manufacturing plants is needed to help reduce transportation costs; b) the low consumer awareness of product characteristics; c) seasonal demand patterns; and d) the large number of SKUs that require handling.

Initiating coverage with BUY on Asian Paints; placing a SELL on Berger

Asian Paints: Led by a high quality management team, Asian Paints has achieved expansion across a wide range of SKUs and across urban/semi-urban/rural India through supply chain efficiencies and through scale related benefits around marketing spend. We expect operating margin expansion over FY13-FY17 of 100bps from scale efficiencies and 100bps from increased share of water-based, high-margin, premium products in the overall portfolio. Also, as the firm continues to invest in: a) further streamlining parts of its supply chain to overcome inefficiencies related to inter-depot and inter-RDC (regional distribution center) transfers; and b) expanding the network of ‘colour ideas’ stores to grab a larger pie of the premium segment; we expect Asian Paints to gain 0.5% market share each year from its peers over FY12-FY17.

Berger Paints: From being predominantly a mid-tier and economy segment focused company in decorative products, Berger appears to be shifting its focus towards investing in supply chain management and increasing its marketing spend to help enhance its positioning in the premium product category. It is offsetting the incremental expense through a reduction in cash discounts to dealers. Whilst we expect Berger to remain competitive against peers such as Kansai Nerolac and Akzo Nobel, we forecast a 0.2% market share loss to Asian Paints each year over FY12-FY17.

Valuation: Given the cash generative nature of the industry, we use a DCF based approach for Asian Paints and Berger with a WACC of 12.8% and 13.2% respectively, and a terminal growth rate of 5%. We value Asian Paints at `4,218 (implying 15% upside, 32x FY13E P/E, 20x FY13E EV/EBITDA), and Berger Paints at `138 (implying 5% upside, 23x FY13E P/E, 13x FY13E EV/EBITDA).

Paints Thematic

Ambit Capital Pvt Ltd 2

CONTENTS

Industry overview……………………….………………………………….. 3 Key growth drivers for the industry……………………………………… 7 Porter analysis of the industry……………………………………………. 8 Drivers of competitive advantages………………………………………. 9 Summary – Asian Paints v/s Berger…………………………………… .11 Accounting analysis………………………………………………………. 12 Relative valuation……………………………………………………..…. 16 Possibility of CCI intervention?...................................................... 18

COMPANIES

Asian Paints……………………………………………………………….. 19 Berger Paints……………………………………………………………… 37

Paints Thematic


Industry overview The paints industry in India in FY12 was around `291bn (US$6bn) in size and has grown at a CAGR of 19% over FY04-FY12 (see exhibit 1 below). This includes volume CAGR of 14% and realization CAGR of 5% over this period.

Exhibit 1: Total paints industry YoY growth rates

-5%

0%

5%

10%

15%

20%

25%

FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12

Value Volume Realisation

Source: Asian Paints, Kansai Nerolac, Ambit Capital research

Exhibit 2: Composition of the Indian paints industry

Unorganised

segment, 35%

Asian Paints, 27%

Berger, 9%

Akzo Nobel, 5%

Kansai Nerolac,

9%

Shalimar, 2%

Other organised,

13%

Source: Company, Ambit Capital research; Using FY12 data from annual reports of the respective companies

Until the 1960s, the Indian paints industry was dominated by foreign players such as ICI Paints, Goodlass Nerolac and British Paints. However, the Foreign Exchange Regulations Act passed in the 1970s did not allow foreign companies to be majority shareholders in Indian firms. As a result, many foreign firms either shut down their India operations or changed their ownership structure.

Anecdotal data suggests that currently around 65% of the overall paints industry is controlled by organised players with the balance 35% comprising unbranded paint manufacturers. Also, as shown in exhibit 2 above, around 80% of the organised paints industry is controlled by five players, with the remaining 20% consisting of new entrants including Sherwin-Williams, Jotun, KAPCI coatings, Nippon Paints etc. (see exhibit 3 below).

Exhibit 3: Key players in the Indian paints industry

Largest shareholder (%) Ownership of

largest shareholder

% market share in decorative paints

(organised)

% market share in industrial paints

(organised)

(%) Overall market

share

Asian Paints Dani, Vakil & Choksi family 53 52 13 44%

Berger K.S. Dhingra (UK Paints India and other companies)

61 11 18 14

Akzo Nobel (excl group merger) Imperial Chemical Industries (Akzo Nobel)

60 8 3 7

Kansai Nerolac Kansai Paints 69 7 27 14

Shalimar Jindal & Jhunjhunwala group

62 1 3

Other organised players Mainly foreign brands 21 33 18

Source: Company, Ambit Capital research

Paints Thematic


Paint products — an overview Paint products are broadly categorised into ‘Decorative’ and ‘Industrial’ segments. Whilst the decorative products predominantly include interiors walls, exterior walls and wood/metal paints, the industrial segment includes products used in the automotive industry, road marking coatings, protective coatings, floor coatings and general industrial coatings.

Decorative products (around 70% of the overall paints industry)

Exhibit 4: Typical decorative paint projects’ cost breakdown

Item % of total project cost Organised/Unorganised

Paint 20-25 Mostly organised

Primer 8-10 Organised/Unorganised based on the painter's choice

Putty 8-10 Mostly unorganised

Other materials 8-10 Mostly unorganised

Labour 45-50

Source: Ambit Capital research, Industry

Based on our discussions with market participants, we estimate that at least 70%-80% decorative paint revenues of the top 4 players comprise revenues from paint sales (emulsions/enamels/distempers) with only a small proportion of total sales arising from primers/putty. This is because the choice of primer or putty in a paint project is largely at the discretion of the painter, who prefers unbranded or a brand other than the top 4 paint brands due to: a) a desire to reduce the total cost of the paint project; or b) his familiarity with a specific style of application.

Decorative coatings in the industry can be classified into product segments as shown in exhibits 5 below.

Exhibit 5: Various segments of the overall decorative paints industry

Type Products Price range

(`/ltr) Historical 3-yr

sales CAGR (%) % mkt share

by value Rank by market share

Premium Textured emulsions, Textured enamels, Exterior emulsions

150-400 28-30 20-25

1. Asian Paints 2. Akzo Nobel/ICI 3. Kansai Nerolac 4. Berger Paints

Mid-tier Economy emulsions, Primers, Premium enamels, Wood care

70-150 15-16 60-65

1. Asian Paints 2. Berger Paints 3. Kansai Nerolac 4. Akzo Nobel/ICI

Economy Distempers, Economy primers

40-80 9-10 15-20

1. Asian Paints 2. Berger Paints 3. Kansai Nerolac 4. Akzo Nobel/ICI


Decorative paints have witnessed a shift away from solvent-based products, towards water-based products. Exhibit 6 on the next page compares the key characteristics of the two categories which has prompted this shift. Penetration of water-based coatings in the exterior emulsions segment of decorative paints is significantly higher compared to the interior emulsions segment. Wood and metal coatings are predominantly solvent-based products.

Paints Thematic


Exhibit 6: Characteristics — water based v/s solvent based

Water-based paints Solvent-based paints

Water is used as a medium for dilution Oil (turpentine) is used as a medium for dilution

More durable, better colour retention and finish Less durable, inferior colour retention and finish

Produce minimum irritant vapours Produce strong vapours during application

Crude and crude based derivatives form around 30%-35% of overall raw materials

Crude and crude based derivatives form around 70%-75% of overall raw materials

Higher price and higher margin product Lower price and lower margin products


Industrial products (around 30% of the overall paints industry)

Exhibit 7 below shows the various segments of the industrial paints industry and the key players operating in each segment. Industrial coatings in India are almost exclusively solvent-borne. The only applications that are currently employing water-borne technology are certain automotive primers and high-end automotive refinishes.

Exhibit 7: Industrial paints sector in India

Industrial coatings % share of industrial coatings market Key players

Auto OEM 24 Kansai Nerolac, BASF, Asian PPG, Nippon, Berger, Maharani Paints, Rajit Paints

Auto refinish 14 Akzo Nobel, Esdee Paints, Asian Paints, BASF Protective/General industries

32 Berger, Akzo Nobel, Kansai Nerolac, Asian Paints, Shalimar

Powders 14 Kansai Nerolac, Marpol, Asian Paints, Jotun

Coil 6 Berger-Becker, Nippon, Akzo Nobel, BASF, PPG, KCC

Others 10


The industrial paints segment includes a significantly high proportion of organised products due to: a) the high level of technical expertise involved in the manufacture of industrial paints compared to decorative paints; and b) B to B relationships of paint manufacturers with companies in the respective industries being the key for their presence in the industrial coatings segment.

Raw material procurement costs and price hikes Exhibit 8 below gives the list of key raw materials required in the manufacture of paint products in India. Whilst more than half of these raw materials are procured from within India, a substantial part (around 30%-40% of the total cost of manufacturing paints) is procured through imports, making the paints industry susceptible to exchange rate fluctuations.

Paints Thematic


Exhibit 8: Procurement of key inputs

Product Indigenous or imported

Additives/biocides Mostly imported

Manufacturing equipment Both indigenous and imported

Solvents Both indigenous and imported

Resins — acrylic/PE/epoxy/amino/PU Both indigenous and imported

Inorganic pigments Both indigenous and imported

High performance pigments Both indigenous and imported

Titanium dioxide Both indigenous and imported

Carbon black Both indigenous and imported

Organic pigments Mostly indigenous

Machine colourants & tinting systems Mostly indigenous

Emulsion resins Only indigenous

Resins — alkyds/phenolics Only indigenous

Source: Ambit Capital research

Also, based on our discussions with management teams of paint manufacturers, 70%-75% of the ingredients for solvent-based paint products and around 35% for water-based paint products include crude derivatives. This exposure to crude derivatives further increases the volatility in raw material procurement costs for paint manufacturers.

Price hikes: Hiking paint prices is the biggest tool that manufacturers in India use to offset the impact of forex and crude price fluctuation on their earnings. For several decades, Asian Paints has had the highest pricing power in the industry. Prices are hiked usually 2-4 times a year. Our discussions with dealers suggest that whilst Berger immediately matches a price hike initiated by Asian Paints, other players including Kansai Nerolac and Akzo Nobel/ICI hike their prices after around two weeks of Asian Paints’ price hike.

Price hikes by manufacturers have not had a material impact on sales volumes in the decoratives industry historically because: a) The net impact on the project cost is muted since paint products form only around 50% of the total project cost; b) Repainting cycles in most households occur every 2-3 years and hence consumer preferences are not linked to YoY changes in product prices; c) Events such as weddings/other celebrations constitute a big demand driver for decorative paint projects in India and such event related demand is not materially affected by a 4%-5% YoY increase in product pricing; and d) Institutional demand and new real estate demand is not likely to see delayed execution of paint projects due to a hike in product prices.

Exhibit 9 below highlights how the magnitude of prices hikes is closely linked to changes in raw material costs over time.

Exhibit 9: Historical correlation between price hikes and raw material costs (%)

Item FY07 FY08 FY09 FY10 FY11 FY12 Correlation Weighted average YoY change in unit cost of raw materials consumed for Asian Paints

8 0 23 (5) 16 NA

YoY change in realisation rate on total sales for Asian Paints

3 3 10 (1) 8 NA 96

Raw material cost as a % of volume sold for Asian Paints 10 (1) 17 (4) 12 17 YoY change in realisation rate on total sales for Indian paints industry

2 5 6 3 8 13 63

Source: Company, Ambit Capital research, Industry

Paints Thematic


Key growth drivers for the industry Although the paints industry in India has grown at a sales value CAGR of 19% over the past decade, these growth rates have been less volatile for decorative products compared to industrial products, as explained below.

Decorative paints

Upgrades from lime-wash to paints: As the aspirational consumption story has accelerated in tier 2/3/4 cities, households have upgraded from lime wash to paints over the past decade.

New real estate: The real estate markets of NCR, Mumbai and Bangalore have witnessed a significant slowdown in volumes over the past two years with 25%-30% YoY decline in registrations. However, residential real estate markets with ticket sizes smaller than `5mn, including affordable housing and plotted developments, have witnessed high volume growth over the past 3-5 years.

Repainting cycles shortening: There has been a gradual reduction in the length of repainting cycle of an average Indian household over the past 10 years, from 5-6 years to around 2-3 years (source: anecdotal evidence). This is due to a combination of growth in average household disposable income and due to the lifestyle upgrades of the average Indian consumer.

Product offering and service standards: Over the past two decades, the industry has witnessed a widening of the product base to include new products like texture interior paints, heat/water resistant exterior emulsions, products catering specifically to kids etc. Also, service standards have improved over this period to include preview facilities using simulation software or in-store demonstrations like Asian Paints’ Signature stores and Asian Paints Colour Ideas and Asian Paints Home-Solutions. These developments have helped create the demand related to lifestyle upgrades and changing customer preferences.

Shift from solvent-based to water-based coatings: Due to the significant price differential of water-based coating/texture paints, the up-trading from solvent-based to water-based paint products has led to growth in the realization rate of paint products across the industry.

Industrial paints

Growth drivers of industrial paints vary across the industries that these products cater to, as highlighted in the exhibit 10 below:

Exhibit 10: Industrial coatings — growth drivers

Sub-sector Growth driver

Auto OEMs Expansion of global and Indian auto majors in India including both domestic and export sales

Increased road infrastructure in India

Easy availability of auto loans

Auto refinish Maintenance, especially of premium vehicles

Worsening traffic conditions on Indian roads

Growth of infrastructure sector Protective coatings/ general industrial Growth of the manufacturing sector

Growth of consumer durables sector Powder coatings (electrostatic; does not require a solvent) Shift towards powder coatings as a technology

Coil coatings Growth of high-end construction segment


Paints Thematic


Porter analysis of the industry Exhibit 11: Porter’s analysis

Source: Ambit Capital research, Michael Porter

Bargaining power of suppliers MODERATE

Paint manufacturers depend on both local and international suppliers and have a low bargaining power vis-à-vis prices of supplies. While some crude based materials are purchased from Indian suppliers like HPCL and BPCL, others often have a wide international market with multiple suppliers. Some key components like titanium dioxide are also in short supply globally.

Bargaining power of buyers MODERATE

Buyers of decorative paints in the B2C market have low bargaining power. Volumes in the industry are not materially affected by price hikes.

Buyer power is high for the industrial segment (B2B), especially auto OEMs and infrastructure companies.

With increasing consumer awareness of decorative products, bargaining power of buyers is improving.

Competitive intensity MODERATE

Strong underlying volume growth in the industry has attracted new entrants like Nippon Paints, Jotun and Sherwin Williams. However, widespread distribution networks of the incumbents have made it difficult for these new entrants to establish a meaningful presence in the industry. Rising marketing spends by top five players has led to a 100bps-150bps reduction in margins and ROEs over the past three years.

Threat of substitution LOW

Whilst wallpapers can be considered a convenient substitute, it is a much smaller market and is not preferred by customers due to the attached maintenance costs. Lime wash is also used as a low quality substitute. However, consumer patterns are shifting away from lime wash and towards paints.

Barriers to entry HIGH

Despite being a relatively simple product to manufacture, the requirement of a strong supply chain, brand and scale makes it difficult to have a material presence in the market. Global majors such as Nippon Paints, Sherwin Williams and Jotun have found it extremely hard to penetrate the Indian paints industry.

Improving Unchanged Deteriorating

Paints Thematic


Drivers of competitive advantages Based on our discussions with multi-brand dealers in the paints industry, we believe the following four to be drivers for outperformance relative to peers in the paints industry.

Supply chain efficiency

Product availability with dealers is one of the biggest drivers of relative outperformance due to the following factors:

Limited appreciation for product differentiation: Our discussions with dealers suggest that the end consumer of paint products is not well informed about product characteristics and the range of options available across various brands. Therefore, beyond a minimum threshold of quality, product differentiation across brands is not a key driver of demand.

Paints are bulky in nature: Paints are bulky in nature and hence: a) transport of finished goods across long distances is not economical; and b) storage of high levels of inventory either at the dealer’s shop or at the depot is not economical.

Large distribution network with wide range of SKUs: Given the B2C/retail nature of the products, the number of dealers in the distribution network increases in proportion to geographical expansion. Also, demand for a wide range of SKUs is spread across the urban/semi-urban/rural geographies of the country. Consequently, firms which target both urban as well as rural markets in India have to deal with management of inventory levels across a significantly wide range of SKUs and a large network of dealers and depots/distributors.

Demand is seasonal and deferrable: Although the extent of seasonality in decorative paints demand has been on a declining trend over the past decade, paints consumption in India is significantly skewed towards festivities and events such as weddings or other family celebrations. Also, it is easy for households to defer renovations/paint projects by 12-24 months depending on the household’s financial status. Consequently, demand for paints products remains uneven throughout the year. This makes it difficult for paint manufacturers to ensure product availability on shop floors during periods of an upward spike in demand.

Paint manufacturers have developed varying degrees of competitive advantages over their peers around product availability despite the hurdles highlighted above by investing in technologically advanced and integrated supply chain management (SCM), customer relationship management (CRM), and enterprise resource planning (ERP) systems. These investments focus on two key aspects: a) higher accuracy of demand forecasts across geographies and SKUs; and b) reduction in the time taken to deliver products once demand for stock is raised by a dealer. Asian Paints beats its competitors in the timing and intensity of focus on building supply chain efficiencies in its distribution network.

Benefits to dealers/painters

The lack of active involvement of the end consumer (especially in the mid-tier and economy segments) enhances the role of dealers/painters in the decorative paint selection process. Consequently, paint manufacturers offer performance based incentives to painters/dealers including:

Rebates per litre are offered to dealers depending on volume of sales for each dealer

Favourable credit terms or higher cash discounts are offered to dealers

Rewards/gifts including international holiday trips are offered to painters based on their performance

Paints Thematic


Berger beats its competitors on this metric by offering the most attractive benefits to both dealers as well as painters. Kansai Nerolac and Akzo Nobel offer attractive benefits predominantly to dealers. Asian Paints offers the least attractive benefits (in a relative manner) to both dealers as well as painters.

Marketing initiatives

Effective marketing of brands and sub-brands of paint manufacturers helps create demand amongst customers, especially for premium products. Moreover, Asian Paints invests heavily on ‘experience centres’ like Asian Paints Signature stores and Asian Paints Colour Ideas stores, which help customers experience the look and feel of products prior to purchase. Overall, Asian Paints invests the most amongst its peers on marketing initiatives.

Range and characteristics of products

Given the varying requirements for paint consumers around product type, price range and packaging size, a wide range of SKUs from paint manufacturers helps them spread their reach across urban, semi-urban and rural India. Asian Paints had the widest range of products to offer its customers in the past.

Few paint manufacturers focus significantly on product characteristics and quality, by offering paints which last longer, are environmentally friendly or have special characteristics such as protection against weather/moisture/algae etc. Examples include Nerolac Suraksha, Berger Breath-Easy, Dulux Velvet Touch, Berger Silk, Asian Paints Royale Play etc. Based on our discussions with market participants, we believe that Kansai Nerolac beats all others in the industry on product characteristics.

Quality of management professionals

Whilst most paint manufacturers focus on quality of top management recruits, Asian Paints is reputed as the only player in the industry which focuses on recruiting high-quality professionals from the top B-schools of India for junior and mid-level managerial roles. Given the importance of operational execution in the paints industry, quality of managerial professionals in the organization is perhaps one of the biggest long term competitive advantages for a paint manufacturer.

Exhibit 12: Comparison of top 4 paint manufacturers across drivers of competitive advantages

Asian Paints

Berger Paints

Kansai Nerolac

ICI/Akzo Nobel

Supply chain management Product range Products with special characteristics Marketing initiatives Benefits to dealers/painters Quality of management professionals Source: Ambit Capital research, Industry, Note: is Strongest and is weakest.

As a result, Asian Paints offers a combination of best product availability and an immensely strong brand recall for its main brand as well as sub-brands. This combination ensures that dealers and painters treat Asian Paints as the safest and most reliable brand to stock in their shops/recommend to customers, despite the lower benefits per unit of product made available to them by Asian Paints.

Paints Thematic


Summary – Asian Paints v/s Berger Exhibit 13 below summarises the difference in our revenue forecasts for Asian Paints and Berger which emerges from expectations of relative market share change and mix change (from economy/mid-tier products to premium products) on the product portfolio.

Exhibit 13: Revenue driver summary for Asian Paints and Berger (FY12-FY15)

Revenue drivers Asian Paints Berger Paints

Market volume growth 10.7% 10.7%

Unorganised to organised shift 2.0% 2.0%

LFL product price hike 5.0% 5.0%

Contribution from mix change* 2.2% 0.9%

Market share change 0.9% -1.1%

Overall value sales CAGR for FY12-15 20.9% 17.5%

Source: Ambit Capital research, Note: *From Economy/Mid-Tier to premium products

Exhibit 15 on the right below highlights our EBITDA margin forecasts for the two companies and hence reflects the ability of Asian Paints to leverage on scale related efficiencies to outperform its peers. Return profiles expected for the two companies are shown in exhibit 14 on the left below.

Exhibit 14: RoE trends for Asian Paints and Berger

20%

25%

30%

35%

40%

45%

50%

55%

60%

FY08

FY09

FY10

FY11

FY12

FY13

E

FY14

E

FY15

E

FY16

E

FY17

E

Berger Paints Asian Paints


Exhibit 15: EBITDA margins Asian Paints v/s Berger

6%

8%

10%

12%

14%

16%

18%

20%

FY08

FY09

FY10

FY11

FY12

FY13

E

FY14

E

FY15

E

FY16

E

FY17

EBerger Paints Asian Paints


Paints Thematic


Accounting analysis Our forensic accounting analysis compares Asian Paints and Berger with Akzo Nobel, Kansai Nerolac and Shalimar Paints. These five players together constitute around 80% of the organised segment.

Both Asian Paints and Berger rank well on the cash conversion matrix, with higher-than-average CFO/EBITDA ratios. While Asian Paints has the lowest debtor days in the sector, its inventory days are broadly in line with the peer group median. On the other hand, Berger’s debtor days are in line with peers and inventory days are amongst the highest in the sector.

Exhibit 16: Cash conversion cycle

Pre-tax CFO as a % of

EBITDA (%) Average Debtor days Average Inventory days

YoY change in CFO as a % of EBITDA (bps)

Company/Metric FY10 FY11 FY12 FY10 FY11 FY12 FY10 FY11 FY12 FY11 FY12

Asian Paints 101 83 78 30 26 26 47 53 55 (1,819) (498)

Berger Paints 103 71 76 45 41 39 60 61 62 (3,195) 580

Kansai Nerolac 80 67 52 47 42 43 45 51 57 (1,319) (1,510)

Akzo Nobel 72 46 61 30 25 28 39 42 46 (2,597) 1578

Shalimar Paints 91 22 43 85 92 95 57 66 71 (6,618) 523

Median 91 67 61 45 41 39 47 53 57 (2,597) 523


As shown in exhibit 17 below, all players in the sector reported RoEs of around 20% with the exception of Asian Paints, which has consistently reported RoEs of 35%-40%. The divergence between the RoE of Asian Paints and its peers is predominantly due to a high PAT margin reported by the company. Whilst Berger has the lowest PAT margin across the sector, it also has high financial leverage. FY10-FY12 has seen declining PAT margins for the sector due to a declining trend in gross margins for each of the paint manufacturers as raw material price increases were not fully offset by the price hikes adopted over this period.

Exhibit 17: Dupont analysis

RoE (%) PAT margin (%) Asset turnover Financial leverage Company/metric

FY10 FY11 FY12 FY10 FY11 FY12 FY10 FY11 FY12 FY10 FY11 FY12

Asian Paints 48.9 38.5 36.0 12.3 10.8 10.2 3.3 3.0 2.9 1.2 1.2 1.2

Berger Paints 20.2 21.8 22.8 6.3 6.3 6.1 2.2 2.3 2.5 1.5 1.5 1.5

Kansai Nerolac 21.4 22.5 20.3 9.6 9.5 8.2 2.0 2.2 2.3 1.1 1.1 1.1

Akzo Nobel 16.1 16.2 14.0 15.3 14.8 10.2 1.0 1.1 1.4 1.0 1.0 1.0

Shalimar Paints 21.9 21.7 22.7 2.7 2.9 3.0 3.7 3.5 3.6 2.2 2.2 2.1

Median 21.4 21.8 22.7 9.6 9.5 8.2 2.2 2.3 2.5 1.2 1.2 1.1


All players in the sector, except Akzo Nobel, have effective tax rates close to the marginal tax rate (see exhibit 18 below).

Paints Thematic


Exhibit 18: Analysis of tax rates (%)

Standalone Consolidated Company

FY11 FY12 FY11 FY12

Asian Paints 30.9 29.7 30.0 29.8

Berger Paints 29.7 28.5 31.0 29.2

Kansai Nerolac 28.7 29.2 NA NA

Akzo Nobel 19.7 18.1 NA NA

Shalimar Paints 29.9 31.0 29.9 31.0


Whilst the average depreciation rate for both Asian Paints and Berger is near the peer group median, Kansai Nerolac has the highest depreciation rate in the sector whilst Shalimar Paints has the lowest depreciation rate.

Exhibit 19: Depreciation analysis

Average depreciation

rate (%) YoY change in

depreciation rate (bps)

Company/Metric FY10 FY11 FY12 FY11 FY12

Asian Paints 5.6 6.5 5.9 84 (57)

Berger Paints 5.5 5.8 6.1 24 33

Kansai Nerolac 7.5 7.5 7.4 2 (14)

Akzo Nobel 6.3 6.0 6.8 (29) 83

Shalimar Paints 4.7 4.3 5.2 (41) 90

Median 5.6 6.0 6.1 2 33


Loans and advances form 19% of the total assets for Asian Paints while the figure stands at 12% for Berger. However, none of the companies have any material amounts of loans and advances to related parties. The relatively high figure for Asian Paints is due to a large amount of capital advances, perhaps relating to the capacity expansion currently in progress.

Exhibit 20: Analysis of cash manipulation

Loans and adv as a % of net assets

% of loans and adv to related parties

Loans and adv to related parties as a % of net assets

Company/Metric

Asian Paints 19 0 0

Berger Paints 12 2 0

Kansai Nerolac 5 2 0

Akzo Nobel 12 0 0

Shalimar Paints 0 0 0

Median 8 0 0


Thanks to the cash generative nature of the industry, most balance sheets in the sector have surplus cash. The table below shows a comparison of investment income generated on cash and marketable investments. Shalimar is the only exception in this comparison due to the lack of adequate surplus available for investment.

Paints Thematic


Exhibit 21: Fictitious revenue booking?

Investment income as a % of cash

and marketable investments (%)

Change in investment income as a % of cash and

marketable investments (bps)

Company/Metric FY09 FY10 FY11 FY11 FY12

Asian Paints 7.5 5.0 7.9 (246) 289

Berger Paints 3.9 7.3 7.0 346 (29)

Kansai Nerolac 4.7 4.8 5.6 10 78

Akzo Nobel 9.8 6.5 9.2 (333) 275

Shalimar Paints 0.1 0.6 0.3 54 (30)

Median 4.7 5.0 0.0 10 (60)


Bad debts in the sector are linked to the inability of a few paint dealers to make payments against credits taken on purchases of stocks. As highlighted further on in the note, whilst Asian Paints offers around 15-17 days of credit to its dealers, others like Berger offer a longer period of 40-45 days to its dealers. Despite this, Berger and Kansai Nerolac have the lowest provisions against debtors in the sector whilst Asian Paints and Akzo Nobel have higher levels of provisions against debtors on their balance sheets. We believe this gap in provisioning practices represents the amount of conservativeness that is built into the account philosophies of Asian Paints and Akzo Nobel.

Exhibit 22: Provisions for debtors (%)

As % of gross debtors As % of gross debtors o/s for more than six months

FY10 FY11 FY12 FY10 FY11 FY12

Asian Paints 5 5 4 71 87 84

Berger Paints* 0 0 0 2 2 3

Kansai Nerolac 0 0 0 0 32 69

Akzo Nobel* 13 8 5 106 114 93

Shalimar Paints 0 0 0 0 0 0

Median 0 0 0 2 32 69


Both Asian Paints and Berger have low levels of contingent liabilities as a proportion of net worth. While contingent liabilities form 4% of net worth for Asian Paints, this number stands at 10% for Berger.

Exhibit 23: Contingent liabilities for Asian Paints (` mn)

Consolidated Asian Paints

FY11 FY12 As a % of net worth (FY12)

Guarantees given by the company 154 131 0

Tax matters in dispute 701 937 3

Other claims not acknowledged as debts 84 94 0

Total disclosed contingent liabilities 939 1,162 4

Consolidated

Berger Paints FY11 FY12 As a % of net worth (FY11)

Sales tax 263 NA 4

Excise & service tax 394 NA 6

Income tax and others 31 NA 0

Total disclosed contingent liabilities 688 NA 10


Paints Thematic


Overall, Asian Paints outperforms its peers on our forensic accounting analysis due to high cash conversion, working capital, RoEs, low leverage and conservative provisioning for debtors. Whilst Berger scores well on cash conversion, related party advances and return on surplus cash, its working capital cycle and RoEs are in line with the sector average. Berger’s provisioning for long term debtors is considerably low compared to its peers.

Performance of the paints industry across various metrics lies somewhere between the FMCG sector (high cash conversion and low financial leverage), and the chemicals industry (modest working capital cycle and modest RoEs). While the RoEs of the paints industry are lower than those of the FMCG industry, we highlight that Asian Paints compares favourably with FMCG companies in terms of its significantly higher RoEs, lower working capital cycle as well as high cash conversion.

Paints Thematic


Relative valuation Exhibit 24: Relative valuation

P/E EV/EBITDA EV/SALES Company name CMP

(LC) Mcap

(US$mn) EPS CAGR

FY12-14 FY13E FY14E

EBITDA CAGR

FY12-14 FY13E FY14E

Sales CAGR

FY12-14 FY13E FY14E

Div yield (FY12)

Indian companies

Asian Paints 3,677 6,373 25.7 27.9 22.5 25.8 17.3 13.9 19.6 3.1 2.5 1.1

Berger Paints 133 823 16.0 21.6 18.7 21.2 12.5 10.7 17.1 1.3 1.1 1.2

Kansai Nerolac 925 902 16.0 19.8 17.2 20.3 12.2 10.2 17.1 1.5 1.3 0.6

Akzo Nobel 881 772 6.6 21.2 18.6 16.2 21.4 17.9 7.1 2.2 1.9 1.8

Mean 17.4 22.6 19.3 21.8 15.9 13.2 15.9 2.0 1.7 1.2

Median 18.0 21.4 18.7 22.5 14.9 12.3 17.8 1.9 1.6 1.2

International companies

Dupont (EI) De Nemours

48 44,575 12.8 11.1 10.1 20.5 7.6 7.1 7.7 1.4 1.3 3.4

PPG Industries 102 15,553 12.7 12.8 11.6 10.6 7.5 7.0 5.0 1.2 1.1 2.2

Sherwin Williams 127 13,140 32.5 20.5 17.1 17.0 12.6 11.0 9.9 1.5 1.4 1.1

Akzo Nobel NV 40 11,798 35.6 13.0 10.9 13.1 6.9 6.2 4.5 0.8 0.8 NA

Kansai Paint 849 2,929 7.3 13.8 14.0 13.9 7.3 6.7 9.5 0.8 0.8 1.2

Nippon Paint 649 2,180 11.3 12.3 11.3 4.7 7.4 7.1 4.7 0.8 0.8 1.4

Dulux Group 3 1,180 (3.8) 14.2 13.1 32.6 8.8 8.0 9.2 1.3 1.2 5.0

Mean 15.5 14.0 12.6 16.1 8.3 7.6 7.2 1.1 1.0 2.4

Median 12.7 13.0 11.6 13.9 7.5 7.1 7.7 1.2 1.1 1.8

Source: Ambit Capital research; Note: International companies follow a calendar year end where FY13=CY12 and FY14=CY13;

Given that Berger is the only firm with a positive net debt/equity ratio of 0.2x amongst the top four Indian players and given that all players have similar tax rates, we look at the P/E ratios for relative valuation comparisons in the sector.

Asian Paints currently trades at an earnings multiple of 27.9x for FY13 and at 22.5x for FY14. These multiples are 23% and 17% higher than the peer group average for FY13 and FY14 respectively. We believe this premium to be justified given: a) the competitive advantages of Asian Paints around supply chain management, product offerings and a better managed franchise; b) relative outperformance against peers with Asian Paints reporting around 27% EPS CAGR over FY07-12 against 14% for Berger; and c) prospects for market share gain form peers and margin expansion likely over the next five years. Our DCF fair value implies valuation multiples of 32.7x for FY13 and 26.2x for FY14 since we expect Asian Paints to pull more market share from its peers over the next five years and hence widen the outperformance relative to its peers in terms of sales growth, margins and hence earnings.

Berger trades at a slight discount of 5% relative to its peers on the earnings multiples for FY13 and FY14. We believe that Berger deserves to trade in line with peers such as Kansai Nerolac and Akzo Nobel since the firm is not expected to grow faster than the overall paints industry in India.

Paints Thematic


Exhibit 25: 1-year forward PE bands for Asian Paints

400

8001,200

1,6002,000

2,4002,800

3,2003,600

4,000A

pr-0

7A

ug-0

7D

ec-0

7A

pr-0

8A

ug-0

8D

ec-0

8A

pr-0

9A

ug-0

9D

ec-0

9A

pr-1

0Se

p-10

Jan-

11M

ay-1

1Se

p-11

Jan-

12M

ay-1

2

12x

28x

24x

20x

16x

Source: Ambit Capital research, Bloomberg

Exhibit 26: 1-year forward EV/EBITDA for Asian Paints

400

8001,200

1,600

2,000

2,4002,800

3,200

3,600

4,000

Apr

-07

Aug

-07

Dec

-07

Apr

-08

Aug

-08

Dec

-08

Apr

-09

Aug

-09

Dec

-09

Apr

-10

Sep-

10Ja

n-11

May

-11

Sep-

11Ja

n-12

May

-12

7x

10x

13x

16x

19x


Exhibit 27: 1-year forward PE bands for Berger

20

40

60

80

100

120

140

160

Apr

-07

Aug

-07

Dec

-07

Apr

-08

Aug

-08

Dec

-08

Apr

-09

Aug

-09

Dec

-09

Apr

-10

Sep-

10Ja

n-11

May

-11

Sep-

11Ja

n-12

May

-12

13x

16x

19x

22x

10x


Exhibit 28: 1-year forward EV/EBITDA for Berger

20

40

60

80

100

120

140

160A

pr-0

7A

ug-0

7

Dec

-07

Apr

-08

Aug

-08

Dec

-08

Apr

-09

Aug

-09

Dec

-09

Apr

-10

Sep-

10Ja

n-11

May

-11

Sep-

11

Jan-

12M

ay-1

2

6x

8x

10x

14x

12x


Paints Thematic


Possibility of CCI intervention? There has been growing concern in corporate circles that the Competition Commission of India (CCI) can crack down on alleged cartelisation in the large B2C sectors. The verdict on Cement and DLF (real estate) are some examples of the recent intervention by CCI. Whilst most such cases of cartelisation have emerged from the earlier MRTP act, many cases are also a result of complaints from customer bodies.

Whilst price fixing remains the frequently sighted basis for cartel practice, other types of cartel arrangements would include dividing of end-markets, allocating of customers and bid rigging. However, if the particular industry is highly fragmented and has numerous players, it is not only difficult to run a cartel but also to prove a cartelisation allegation; in such cases the CCI uses indirect evidence. The CCI investigates three types of offences which according to it would result in an allegation of cartelisation: (a) anti-competitive agreements; (b) abuse of dominance; and (c) merger control. Also, once the investigation starts based on circumstantial evidences, the onus lies on the corporate to prove the allegations wrong. Lastly, none of the rulings of CCI have led to any fine payments by any of the parties and most have them have appealed to the Competition Appellate Tribunal.

Sector dynamics for the Indian paints industry include a combination of: a) the market leader (Asian Paints) controlling over 40% market share of the organised space; b) the top five players controlling over 80% of the organised market, and c) synchronization of price hikes across the top five players in the industry, although initiated by the market leader. There could be concerns around whether the CCI will look at either Asian Paints’ dominant position in the decorative paints market or the market share controlled by the top five players in the industry, as allowing the paint manufacturers to benefit from a monopolistic positioning in pricing of paint products and hence being detrimental to the end consumer.

However, our discussions with market participants suggest that although the top 4-5 players control around 80% of the organised market for paints in India, the remaining 20% is significantly fragmented in nature and any intentional reduction in supply of paint products by the top 5 players will allow the other branded players like Nippon, Sherwin Williams and Jotun to increase their respective presence in the market. Moreover, most pricing actions in the paints industry are a direct consequence of changes in the pricing of crude and foreign exchange rates, rather than being a result of exploitation of the dominant positioning of a cartel of market leaders.

Consequently, we DO NOT believe that a potential CCI intervention is a big risk for the paints industry.

Paints July 18, 2012

Asian Paints Bloomberg: APNT IN EQUITY Reuters: ASPN.NS

Accounting: GREEN Predictability: GREEN Earnings momentum: GREEN

Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit Capital may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decision.

Please refer to the Disclaimers at the end of this Report.

BUY

Key financials

Year to March FY11 FY12E FY13E FY14E FY15E

Operating income (` mn) 77,062 96,322 114,742 137,742 164,839 EBITDA (` mn) 13,956 16,161 20,484 25,179 30,826 EBITDA margin (%) 18.1 16.8 17.9 18.3 18.7 EPS (`) 87.9 103.1 131.3 162.8 199.0 RoE (%) 43.3 40.1 41.0 41.3 40.9 RoCE (%) 41.2 38.1 38.8 41.2 42.4 P/E (x) 41.6 35.5 27.9 22.5 18.4


INITIATING COVERAGE


Shariq Merchant Tel: +91 22 3043 3246 [email protected]

Recommendation

CMP: `3,658

Target Price (12 month): `4,218

Previous TP: NA

Upside (%) 15

EPS (FY10): `131.3

Change from previous (%) NA


Stock Information

Mkt cap: `356bn/US$6,360mn

52-wk H/L: `4,191/2,250


Beta: 0.62

BSE Sensex: 17,105

Nifty: 5,193

Stock Performance (%)

1M 3M 12M YTD

Absolute (4.4) 12.3 18.7 43.0

Rel. to Sensex (6.3) 11.6 26.1 31.7

Performance (%)

15,00016,00017,000

18,00019,00020,000

Jul-11 Dec-11 May-12

2,5002,8003,100

3,4003,7004,000

Sensex Asian Paint

2-year P/E or EV/EBITDA

4001,0001,6002,2002,8003,4004,000

Apr

-07

Aug

-07

Dec

-07

May

-08

Sep-

08

Feb-

09

Jun-

09

Nov

-09

Mar

-10

Jul-

10

Dec

-10

Apr

-11

Sep-

11

Jan-

12

Jun-

12

12x

28x24x20x16x

Source: Bloomberg, Ambit Capital research

Pulling the levers that matter Asian Paints’ management team’s focus on supply chain efficiencies has helped it expand across product categories/geographies and increase its overall market share amongst the top 5 players to 53% in FY12 from 43% in FY06. With a combination of scale benefits around brand building, operational leverage and further improvements targeted for its distribution model over FY12-FY17, we expect the firm to gain another 2.5 percentage points of market share, 200bps EBITDA margin expansion and EPS CAGR of 23%. We initiate with a BUY.

Competitive position: STRONG Change to this position: POSITIVE

Asian Paints has reported CAGR in revenue of 21% and in EPS of 20% over FY02-FY12. Whilst its peers are trying to catch up, we expect Asian Paints to continue to gain share and generate 23% EPS CAGR over FY12-FY17 due to:

Focus on supply chain efficiencies enables outperformance versus peers around product availability on shop floors whilst expanding its product portfolio and distribution network. This includes the use of technology to integrate manufacturing plants, processing centers and depots and thereby accurately forecast demand and track the performance of dealers. Further efficiencies are being targeted through distribution centers next to manufacturing units to reduce inter-depot transfer of stock.

Brand development: Thanks to scale related benefits around a larger marketing budget, Asian Paints is focusing on the rapid growth of premium products in the industry (FY08-FY12 value CAGR of 28%-30% v/s 10%-15% for mid-tier and economy product categories) and on increasing consumer involvement in brand selection. Initiatives such as widening its network of ‘experience shops’ like ‘Color Ideas’ are likely to help the group grab a bigger share of the shift towards premium paints, which attract 10%-12% higher gross margins compared to economy/mid-tier products.

Quality of management team: Discussions with ex-employees and market participants suggest that Asian Paints has historically benefited from a lack of management level focus amongst competitors due to: a) several changes in controlling shareholders for peers; and b) the significant presence of a foreign entity on the board for peers. Moreover, Asian Paints has a reputation of hiring and retaining high quality professionals including graduates from top business schools as early as the 1970s and 1980s.

Valuation: Whilst an FY13 P/E multiple of 27.9x factors in the gap in the operational quality of Asian Paints v/s its peers, it does not take into account the likelihood of further market share gains and operating margin expansion in future. Our DCF model uses a WACC of 12.8%, terminal value of 5% from FY25 and forecasts revenue CAGR of 20% and EPS CAGR of 25% over FY12-FY15 to generate a fair value of `4,218.

Asian Paints


Company Financial Snapshot

Profit and Loss (consolidated, ` mn) FY12 FY13E FY14E Net sales 96,322 114,742 137,742 Optg. Exp(Adj for OI.) 80,161 94,257 112,562 EBIDTA 16,161 20,484 25,179 Depreciation 1,211 1,595 1,953 Interest Expense 410 302 151 PBT 14,540 18,587 23,075 Tax 4,335 5,576 6,923 Adj. PAT 10,205 13,011 16,153 Profit and Loss Ratios EBIDTA Margin % 16.8 17.9 18.3 Adj Net Margin % 10.3 11.0 11.3 P/E (X) 35.5 27.9 22.5 EV/EBIDTA (X) 21.9 17.3 13.9 Dividend Yield (%) 1.1 1.5 1.9

Company Background

Asian Paints was founded in 1942 by four professionals, Mr.Champaklal Choksey, Mr. Suryakant Dani, Mr. ChimanlalChoksi and Mr. Arvind Vakil. The company became India’slargest paints manufacturer in 1968 and has held that position ever since. In India, Asian Paints controls around 42%market share in the organised paints industry includingaround 55% share in the decorative coatings and around 13%share in the industrial coatings segment. The companyoperates in India through 106 depots and 27,000 dealers.The company also operates outside India through itssubsidiaries Berger International Limited, Apco Coatings, SCIBPaints and Taubmans.

Balance Sheet (consolidated, ` mn)

FY12 FY13E FY14E Total Assets 58,962 68,584 79,257 Net Fixed Assets 19,176 22,410 22,457 Current Assets 36,238 42,174 52,800 Other Assets 3,547 4,000 4,000 Total Liabilities 58,962 68,584 79,257 Networth 27,485 33,909 41,668 Debt 4,725 5,139 2,319 Current Liabilities 25,823 28,607 34,341 Deferred Tax 928 928 928 Balance Sheet Ratios

ROE % 40.1 41.0 41.3 ROCE % 38.1 38.8 41.2 Net Debt/Equity (0.1) (0.1) (0.3) Equity/Total Assets 0.8 0.8 0.9 P/BV (X) 12.8 10.3 8.4

Cash Flow (consolidated, ` mn) FY12 FY13E FY14E PBT 14,540 18,587 23,075 Depreciation 1,211 1,595 1,953 Tax (4,296) (5,576) (6,923) Change in Wkg Cap (2,795) (2,430) (1,323) Others (398) 302 151 CF from Operations 8,263 12,479 16,933 Capex (6,732) (4,829) (2,000) Investments 1,610 (453) - CF from Investing (5,121) (5,282) (2,000) Change in Debt 970 - (3,359) Interest (404) (302) (151) Dividends (3,831) (6,172) (7,855) Issuance of Equity - - - CF from Financing (3,265) (6,474) (11,365) Change in Cash (123) 722 3,568

YoY change in market share amongst too five players Return profiles generated by our DCF model

-2.1%

-1.2%

-0.3%

0.6%

1.5%

2.4%

3.3%

4.2%

AsianPaints

Berger AkzoNobel

KansaiNerolac

Shalimar


-20%

0%

20%

40%

60%

80%

100%

120%

FY07

FY08

FY09

FY10

FY11

FY12

FY13

E

FY14

E

FY15

E

FY16

E

FY17

E

0%

10%

20%

30%

40%

50%

60%

EPS growth EBIT Margins

RoE (%) YoY growth in sales


Asian Paints


Asian Paints — SWOT analysis Exhibit 1: SWOT analysis for Asian Paints

Strengths Weaknesses

Powerful brand and enjoys the best recall value amongst customers as well as painters. Controls over 50% market share amongst the top four players across all product categories – economy, mid-tier and premium products.

Best-in-class supply chain, with strong focus on strengthening supply chain and distribution. Delivery time to dealers as low as 3-4 hours in tier 1 and tier 2 cities (v/s 1-2 days for peers) and 1-2 days for smaller cities (v/s 3-5 days for peers).

In-depth understanding of the market with a wide range of products meeting various consumer requirements in convenient SKUs (800-1000 in number).

Strong balance sheet with net cash (Berger and Shalimar have net debt) and free cash flows exceeding `1.5bn in FY12.

High quality management team with ability to hire and retain quality professionals across junior, middle and senior levels.

Small presence in the industrial segment through its JV with PPG and Asian Paints Industrial Coatings

Opportunities Threats

Its foray into the marine and consumer packaging segment with its second JV with PPG throws up new growth opportunities

Despite its market leadership in the decoratives segment, its small market share in the industrial space still leaves a relatively untapped segment by Asian Paints.

Its strong brand and aggressive marketing should help it gain substantial share in the fast growing exterior paints market

The entry of new international players like Sherwin Williams, Jotun and Nippon Paints will lead to an increase in the competitive intensity

With crude and crude oil derivatives being primary inputs of its finished product, volatility in global prices can negatively impact gross margins

Sharp depreciation in the rupee can negatively impact raw material prices that are either imported or follow import parity pricing

Source: Ambit Capital research, Industry, Company

Exhibit 2: Explanation for our forensic accounting scores

Segment Score Comments

Accounting GREEN

Asian Paints has in the past, reported high cash conversion, efficient management of working capital and low levels of loans and advances and contingent liabilities. Consequently, we give a high rating to the quality of its accounting.

Predictability GREEN

Due to a combination of high pricing power, presence across products, categories and SKUs, exposure predominantly to consumer activity led sector of the economy, earnings show stability across the economic cycle. Hence visibility of cash flows in future is high.

Earnings Momentum GREEN The strong performance and visibility has led to consensus upgrading its estimates for FY14 by 13% over the past 1 year and 1% over the past 6 months.


Asian Paints


As shown in exhibits 3-4 below, over the past 10 years the group has reported 21% revenue CAGR and 21% EBITDA CAGR.

Exhibit 3: Consolidated sales (` mn, LHS) v/s sales growth (RHS)

-10,00020,00030,00040,00050,00060,00070,00080,00090,000

100,000

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

FY12

14%

16%

18%

20%

22%

24%

26%

28%

30%

Consolidated Sales (LHS) Sales growth

Source: Ambit Capital research, Company

Exhibit 4: EBITDA (` mn, LHS) v/s EBITDA margin (RHS)

-

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

FY12

12%

14%

16%

18%

20%

22%

EBITDA (LHS) EBITDA Margin

Source: Ambit Capital research, Company

Exhibit 5: Business segments for Asian Paints

Segment % of total Description

Decorative 78 Around 30% of this segment is interiors, 30% exteriors, 20% enamel and 20% others. Royale and Apex are the largest brands for the company by value.

Automotive (APPG)

4 The company operates this segment in a 50:50 JV with PPG Industries. Its key clients include Honda, Hyundai, Tata Motors, M&M and GM

Other industrial 5

The company has a presence in the coatings segment through Asian Paints Industrial Coatings. It has entered into another JV with PPG to grow its share in the segment.

International 13 The company operates in the Middle East, Caribbean, South Pacific and other Asian markets, with the Middle East forming the largest market for the company.

Total 100


Asian Paints


Competitive advantages v/s peers As shown in exhibit 6 below, over the past six years, Asian Paints has consistently increased its market share amongst the top five players in the industry.

Exhibit 6: YoY change in market share

-2.1%

-1.2%

-0.3%

0.6%

1.5%

2.4%

3.3%

4.2%

Asian Paints Berger Akzo Nobel Kansai Nerolac Shalimar



Having spoken to the company’s management, ex-employees, competitors, and dealers of Asian Paints, we have identified the key sustainable competitive advantages which are likely to help the company to continue to outperform its peers in future.

Focus on supply chain management Since Asian Paints has had a strategy of diversifying across geographies and product SKUs, supply chain management has always been a key area of focus for the management team. To overcome the hurdles highlighted above, Asian Paints has been investing in the following initiatives which will likely help the group to continue to outperform versus its peers:

Use of technology for inventory management: Alongside expansion of its dealer network, Asian Paints started the use of computers on shop floors in 1983 to automate the manner of generating details of dispatches to the depots. Thereafter the firm invested in branch computerization which helped zonal distribution centers get their daily stock position levels. Also, between 1999 and 2002, the company invested in the implementation of supply chain management software from i2 technologies and enterprise resource planning solutions from SAP. This led to the integration of manufacturing plants, regional distribution centers and processing centers, thereby simplifying the tracking of demand and inventory levels across the country. These initiatives helped the company to: a) improve the accuracy of demand forecasts which helped lower inventory stock and working capital costs; and b) track the performance of dealers, take corrective action and incentivise the high performing dealers.

Whilst competitors such as Kansai Nerolac and Berger Paints have made similar technological advancements to their networks recently, and since these peers have lagged Asian Paints in adopting such moves by 8-10 years, we do not expect the subsequent benefits arising from these improvements to be as rapid as they were for Asian Paints 10 years ago.

Asian Paints


Exhibit 7: Improvement in the working capital cycle for Asian Paints

0

10

20

30

40

50

60

FY99

FY00

FY01

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

FY12

Working Capital (Days)


Streamlining further inefficiency through DCs: Asian Paints has in total around 2000 SKUs which are delivered to the dealers (excluding new SKUs which are created on shop floors using tinting machines). These include fast moving SKUs which are managed across the distribution network on a daily basis, and slow moving SKUs which are managed relatively infrequently across the year. The inventory for fast moving SKUs is currently maintained only at the depots and stocks are supplied straight from the manufacturing units to the depots. The inventory for slow moving SKUs is maintained at six regional distribution centers (RDCs) and once demand is raised from a depot for a slow moving SKU, stock is supplied from the RDC to the depot.

The current distribution network faces two aspects of inefficiencies: a) fast moving SKUs: Depending on stock availability in the overall network, demand for fast moving SKUs at ‘Depot 1’ is sometimes addressed by stock availability at ‘Depot 2’. This leads to a part of the inventory in the system moving in the following manner — ‘manufacturing unit depot 1 depot 2’; and b) slow moving SKUs: Inventory for a given slow moving SKU could end up moving in the following manner — ‘manufacturing unit RDC X RDC Y depot’.

In order to reduce these inefficiencies by leveraging upon a wide network of manufacturing units, the company is in the process of setting up Distribution Centers (DCs) next to the manufacturing units. These DCs will serve as large format hubs for inventory storage of both fast as well as slow moving SKUs. Whilst for slow moving SKUs the DC network will aim at replacing the RDC network in its entirety; for the fast moving SKUs, the DC network will aim at reducing the transfer of surplus stock from one depot to another within the distribution network by moving stocks in the following manner — ’manufacturing unit DC depot 2’. Success in achieving these efficiencies through DCs will rely on Asian Paints’ ability to further improve its demand forecasts for fast moving SKUs.

Exhibit 8: Distribution comparison for Asian Paints v/s peers

Revenues (stndln) Capacity (FY11, MT) Capacity utilization Dealers RDC Depots Dealer/Depot

Asian Paints 79,642 594,150 80% 28,000 6 106 264

Berger 26,517 251,742 71% 16,000 NA 110 145

Akzo Nobel 13,051 88,540 82% 7,000 NA NA NA

Kansai Nerolac 26,006 220,800 86% 12,000 10 69 174

Shalimar 4,838 57,000 92% 7,000 NA 54 130


Asian Paints has so far set up 4 DCs next to its manufacturing units to replace the existing network of six RDCs across India. We believe that successful

Asian Paints


implementation of the DC network will allow Asian Paints to further improve the ratio of ‘No. of dealers/Number of depots’ compared with peers.

High pricing power allows it to create a ‘push-based’ demand: In anticipation of an upcoming product price hike from Asian Paints, dealers have historically been forced to stock up inventory levels in their shops a few weeks ahead of the seasonal spike in end consumer demand. For example, due to an expected 3%-4% price hike on September 1, dealers increase inventory levels at their stores by mid-August, thereby spreading out in time, the pressure of inventory management for Asian Paints in the high-demand period of September.

Consequently, our primary data contacts suggest that whilst 10 years ago Asian Paints would supply stocks to dealers in select tier 1 cities within 1 day v/s 4-5 days for peers, now the turnaround time has been reduced to 3-4 hours for Asian Paints v/s up to 1-2 days for its peers in such cities. Also, in the absence of such supply chain efficiencies, expansion across product segments and geographies can be detrimental to working capital cycle management of a paint manufacturer. This has been one of the biggest reasons why the lack of timing and intensity of focus from competitors on streamlining of the distribution process has prevented them from rapidly expanding across semi-urban/rural India and across the economy, mid-tier and premium segments of products.

Despite the higher dealer-incentives given out by other paint manufacturers, due to the shelf space related constraints on shop floors, dealers prefer brands where customer demand can be serviced quickly and thereby makes it safe for them to invest in stock purchases from such companies.

Width of product offering Our discussions with the big dealers of paints in India suggest that unlike its peers, Asian Paints places significant reliance on consumer surveys to introduce new SKUs regularly over time. One of the most widely acknowledged examples of this has been the diversification of Asian Paints’ product offering across various container sizes. Until the 1970s, the Indian paints companies were supplying paints in containers of size 500ml or larger. However, Asian Paints was the first company to sense the demand for smaller containers and hence has introduced packs as small as 50ml. Also, Asian Paints has been ahead of its peers in penetrating the semi-urban and rural parts of India. Whilst other manufacturers have attempted to match Asian Paints’ product offering and geographical reach, a relatively weak supply chain model has constrained their ability to expand as fast as Asian Paints.

Excellent brand recall Asian Paints’ brand has become synonymous with paints in general in the minds of many Indian consumers. Discussions with dealers suggest that Asian Paints’ brand recall in the decorative paints market is strong enough to compel dealers to stock Asian Paints’ products in their stores irrespective of which brand the dealers wish to push to the customers.

Also, Asian Paints is the only company in this sector which has strong recall for not only the parent brand (Asian Paints), but also for sub-brands like Royale, Apex, Apcolite, Utsav and Gattu. We expect the following factors to have helped the group develop a strong brand recall over the past couple of decades:

Direct interaction/training programmes for painters: With an evolving range of paint products, increasing sophistication in paint application processes and changing consumer preferences, education and training of painters has become critical for a paint manufacturer. Asian Paints carries out regular training programmes for painters, especially for its more sophisticated

Asian Paints


emulsion products like Royale Play. A list of such trained painters is available to customers to ensure that high quality standards are maintained for application of the sophisticated paint products.

“Experience stores” like Colour ideas and Signature stores: The Indian consumer’s involvement in brand selection for a paint project has increased substantially over the past two decades. Most players have tried to capitalize on it through personalised consultation services to customers for their home, for example ‘Home Solutions’ by Asian Paints and ‘Home Painting Services’ by Berger Paints. Moreover, Asian Paints has leveraged on this shift in consumers’ preferences through the opening of stores such as Color Ideas, Kids World and Signature stores. These stores expose the customers to the entire range of products by giving them a look and feel of the various options available to them if they wish to change the décor of their home. Whilst such marketing initiatives are replicable, we believe that Asian Paints benefits from a bigger and stronger balance sheet (see next section) available to fund these capital intensive initiatives.

Scale related benefits through marketing spend: As shown in exhibit 9 below, whilst marketing spend as a percentage of sales for Asian Paints is not materially different from that of its competitors like Berger Paints and Kansai Nerolac, the scale of its business has allowed Asian Paints to spend incrementally higher amounts on marketing and promotions.

Exhibit 9: Asian Paints’ advertisement spend v/s peers (` mn)

-500

1,0001,5002,0002,5003,0003,5004,0004,500

FY06 FY07 FY08 FY09 FY10 FY11 FY12

3.2%

3.4%

3.6%

3.8%

4.0%

4.2%

4.4%

4.6%

Asian Paints Berger Paints Akzo NobelKansai Nerolac Ad spend as % of sale


Strong balance sheet and cash flows As shown in exhibit 10 below, Asian Paints has the most efficient working capital cycle and cash conversion cycle in the sector with no debt on the balance sheet and enough free cash flows to provide for planned capacity expansion

Exhibit 10: Balance sheet comparison v/s peers (FY12)

CFO/EBITDA (FY10-FY12)

Debtor days

Inventory days

Net debt/ Equity

CFO FCF

Asian Paints 87% 26 55 (0.1) 8,263 1,532

Berger Paints 82% 39 62 0.2 1,760 397

Kansai Nerolac 65% 43 57 (0.1) 1,023 (1,216)

Akzo Nobel 59% 28 46 (0.7) 1,413 85

Shalimar Paints 59% 95 71 0.9 114 79


Inventory days for Asian Paints are lower than those of its peers due to a more efficient supply chain management and higher predictability of demand (due to higher pricing power. Asian Paints’ debtor days are lower than those of its peers

Asian Paints


predominantly due to the difference in credit options provided to dealers. Asian Paints provides a typical dealer with options of 15-17 day credit lines or around 4-5% discount on advance cash payments. In comparison to this, Berger offers a credit of 40-45 days and a cash discount which is slightly higher than 5%.

Our discussions with the management teams of the respective companies suggest that whilst most of Asian Paints’ sales are carried out through cash advance payments, only 30%-35% of Berger’s sales are carried out through cash advances with the balance being credit related. Since dealers do not have the option of returning unsold inventory in their stores to the manufacturer, the divergence in cash v/s credit terms preferred by dealers for the two brands is a reflection of the different levels of confidence dealers have in being able to sell the products of a specific brand.

A high quality management team

Exhibit 11: Changes in promoters of Asian Paints and its peers since inception of the respective companies

Year Change in ownership Event details

Asian Paints

1942 No Formed by Choksey, Choksi, Vakil and Dani. Choksey moved out in 1997 after disputes with the promoters.

Berger Paints

1923 No Hadfields (India) was incorporated

1947 Yes Acquired by British Paints

1965 Yes British Paints was acquired by Celanese Corp

1969 Yes Berger, Jenson Nicholson Ltd bought British Paints (India) from Celanese Corp

1976 Yes Foreign holding in the company was diluted to below 40% by sale of shares to the UB Group

1983 No Name of the company changed from British Paints India to Berger Paints

1991 Yes The business was sold to the Dhingra brothers

Kansai Nerolac

1920 No Formed as Gahgan Paints. Entered into collaboration with Goodlass Group UK

1933 Yes Acquired by Lead Industries Group (creation of Goodlass Wall)

1957 No Goodlass Wall became Goodlass Nerolac Paints and went public

1976 Yes Became part of the Tata Forbes group on acquisition of a part of the shareholding by Forbes Gokak

1999 Yes After selling 36% to Kansai Paint Co in 1986, Kansai bought the remaining holding of Tata Forbes in 1999 and renamed it Kansai Nerolac in 2006

Akzo Nobel

1911 No Set up in India as Brunner Mond & Co

1929 Yes Name changed to Imperial Chemical Industries after a merger at the parent level

1984 No After entering several businesses, ICI merged all its group companies

1987-2007 No Entered and exited various businesses (pharmaceuticals, catalysts, rubber chemicals, adhesives etc)

2008 Yes Akzo Nobel bought the entire share capital of Imperial Chemical Industries globally. The name of the company was changed to Akzo Nobel India

Shalimar Paints

1902 No Incorporated as Shalimar Paint Colour & Varnish

1928 Yes Pinchin Johnson bought the controlling stake and it became a part of the Red Hand Composition Group

1963 No After going public in 1961, changed its name to Shalimar Paints

1964 Yes Red Hand Composition bought over by International Paints, which became part of the Courtaulds Group

1989 Yes Sold to SS Jhunjhunwala and OP Jindal Group


Our discussions with ex-employees of various paint companies suggest that the intense focus on streamlining distribution and supply chain, and hence accelerate growth, has been driven by a combination of two key characteristics of the management team:

Asian Paints


Fewer distractions amongst promoters: Asian Paints is the only paints

company in the sector which has not seen a change in its controlling shareholder (promoter) over the past 70 years. As shown in exhibit 11 above – all its competitors have seen: a) a change in the controlling shareholder; and b) significant presence of a foreign entity on the board of directors. Our primary data contacts suggest that this consistency at the board level has helped Asian Paints maintain focus on execution of a stable long term strategy over these decades.

Focus on quality of managers at all levels: Ex-employees of Asian Paints suggest that in order to execute well its strategy of improving operational efficiencies, the company has always focused on hiring and retaining high quality professionals — for example recruitment of graduates from top business schools in India including IIMs even during 1970s. As a result, the middle management team at Asian Paints usually includes relatively young professionals who are in the age group of 40-45 years and have had 15-20 years of experience in the industry, mostly with Asian Paints.

Asian Paints


Key assumptions and forecasts

Revenue growth drivers

Exhibit 12: Summary assumptions table (%)

FY13E FY14E FY15E

Industry level drivers

Industry volume growth 10.6 10.7 10.9

Contribution from unorganised to organised shift 2.0 2.0 2.0

Asian paints level drivers

Contribution from market share gain vs peers 0.9 0.9 0.9

LFL price hike 5.0 5.0 5.0

Contribution from mix change (economy/mid-tier to premium) 2.2 2.2 2.2

Total volume growth for Asian Paints (AP) 13.5 13.7 13.8

Contribution from realisation rate hike for AP 7.2 7.2 7.2

Total value 20.7 20.9 21.0


As shown in exhibit 12 above, we segregated our revenue growth forecasts on Asian Paints into the following components:

Overall market volume growth: Demand for industry volume growth rate has historically been linked closely to the overall GDP growth rate for the country as shown in exhibit 13 below. Consequently, we have assumed a 1.6x GDP growth multiple with our inhouse assumptions of 6.6% GDP growth rate for FY13 and a 10bps increase in the growth rate over FY14-FY15. This is because we expect only a gradual recovery in the GDP growth rate due to headwinds in the form of lower global GDP growth and the structural nature of inflation in India.

Exhibit 13: Paint industry volume growth v/s GDP growth

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

16.0%

FY07 FY08 FY09 FY10 FY11 FY12 FY13E FY14E FY15E

1.30

1.40

1.50

1.60

1.70

1.80

1.90

GDP Growth Industry Volume Growth GDP Multiplier (RHS)


Shift from unorganised to organised at the industry level: We have assumed that the organised proportion of the overall paints industry will increase from 65% currently to around 70% by FY17. This corresponds to 2% contribution to the growth rate of the organised market for FY13-FY15 reducing to 1% in FY16 and FY17.

Asian Paints


Exhibit 14: Growth led by shift from the unorganised to the organised market

Shift from unorganised to organised FY13E FY14E FY15E FY16E FY17E

Organised market as a % of total 66.3% 67.6% 69.0% 69.7% 70.4%

Unorganised to organised shift contribution 2.0% 2.0% 2.0% 1.0% 1.0%


Like for like (LFL) product price hike: We have assumed that LFL product price hikes for Asian Paints amount to around 5% per year. This is based on historical 10-year CAGR in the realization rate of 5% as highlighted in exhibit 1 on page 3.

Market share gain v/s peers: Asian Paints has gained around 11 percentage points in market share each year over the past seven years. This has been achieved through a combination of efficient supply chain management ensuring better availability of products at dealers’ shopfloors, superior marketing campaigns v/s peers’ and a wider product offering. Given the scale benefits available to Asian Paints, we expect marketing spend related competitive advantages to continue. Also, since the company continues to focus on further improving its reach and supply chain across semi-urban, rural and slow moving product categories, we expect Asian Paints to continue to win market share from its competitors, albeit at a slower than the historical run-rate given that Asian Paints already controls over 50% of the market share controlled by the top 5 players. Consequently, we have assumed from the current market share of around 53% amongst the top five organised players in the paints industry, Asian Paints will gain 0.5 percentage points each year. This translates to a 0.9 percentage point contribution to the annual revenue growth rate for Asian Paints over the next five years and implies a market share of 55.6% for Asian Paints (amongst the top 5 players) by FY17.

Exhibit 15: Asian Paints’ market share

42.0%

44.0%

46.0%

48.0%

50.0%

52.0%

54.0%

56.0%

FY07

FY08

FY09

FY10

FY11

FY12

FY13

E

FY14

E

FY15

E

FY16

E

FY17

E

Asian's market share

Source: Ambit Capital research, *Amongst the top 5 players

Exhibit 16: Shift in industry market share from FY07-17E

44.4%53.1% 55.6%

18.3%17.7% 16.7%

37.3%29.3% 27.8%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

FY07 FY12 FY17E

Others

BergerPaints

AsianPaints


Product mix change from economy/mid-tier to premium: As shown in exhibit 17 below, based on our discussions with market participants, we estimate that around 25% of decorative paints product sales for Asian Paints are derived from premium products with the balance relating to economy/mid-tier products. This proportion is higher compared to the industry average of around 20% since Asian Paints has grabbed a bigger pie of the shift from –economy/mid-tier segment to premium segment over the past decade.

Whilst we expect the proportion of premium products for the industry to rise to 26% over the next three years, we expect this share for Asian Paints to rise to

Asian Paints


33% over the same period. Our discussions with management teams and industry participants suggest that gross margins on premium products are 10%-12% higher compared to –economy/mid-tier products. Consequently, we expect an expansion in EBITDA margin of 80bps for Asian Paints over the next three years (versus 40bps for Berger) based on the mix change in its decorative revenues.

Exhibit 17: Product mix assumptions

Economy Mid-tier Premium Average

Price (`/Ltr) % price CAGR**

Current average price (`/litre) 40 120 200

Current Asian Paints mix* 15% 60% 25% 128

3 Year forward Asian Paints mix 12% 55% 33% 137 2.2%

Gross margins (current) 36% 36% 47% 38.8%

Source: Ambit Capital research; Note:* means Ambit’s assumptions based on discussions with dealers, competitors and other market participants;** Price CAGR implies change in average product price in Rs/Litre due to change in product mix across various segments

Other assumptions and forecasts

Exhibit 18: Key assumptions

FY11 FY12 FY13E FY14E FY15E Comments

Profit and Loss

Standalone revenue growth 25.2% 25.9% 21.8% 22.6% 22.8%

Derived using market volume growth, shift from unorganised to organised, market share shift, change in product mix and price increases as explained in exhibit 12 on page 29.

Joint Ventures growth 23.8% 6.3% 24.6% 39.1% 23.7% Factoring in contribution from the second JV with PPG beginning from FY14

International business growth -

18.5% 26.8% 10.0% 10.0% 10.0%

Slowdown in global markets to lead to muted growth in the international business.

Consolidated revenue growth 15.3% 25.0% 20.0% 21.4% 21.1%

Gross Margins 41.9% 40.0% 40.8% 41.1% 41.4% Lower crude prices, price hikes and changing product mix towards water-based paints to lead to gross margin expansion.

Salaries and wages (% of sales) 5.9% 5.5% 5.4% 5.4% 5.3% Benefits of economies of scale factored in

Freight & handling (% of sales) 4.0% 4.1% 4.2% 4.1% 4.1% Expect freight to remain stable

Advert & publicity (% of sales) 4.4% 4.3% 4.3% 4.2% 4.1% Benefits of economies of scale factored in

Cash discount (% of sale) 4.1% 4.1% 4.0% 4.0% 4.0% Minor reduction as the company benefits from its market leader position

Others (% of sale) 6.5% 6.0% 6.1% 6.1% 6.1% Expect other expenses to remain stable

EBITDA margins 17.0% 15.7% 16.8% 17.3% 17.8%

Tax rate 30.1% 29.8% 30.0% 30.0% 31.0% Expect stable tax rates close to the maximum marginal rate

Net profit margins 10.9% 10.3% 11.0% 11.3% 11.6%

Balance sheet

Capex (` mn) 4,874 1,166 7,000 4,000 2,000 Capital work in progress 433 6,171 4,000 2,000 1,000

Capex led by capacity addition which will come on stream in FY14

Working capital days 6 12 17 19 19 Expect working capital days to be maintained at 19 days

Debtor days 26 26 26 26 26 Expect debtor days to remain steady

Creditor days 71 71 71 68 68 Expect creditor days to remain steady

Inventory days 54 55 56 57 57 Expect inventory days to remain steady

Net debt/(cash) to equity (0.2) (0.1) (0.1) (0.3) (0.4)

Cash flows (` mn)

Operating cash flows 7,613 8,263 12,479

16,933 20,377

Free cash flows 6,052 1,532 7,649 14,933 19,377

Free cash flows to grow substantially as the company finishes capex in FY14


Asian Paints


Valuation Given the cash generative nature of the business, we use a DCF based model to arrive at a fair value for Asian Paints. The assumptions for weighted average cost of capital and terminal growth rates are shown in exhibit 19 below. We have assumed zero debt on Asian Paints’ balance sheet in future given its strong cash generation and hence enough surplus cash available on balance sheet to fund capital expenditure in future.

Exhibit 19: Valuation assumptions

Particulars Amount

Risk free rate (%) 8.5

Beta (2 year monthly) 0.62

Equity risk premium 7.0

Cost of equity (%) 12.8

Cost of debt (%) 12.0

Debt/equity ratio 0

Tax rate (%) 30.0

WACC (%) 12.8


We use a three-stage DCF approach for Asian Paints. Stage 1 includes explicit forecasts for income statement and balance sheet for the next five years with sales CAGR of 19%, EBITDA CAGR of 23% and EPS CAGR of 23% (FY08-FY12 CAGR of 25%). Stage 2 includes a decline in sales growth rate over seven years from 18.5% in FY17 to 7% in FY24 i.e. sales CAGR of 13% and EPS CAGR of 13% over this period. Stage 3 includes terminal growth forecasts with a growth rate to perpetuity of 5%. Our DCF model generates a fair value for Asian Paints of `4,218 per share (implying 15% upside, 32x FY13E P/E, 20x FY13E EV/EBITDA).

The cash flow and return profiles generated by our DCF model are shown in exhibits 20-21. Whilst Asian Paints has reported 29% CFO CAGR over FY06-12 of 29%, we forecast the same growth rate of 29% in CFO over FY12-17 as well.

Exhibit 20: Cash flow profiles (` mn)

-

5,000

10,000

15,000

20,000

25,000

30,000

FY06

FY07

FY08

FY09

FY10

FY11

FY12

FY13

E

FY14

E

FY15

E

FY16

E

FY17

E

CFO FCF


Exhibit 21: Return profiles generated by our DCF (%)

-20%

0%

20%

40%

60%

80%

100%

120%

FY07

FY08

FY09

FY10

FY11

FY12

FY13

E

FY14

E

FY15

E

FY16

E

FY17

E

0%

10%

20%

30%

40%

50%

60%

EPS growth EBIT Margins

RoE (%) YoY growth in sales


As shown in the charts below, Asian Paints has traded at a P/E multiple range of 24-30x over the past two years vs current FY13 multiple of 27.9x. Given the acceleration in its brand building initiatives for premium products and further scale efficiencies being targeted for its distribution model, we expect Asian Paints to

Asian Paints


further widen the outperformance gap vis-à-vis its competitors in future. This, we believe justifies an all time high P/E multiple for Asian Paints.

Exhibit 22: 1-year forward PE bands for Asian Paints

400

8001,200

1,6002,000

2,4002,800

3,2003,600

4,000

Apr

-07

Aug

-07

Dec

-07

Apr

-08

Aug

-08

Dec

-08

Apr

-09

Aug

-09

Dec

-09

Apr

-10

Sep-

10Ja

n-11

May

-11

Sep-

11Ja

n-12

May

-12

12x

28x

24x

20x

16x


Exhibit 23: 1-year forward EV/EBITDA for Asian Paints

400

8001,200

1,600

2,000

2,4002,800

3,200

3,600

4,000

Apr

-07

Aug

-07

Dec

-07

Apr

-08

Aug

-08

Dec

-08

Apr

-09

Aug

-09

Dec

-09

Apr

-10

Sep-

10Ja

n-11

May

-11

Sep-

11Ja

n-12

May

-12

7x

10x

13x

16x

19x


Asian Paints


Balance sheet

Year to March (` mn) FY11 FY12 FY13E FY14E FY15E

Shareholders' equity 959 959 959 959 959 Reserves & surpluses 20,915 26,526 32,950 40,709 50,820 Total net worth 21,874 27,485 33,909 41,668 51,779 Minority interest 1,099 1,367 1,781 2,319 3,019 Preference share capital 0 0 0 0 0 Debt 2,292 3,359 3,359 0 0 Deferred tax liability 852 928 928 928 928 Total liabilities 26,117 33,139 39,977 44,916 55,726 Gross block 20,249 21,458 28,458 32,458 34,458 Net block 13,099 13,006 18,410 20,457 20,310 CWIP 433 6,171 4,000 2,000 1,000 Investments 4,290 3,547 4,000 4,000 4,000 Cash & equivalents 6,262 6,243 6,965 10,534 20,933

Debtors 5,731 7,813 8,802 10,566 12,645 Inventory 13,054 15,989 19,490 23,397 28,000 Loans & advances 2,107 5,135 5,658 6,793 8,129 Other current assets 1,130 1,059 1,257 1,509 1,806 Total current assets 28,284 36,238 42,174 52,800 71,514 Current liabilities 16,321 21,374 23,577 28,303 33,871 Provisions 3,668 4,449 5,030 6,038 7,226 Total current liabilities 19,989 25,823 28,607 34,341 41,097 Net current assets 8,296 10,415 13,567 18,459 30,417 Miscellaneous 0 0 0 0 0 Total assets 26,117 33,139 39,977 44,916 55,726 Source: Company, Ambit Capital research

Income statement


Operating income 77,062 96,322 114,742 137,742 164,839

% growth 15.3% 25.0% 19.1% 20.0% 19.7%

Operating expenditure 63,933 81,235 95,439 113,862 135,443

Operating profit 13,130 15,087 19,303 23,880 29,396

% growth 7.0% 14.9% 27.9% 23.7% 23.1%

Depreciation 1,131 1,211 1,595 1,953 2,148

EBIT 11,998 13,876 17,707 21,927 27,249

Interest expenditure 222 410 302 151 0

Non-operating income 826 1,074 1,182 1,300 1,430

Adjusted PBT 12,602 14,540 18,587 23,075 28,678

Tax 3,789 4,335 5,576 6,923 8,890

Adjusted PAT/Net profit 8,814 10,205 13,011 16,153 19,788

% growth 0% 16% 27% 24% 23%

Prior period items 0 0 0 0 0

Reported PAT/Net profit 8,814 10,205 13,011 16,153 19,788

Minority interest 381 319 414 538 700

Share of associates 0 0 0 0 0

Adjusted consolidated net profit 8,432 9,887 12,597 15,615 19,088

Reported consolidated net profit 8,432 9,887 12,597 15,615 19,088 Source: Company, Ambit Capital research

Asian Paints


Cash flow statement


EBIT 12,825 14,950 18,889 23,227 28,678

Depreciation 1,131 1,211 1,595 1,953 2,148

Others (652) (807) - - -

Tax (3,924) (4,296) (5,576) (6,923) (8,890)

(Incr)/decr in net working capital (1,767) (2,795) (2,430) (1,323) (1,559)

Cash flow from operations 7,613 8,263 12,479 16,933 20,377

Capex (1,561) (6,732) (4,829) (2,000) (1,000)

(Incr)/decr in investments (3,109) 1,075 (453) - -

Other income (expenditure) 460 478 - - -

Others 62 57 - - -

Cash flow from investments (4,148) (5,121) (5,282) (2,000) (1,000)

Net borrowings 56 970 - (3,359) -

Issuance of equity - - - - -

Interest paid (222) (404) (302) (151) -

Dividend paid (3,168) (3,831) (6,172) (7,855) (8,978)

Others - - - - -

Cash flow from financing (3,335) (3,265) (6,474) (11,365) (8,978)

Net change in cash 129 -123 722 3,568 10,399

Closing cash balance 6,516 6,243 6,965 10,534 20,933

Free cash flow 6,052 1,532 7,649 14,933 19,377Source: Company, Ambit Capital research

Ratio analysis

Year to March (%) FY11 FY12 FY13E FY14E FY15E

EBITDA margin (%) 18.1 16.8 17.9 18.3 18.7

EBIT margin (%) 16.6 15.5 16.5 16.9 17.4

Net profit margin (%) 10.9 10.3 11.0 11.3 11.6

Dividend payout ratio (%) 42.3 45.1 49.0 50.3 47.0

Net debt:equity (x) (0.2) (0.1) (0.1) (0.3) (0.4)

Working capital turnover (x) 37.9 23.1 17.4 17.4 17.4

Gross block turnover (x) 4.4 4.7 4.7 4.6 5.0

RoCE(%) 41.2 38.1 38.8 41.2 42.4

RoIC(%) 52.1 53.3 54.1 53.7 60.6

RoE(%) 43.3 40.1 41.0 41.3 40.9Source: Company, Ambit Capital research

Valuation parameters


EPS (`) 87.9 103.1 131.3 162.8 199.0

Diluted EPS (`) 87.9 103.1 131.3 162.8 199.0

Book value per share (`) 228.0 286.5 353.5 434.4 539.8

Dividend per share (`) 32.0 40.0 55.0 70.0 80.0

P/E (x) 41.6 35.5 27.9 22.5 18.4

P/BV (x) 16.0 12.8 10.3 8.4 6.8

EV/EBITDA (x) 25.3 21.9 17.3 13.9 11.4

EV/EBIT (x) 27.5 23.7 18.8 15.1 12.2 Source: Company, Ambit Capital research

Asian Paints


This page has been intentionally left blank

Paints July 18, 2012

Berger Paints Bloomberg: BRGR IN EQUITY Reuters: BRGR.NS

Accounting: AMBER Predictability: GREEN Earnings momentum: AMBER

Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit Capital may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decision.

Please refer to the Disclaimers at the end of this Report.

SELL

Key financials

Year to March FY11 FY12 FY13E FY14E FY15E

Operating income (` mn) 23,281 29,477 34,464 40,416 47,454 EBITDA (` mn) 2,800 3,340 4,028 4,820 5,775 EBITDA margin (%) 12.0 11.3 11.7 11.9 12.2 EPS (`) 4.3 5.2 6.1 7.0 8.7 RoE (%) 23.3 24.3 24.3 23.7 24.9 RoCE (%) 18.0 19.1 18.5 17.8 19.1 P/E (x) 30.2 25.2 21.6 18.7 15.1


INITIATING COVERAGE


Shariq Merchant Tel: + 91 22 3043 3246 [email protected]

Recommendation

CMP: `131

Target Price (12 month): `138

Previous TP: NA

Upside (%) 5

EPS (FY13): `6.4

Change from previous (%) NA


Stock Information

Mkt cap: `46bn/US$832mn

52-wk H/L: `153/78


Beta: 0.9

BSE Sensex: 17,105

Nifty: 5,193

Stock Performance (%)

1M 3M 12M YTD

Absolute -12.2 17.7 29.2 52.3

Rel. to Sensex -14.1 17.0 36.6 41.0

Performance (%)

15,000

16,000

17,000

18,000

19,000

20,000

Jul-11 Dec-11 Apr-12

70

90

110

130

150

Sensex Berger

1 Year Forward P/E bands

20406080

100120140160

Apr

-07

Aug

-07

Dec

-07

Apr

-08

Aug

-08

Dec

-08

Apr

-09

Aug

-09

Dec

-09

Apr

-10

Sep-

10

Jan-

11

May

-11

Sep-

11

Jan-

12

May

-12

13x16x19x

22x

10x

Source: Bloomberg, Ambit Capital research

Yet to show its colours Berger has historically focused on mid-tier and economy product segments offering higher rewards to dealers and painters compared to its peers. It seems to be shifting its focus towards investing in supply chain management and increasing marketing spends to help improve its positioning in the premium product category. However, we expect the company to continue to lose 0.2% market share each year to Asian Paints given lower scale efficiencies and a relatively less aggressive strategy towards building distribution related efficiencies.

Competitive position: MEDIUM Change to this position: NONE

Strong presence in mid-tier and economy: Berger is the second largest player in the mid-tier and economy segments of the decorative paints industry. This dominant positioning has been supported by strong relationships with painters and dealers through higher cash discounts and other benefits. However, with higher margins in the premium segment and with FY07-FY12 CAGR of 28%-30% for the segment, Berger has lagged its peers in benefiting from the shift from economy/mid-tier to premium products.

Changing focus towards premium category: Through increased focus on supply chain management (centralized integration technology installation likely in FY13) and increased advertising spends as a proportion of sales, offset by a gradual reduction in cash discounts offered to dealers, Berger is trying to improve its presence in the premium products category.

However, it might be too little too late. Whilst we expect Berger to hold on to its market share vis-à-vis Akzo Nobel and Kansai Nerolac, we forecast a loss of 0.2% in market share against Asian Paints over FY13-FY17 because: a) Berger is trailing 10-12 years behind Asian Paints in implementing technological improvements in the direction of integrating the various parts of its distribution model; b) Despite an increase in ad spends recently, the quantum of marketing spend on brand building is only one-thirds Asian Paints’; and c) Our discussions with market participants suggest that Asian Paints is far more aggressive v/s Berger in its approach towards distribution.

Valuation: Berger is currently trading at 21.6x FY13 and 18.7x FY14 earnings multiples. These valuation multiples are at a 20%-25% discount to Asian Paints and a 5% discount v/s peers like Akzo Nobel and Kansai Nerolac. Given the high exposure of Kansai Nerolac to industrials and the recent corporate governance concerns around Akzo Nobel, Berger deserves to trade at least in line with these peers. Our DCF model uses 13.2% WACC, forecasts 18% revenue CAGR and 21% EPS CAGR over FY12-FY15, and gives a fair value of `138. Given limited upside potential, we initiate with a SELL.

Berger Paints


Company Financial Snapshot

Profit and Loss (consolidated, ` mn) FY12 FY13E FY14E Net sales 29,477 34,464 40,416 Optg. Exp(Adj for OI.) 26,137 30,436 35,595 EBIDTA 3,340 4,028 4,820 Depreciation 472 599 751 Interest Expense 323 433 563 PBT 2,545 2,996 3,506 Tax 744 899 1,087 Adj. PAT 1,801 2,097 2,419 Profit and Loss Ratios EBIDTA Margin % 11.3 11.7 11.9 Adj Net Margin % 6.1 6.1 6.0 P/E (X) 25.2 21.6 18.7 EV/EBIDTA (X) 14.6 12.5 10.7 Dividend Yield (%) 1.1 1.2 1.5

Company Background

Berger Paints India is the second largest manufacturer ofpaints in the country with a market share of around 17% inthe overall organised paints industry. The company’s roots go back to 1923 when it was established as a small paintscompany called Hadfields India Limited, based in Kolkata withits only manufacturing facility in Howrah, West Bengal. Sincethen the company has gone through several ownership changes, including acquisition by British Paints (Holding)Limited, U.K. in 1947. Since 1991, majority stakes in thecompany have been owned by UK Paints Group led by theDhingra brothers. Key sub-brands of the company includeLuxol, Bison, Rangoli, Weathercoat, Silk and Breathe Easy.

Balance Sheet (consolidated, ` mn)

FY12 FY13E FY14E Total Assets 17,868 22,172 25,879 Net Fixed Assets 5,819 7,990 9,739 Current Assets 12,001 14,134 16,093 Other Assets 48 48 48 Total Liabilities 17,868 22,172 25,879 Networth 7,915 9,365 11,014 Dept 3,410 5,210 6,010 Current Liabilities 6,231 7,285 8,543 Deferred Tax 312 312 312 Balance Sheet Ratios

ROE % 24.3 24.3 23.7 ROCE % 19.1 18.5 17.8 Net Dept/Equity 0.2 0.3 0.3 Equity/Total Assets 0.7 0.6 0.6 P/BV (X) 1.1 1.0 0.8

Cash Flow (consolidated, ` mn) FY12 FY13E FY14E PBT 2,545 2,996 3,506 Depreciation 472 599 751 Tax (794) (899) (1,087) Change in Wkg Cap (355) (498) (546) Others (108) 563 584 CF from Operations 1,760 2,762 3,208 Capex (1,363) (2,770) (2,500) Investments 658 - - CF from Investing (705) (2,770) (2,500) Change in Debt 190 1,800 800 Interest (274) (563) (584) Dividends (406) (648) (769) Issuance of Equity 6 - - CF from Financing (484) 589 (553) Change in Cash 571 580 155

Shift in market share with change in marketing strategy Return profiles generated by our DCF model (%)

16.0%

16.5%

17.0%

17.5%

18.0%

18.5%

19.0%

FY05 FY06 FY07 FY08 FY09 FY10 FY11

3.0%

3.4%

3.8%

4.2%

4.6%

5.0%

Market Share (LHS)Cash disc as % of saleMarketing spend as % of sale

0%

10%

20%

30%

40%

50%

FY07

FY08

FY09

FY10

FY11

FY12

FY13

E

FY14

E

FY15

E

FY16

E

FY17

E

0%

5%

10%

15%

20%

25%

30%

EPS growth (RHS)EBIT Margins (LHS)RoE (%) (LHS)YoY growth in sales (LHS)


Berger Paints


Berger Paints — SWOT analysis Exhibit 1: SWOT analysis for Berger Paints

Strengths Weaknesses

Its strong foothold in West Bengal has helped the company become a market leader in Eastern India and has been building leadership positions in regions outside Eastern India in recent years

Berger has good relationships with dealers and painters thanks to better benefits and cash discounts provided to them

Berger has a strong positioning in the mid-tier and economy segments of the market

Smaller product range compared with Asian Paints

Supply chain not as effective as that of Asian Paints (1-2 days for stock delivery v/s 3-4 hours for Asian Paints in tier 1 and tier 2 cities)

Slow to react to changes in industry such as the shift to premium segment paint products

Lost market share to Asian Paints in the decorative segment

Opportunities Threats

After having lagged the industry in its shift to the higher-margin water-based paints, its increased focus on emulsions can help the company increase the pace of shift

With significant new capacities coming up over the next few years, Berger can strengthen its position in Northern, Western and Southern parts of the country where it currently has a smaller presence.

Expansion of new entrants like Sherwin Williams, Jotun and Nippon Paints (entered in 2006/2007) can lead to an increase in the competitive intensity in future

With crude and crude oil derivatives being primary inputs of its finished product, volatility in global prices will impact gross margins

Sharp depreciation in the rupee will impact raw material prices that are either imported or follow import parity pricing

Source: Ambit Capital research, Industry, Company

Exhibit 2: Explanation for our forensic accounting scores

Segment Score Comments

Accounting AMBER Whilst Berger scores well on cash conversion, related party advances and return on surplus cash, its working capital cycle and ROEs are average and provisions for debtors outstanding for more than six months is significantly low compared to its peers.

Predictability GREEN Given: a) high correlation for industry volume growth rates with GDP; b) strong correlation of raw material costs with crude and foreign exchange rates; and c) market share changes across various players in the industry, predictability of earnings remains high for Berger.

Earnings Momentum AMBER Consensus has downgraded its estimates on the FY14 earnings by 1% over the past 3 months.


Berger Paints


As shown in the exhibits 3-4, over the past 10 years the company has reported 19% revenue CAGR, EBITDA CAGR of 20% and 18% EPS CAGR.

Exhibit 3: Sales v/s sales growth (consolidated)

-

5,000

10,000

15,000

20,000

25,000

30,000

35,000

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

FY12

12%

14%

16%

18%

20%

22%

24%

26%

28%

Consolidated Sales Sales growth


Exhibit 4: EBITDA v/s EBTIDA margin (consolidated)

-

500

1,000

1,500

2,000

2,500

3,000

3,500

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

FY12

8.0%

8.5%

9.0%

9.5%

10.0%

10.5%

11.0%

EBITDA EBITDA Margin


From being an economy/mid-tier brand …

Exhibit 5: Berger’s product portfolio across the three product categories

Segment Products Current share of

revenues Category value

CAGR (FY06-FY11)

Premium Luxol Silk, Satin; Weathercoat, Silk and Breathe Easy 10% 25-30%

Mid Rangoli, Luxol Enamel, Bison Super Emulsion 60%-70% 15-20%

Economy Jadoo, Butterfly 20%-30% 10-12%


Based on our discussions with primary data sources, around 90% of Berger’s decorative revenues relate to the mid-tier and economy segments of decorative products. Although Berger has aggressively launched premium category products in the past, its focus has been on product characteristics such as Weather-protection and Silk/Satin feel. In fact, several dealers and industry participants told us that Berger’s product quality is found to be better compared to that of Asian Paints for the same paint category. However, in the absence of substantial investment in distribution efficiencies and in brand building, Berger has not been able to expand the proportion of premium products in its overall portfolio over FY07-FY12.

Since the premium products category has grown twice as fast as the mid-tier and economy product categories over the past five years, Berger has lost market share against Asian Paints over this period (see exhibit 6 on page 23).

Berger Paints


… towards building the aspirational connect Based on our discussions with dealers, distributors and the management team, we believe that Berger is increasing its focus on the premium product segment through a combination of the following initiatives:

Exhibit 6: Increasing advertising spends v/s cash discounts

7.0%

7.5%

8.0%

8.5%

9.0%

9.5%

10.0%

10.5%

11.0%

FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11

2.5%

3.0%

3.5%

4.0%

4.5%

5.0%

EBITDA Margins (LHS) Adv as a % of sale Cash disc as a % of sale


Change in brand positioning: In order to build aspirational connect with the end consumer who is increasingly becoming aware of the products available in the paints industry, over the past five years Berger’s advertising spends as a proportion of sales has increased consistently (see exhibit 6 above)

Improving supply chain management: Whilst Asian Paints took the lead in installing a technologically advanced centralized supply chain management and ERM system over 1999-2002, Berger is in the process of implementing similar technological advances to its distribution channel. Our discussions with management suggest that a new customer relationship management platform will be operational in FY13 and will improve the accuracy of demand forecasting for the group in the coming years.

Reduction in cash discounts to dealers: Our channel checks suggest that Berger has historically been the most aggressive amongst the top five players in the industry in terms of providing cash discounts, especially to painters. Also, Berger provides longer credit options (40-45 days v/s 15-17 days for Asian Paints) and higher cash discounts on advance payments (6%-7% v/s 4%-5% for Asian Paints) to its dealers. As shown in exhibit 6 above, cash discounts as a proportion of sales have been declining consistently over past five years.

Berger Paints


Long, hard road ahead Whilst these initiatives are likely to help Berger hold on to its market share vis-à-vis Kansai Nerolac (KNP) and Akzo Nobel (ICI), we forecast a loss of 0.2 percentage points in market share against Asian Paints each year over the next five years due to the following factors:

Widening gap in supply chain management: As highlighted previously, Berger is working on implementing a technologically advanced customer relationship management system to manage daily distribution efficiencies. Asian Paints, on the other hand, having invested significantly in technological advances between 1999 and 2002, is now focusing on removing inefficiencies relating to inter-dealer and inter-RDC stock transfers.

Hard to match scale efficiencies of Asian Paints: Although Berger has increased its spend on marketing as a proportion of overall sales, its absolute quantum of marketing spend is only one-thirds that of Asian Paints. Hence, we do not expect the marketing initiatives, on their own, to help build strong positioning for Berger in the premium product segment over the next couple of years.

Management’s focus on quality v/s aggression: Our discussions with the market participants suggest that the company is heavily focused on product quality and less on aggressive product distribution compared to its peers. Also, we were told by large dealers and other market participants that whilst the quality of management of the company has seen significant improvement ever since Mr. Subir Bose was appointed from Asian Paints as the MD of Berger Paints India, Berger’s expansion strategy has not yet matched the aggression demonstrated by some of its competitors.

Berger Paints


Key assumptions

Revenue growth drivers

Exhibit 7: Summary assumptions for Berger

FY13E FY14E FY15E

Industry level drivers

Industry volume growth 10.6% 10.7% 10.9%

Contribution from unorganised to organised shift 2.0% 2.0% 2.0%

Berger level drivers

Contribution from market share loss vs peers (1.1%) (1.1%) (1.1%) LFL price hike 5.0% 5.0% 5.0%

Contribution from mix change (economy/mid-tier to premium) 0.9% 0.9% 0.9%

Total volume growth for Berger 11.4% 11.6% 11.7%

Contribution from realisation rate hike for Berger 5.9% 5.9% 5.9%

Total value 17.4% 17.5% 17.7%


As shown in exhibit 7 above, we segregated our revenue growth forecasts on Berger Paints into the following components:

Overall market volume growth: Demand for industry volume growth rate has historically been linked closely to the overall GDP growth rate for the country as shown in exhibit 8 below. Consequently, we have assumed a 1.6x GDP growth multiple with our house assumptions of 6.6% GDP growth rate in FY13 and a 10bps increase in the growth rate over FY14-FY15. This is as we expect a gradual recovery in the GDP growth rate due to headwinds in such as lower global GDP growth and the structural nature of inflation in India.

Exhibit 8: Industry volume growth v/s GDP growth

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

16.0%

FY07 FY08 FY09 FY10 FY11 FY12 FY13E FY14E FY15E

1.30

1.40

1.50

1.60

1.70

1.80

1.90

GDP Growth Industry Volume Growth GDP Multiplier (RHS)


Shift from unorganised to organised at the industry level: We have assumed that the organised proportion of the overall paints industry will increase to around 70% by FY17 from 65% currently. This corresponds to a 2% contribution to the growth rate of the organised market for FY13-FY15, reducing to 1% in FY16 and FY17.

Berger Paints


Exhibit 9: Growth led by shift from the unorganised to the organised market (%)

Shift from unorganised to organised FY13E FY14E FY15E FY16E FY17E

Organised market as a % of total 66.3 67.6 69.0 69.7 70.4

Unorganised to organised shift contribution 2.0 2.0 2.0 1.0 1.0


Like for like (LFL) product price hike: We have assumed that LFL product price hikes amount to around 5% per year for Berger. This is based on historical 10-year CAGR in realization rate of 5% for the industry as highlighted in exhibit 1 on page 3.

Market share loss v/s Asian Paints: As discussed on page 41, whilst we do not expect Berger to lose market share to Kansai Nerolac and Akzo Nobel, we expect Asian Paints to grab market share from all players, including Berger in the foreseeable future. Consequently, we expect a 0.2 percentage point reduction in market share for Berger each year, implying a 1 percentage point market share reduction over FY12-FY17 for the group.

Exhibit 10: Berger’s market share

16.0%

16.5%

17.0%

17.5%

18.0%

18.5%

FY07

FY08

FY09

FY10

FY11

FY12

FY13

E

FY14

E

FY15

E

FY16

E

FY17

E

Berger's market share


Exhibit 11: Shift in industry market share from FY07-FY17E

44.4% 53.1% 55.6%

18.3%17.7% 16.7%

37.3% 29.3% 27.8%

0%10%

20%30%

40%50%60%

70%80%

90%100%

FY07 FY12 FY17EAsian Paints Berger Paints Others


Product mix change from economy/mid-tier to premium: Given Berger’s weak positioning in the premium paints segment, we expect Berger to be slower than Asian Paints (and hence the market average) in benefiting from the shift from economy/mid-tier segment to the premium segment as shown in exhibit 12 below. We expect the effective operating margin benefit, as a result of the shift to premium products, to stand at 40bps for Berger (compared with 80bps for Asian Paints).

Exhibit 12: Average price increase caused by changing product mix

Economy Mid-tier Premium Avg Price

(`/Ltr)/margin**

Average current price (`/Ltr) 40 120 200

Current Berger product mix* 20% 70% 10% 112

FY15E Berger product mix 20% 66% 14% 115

Gross margins 36% 36% 47% 37.1%

Source: Ambit Capital research, Note:* means Ambit’s assumptions based on discussions with dealers, competitors and other market participants;** Price CAGR implies change in average product price in Rs/Litre due to change in product mix across various segments

Berger Paints


Other assumptions and forecasts

Exhibit 13: Key assumptions for Berger

FY11 FY12 FY13E FY14E FY15E Comments

Profit and Loss

Standalone revenue growth 24.5% 26.5% 18.3% 19.2% 19.3%

Derived using market volume growth, shift from unorganised to organised, market share shift, change in product mix and price increases as explained in exhibit 7.

International business revenue growth 12.1% 23.3% 15.9% 16.7% 16.8%

Slowdown in global markets to lead to muted growth in the international business.

Consolidated revenue growth

23.1% 26.1% 18.1% 18.9% 19.1%

Gross margins 36.9% 36.1% 37.0% 37.2% 37.4%

Factor in marginal gross margin expansion due to lower crude prices, price hikes and changing product mix restricted by its lower ability to compete with the market leader.

Salaries and wages as a % of sales

6.2% 5.6% 5.7% 5.6% 5.5% Benefits of economies of scale factored in

Freight & Handling (% of sales) 5.5% 5.6% 5.6% 5.6% 5.6%

Expect freight expenses to remain stable

Advert & Publicity (% of sales) 4.9% 5.1% 5.2% 5.3% 5.4%

Cash discount (% of sale) 3.3% 3.4% 3.3% 3.2% 3.1%

Company to focus more direct advertising whilst reducing focus on cash discounts

Others as a % of sales 6.6% 6.8% 6.4% 6.5% 6.5% Do not expect any other scale benefits to favourable impact margins

EBITDA Margins 10.2% 9.9% 10.7% 11.0% 11.3%

Tax rate 30.5% 29.2% 30.0% 31.0% 31.0% Expect stable tax rates close to the maximum marginal rate

Net Profit Margins 6.4% 6.1% 6.1% 6.0% 6.3%

Balance Sheet

Capex (` mn) (716) (1,040) (1,132) (3,500) (2,500)

Capital work in progress (` mn) 818 NA 500 1,000 1,000

Capex driven by current expansion plans for various capacities coming on stream over the next few years

Working Capital Days 46 45 44 42 41 Expect marginal improvement in working capital cycle

Debtor days 41 39 41 40 40 Expect debtor days to remain constant

Creditor days 56 60 63 63 63 Expect creditor days to remain constant

Inventory days 61 62 63 61 60 Expect improvement in inventory days due to steps taken in improving the supply chain.

Net debt to equity 0.3 0.2 0.4 0.4 0.2 Increase in free cash flows from FY15 will help reduce debt on the books

Cash Flows (` mn)

Operating cash flows 1274 1,760 2764 3211 3,611

Free cash flows 234 397 (6.0) 711 2611 Capex to affect cash flows until FY14


Berger Paints


Valuation Given the cash generative nature of the business, we use a DCF based model to arrive at a fair value for Berger Paints. The assumptions for weighted average cost of capital and terminal growth rates are shown in exhibit 14 below.

Exhibit 14: Assumptions in calculation of WACC

Particulars Amount

Risk free rate (%) 8.5

Beta (2 year monthly) 0.85

Equity risk premium 7.0

Cost of equity (%) 14.5

Cost of debt (%) 12.0

Debt/equity ratio 20%

Tax rate (%) 30.0

WACC (%) 13.2


We use a three-stage DCF approach for Berger Paints. Stage 1 includes explicit forecasts for income statement and balance sheet for the next five years with sales CAGR of 18%, EBITDA CAGR of 22% and EPS CAGR of 23% (FY08-FY12 CAGR of 16%). Stage 2 includes a decline in sales growth rate over seven years from 17% in FY17 to 6% in FY24 i.e. sales CAGR of 11% and EPS CAGR of 12% over this period. Stage 3 includes terminal growth forecasts with a growth rate to perpetuity of 5%.

Our DCF model gives a fair value of `138 (implying 5% upside, `138 (implying 5% upside, 23x FY13E P/E, 13x FY13E EV/EBITDA). As shown in the exhibits 15-16 below, Berger is currently trading at all-time multiples.

Exhibit 15: 1-year forward PE bands for Berger

20

40

60

80

100

120

140

160

Apr

-07

Aug

-07

Dec

-07

Apr

-08

Aug

-08

Dec

-08

Apr

-09

Aug

-09

Dec

-09

Apr

-10

Sep-

10Ja

n-11

May

-11

Sep-

11Ja

n-12

May

-12

13x

16x

19x

22x

10x


Exhibit 16: 1-year forward EV/EBITDA for Berger

20

40

60

80

100

120

140

160

Apr

-07

Aug

-07

Dec

-07

Apr

-08

Aug

-08

Dec

-08

Apr

-09

Aug

-09

Dec

-09

Apr

-10

Sep-

10Ja

n-11

May

-11

Sep-

11

Jan-

12M

ay-1

2

6x

8x

10x

14x

12x


The cash flow and return profiles generated by our DCF model are shown in exhibits 17-18 below. Whilst the group’s cash flow operations (CFO) have had 22% CAGR over the past four years, we forecast 19% growth in CFO over FY12-FY17 assuming a more streamlined distribution network, steady positioning vis-à-vis Kansai Nerolac and Akzo Nobel, and a slowdown in the proportion of market share loss to Asian Paints to 0.2 percentage points per annum. However, given limited upside potential, we initiate with a SELL recommendation.

Berger Paints


Exhibit 17: Cash flow profiles (` mn)

(2,500)

(1,500)

(500)

500

1,500

2,500

3,500

4,500FY

06

FY07

FY08

FY09

FY10

FY11

FY12

FY13

E

FY14

E

FY15

E

FY16

E

FY17

E

CFO FCF


Exhibit 18: Return profiles generated by our DCF (%)

0%

10%

20%

30%

40%

50%

FY07

FY08

FY09

FY10

FY11

FY12

FY13

E

FY14

E

FY15

E

FY16

E

FY17

E

0%

5%

10%

15%

20%

25%

30%

EPS growth (RHS)EBIT Margins (LHS)RoE (%) (LHS)YoY growth in sales (LHS)


Berger Paints


Balance sheet


Shareholders' equity 692 692 692 692 692

Reserves & surpluses 6,203 7,223 8,673 10,322 12,351

Total net worth 6,895 7,915 9,365 11,014 13,043

Minority Interest 0 0 0 0 0

Preference share capital 0 0 0 0 0

Debt 3,022 3,410 5,210 6,010 5,610

Deferred tax liability 263 312 312 312 312

Total liabilities 10,181 11,637 14,887 17,336 18,965

Gross block 7,157 8,317 11,317 13,317 14,317

Net block 4,341 5,089 7,490 8,739 8,896

CWIP 818 730 500 1,000 1,000

Investments 526 40 40 40 40

Cash & equivalents 1,265 1,824 2,404 2,559 3,292

Debtors 2,753 3,586 4,155 4,761 5,591

Inventory 4,437 5,544 6,326 7,308 8,451

Loans & advances 560 987 1,154 1,353 1,589

Other current assets 0 60 94 111 130

Total current assets 9,015 12,001 14,134 16,093 19,052

Current liabilities 4,068 5,530 6,466 7,582 8,903

Provisions 452 701 820 961 1,129

Total current liabilities 4,520 6,231 7,285 8,543 10,031

Net current assets 4,495 5,770 6,848 7,549 9,021

Miscellaneous 0 8 8 8 8

Total assets 10,181 11,637 14,887 17,336 18,965 Source: Company, Ambit Capital research

Income statement

Year to March (` mn) FY11 FY12E FY13E FY14E FY15E

Operating income 23,281 29,477 34,464 40,416 47,454

% growth 23.1% 26.6% 16.9% 17.3% 17.4%

Operating expenditure 20,908 26,442 30,772 35,965 42,086

Operating profit 2,373 3,035 3,692 4,451 5,369

% growth 19.1% 27.9% 21.7% 20.6% 20.6%

Depreciation 401 472 599 751 843

EBIT 1,971 2,563 3,094 3,700 4,526

Interest expenditure 238 323 433 563 584

Non-operating income 428 305 336 369 406

Adjusted PBT 2,161 2,545 2,996 3,506 4,348

Tax 660 744 899 1,087 1,348

Adjusted PAT/Net profit 1,501 1,801 2,097 2,419 3,000

% growth 25% 20% 16% 15% 24%

Prior period Items - - - - -

Reported PAT/Net profit 1,501 1,801 2,097 2,419 3,000

Minority Interest 0 0 0 0 0

Share of associates 0 0 0 0 0

Adjusted consolidated net profit 1,501 1,801 2,097 2,419 3,000

Reported consolidated net profit 1,501 1,801 2,097 2,419 3,000 Source: Company, Ambit Capital research

Berger Paints


Cash flow statement


EBIT 2,399 2,868 3,429 4,069 4,932

Depreciation 401 472 599 751 843

Others (131) (431) 131 20 (80)

Tax (705) (794) (899) (1,087) (1,348)

(Incr)/decr in net working capital (691) (355) (498) (546) (739)

Cash flow from operations 1,274 1,760 2,762 3,208 3,607

Capex (1,040) (1,363) (2,770) (2,500) (1,000)

(Incr) / decr in investments 795 487 - - -

Other income (expenditure) 118 161 - - -

Others 15 10 - - -

Cash flow from investments (111) (705) (2,770) (2,500) (1,000)

Net borrowings 348 190 1,800 800 (400)

Issuance of equity - 6 - - -

Interest paid (237) (274) (563) (584) (503)

Dividend paid (421) (406) (648) (769) (972)

Others - - - - -

Cash flow from financing (310) (484) 589 (553) (1,875)

Net change in cash 853 571 580 155 733

Closing cash balance 1,265 1,824 2,404 2,559 3,292

Free cash flow 234 397 (8) 708 2,607 Source: Company, Ambit Capital research

Ratio analysis

Year to March (%) FY11 FY12E FY13E FY14E FY15E

EBITDA margin (%) 12.0 11.3 11.7 11.9 12.2

EBIT margin (%) 10.3 9.7 9.9 10.1 10.4

Net profit margin (%) 6.4 6.1 6.1 6.0 6.3

Dividend payout ratio (%) 34.9 31.5 30.9 31.8 32.4

Net debt: equity (x) 0.3 0.2 0.3 0.3 0.2

Working capital turnover (x) 5.2 5.1 5.0 5.4 5.3

Gross block turnover (x) 3.3 3.5 3.0 3.0 3.3

RoCE(%) 18.0 19.1 18.5 17.8 19.1

RoIC(%) 20.5 23.6 22.8 21.8 23.9

RoE(%) 23.3 24.3 24.3 23.7 24.9Source: Company, Ambit Capital research

Valuation parameters


EPS (`) 4.3 5.2 6.1 7.0 8.7

Diluted EPS (`) 4.3 5.2 6.1 7.0 8.7

Book value per share (`) 99.6 114.4 135.3 159.2 188.5

Dividend per share (`) 1.3 1.4 1.6 1.9 2.4

P/E (x) 30.2 25.2 21.6 18.7 15.1

P/BV (x) 1.3 1.1 1.0 0.8 0.7

EV/EBITDA (x) 17.3 14.6 12.5 10.7 8.8

EV/EBIT (x) 20.2 17.0 14.7 12.6 10.3 Source: Company, Ambit Capital research

Berger Paints


Notes:

Berger Paints


Institutional Equities Team

Saurabh Mukherjea, CFA Head of Equities (022) 30433174 [email protected]

Research

Analysts Industry Sectors Desk-Phone E-mail

Aadesh Mehta Banking / NBFCs (022) 30433239 [email protected]

Anand Mour FMCG (022) 30433169 [email protected]

Ankur Rudra, CFA Technology / Telecom / Education (022) 30433211 [email protected]

Ashvin Shetty Automobile (022) 30433285 [email protected]

Bhargav Buddhadev Power / Capital Goods (022) 30433252 [email protected]

Chhavi Agarwal Construction / Infrastructure (022) 30433203 [email protected]

Dayanand Mittal Oil & Gas (022) 30433202 [email protected]

Gaurav Mehta Derivatives Research (022) 30433255 [email protected]

Harshit Vaid Power / Capital Goods (022) 30433259 [email protected]

Jatin Kotian Metals & Mining / Healthcare (022) 30433261 [email protected]

Krishnan ASV Banking (022) 30433205 [email protected]

Nitin Bhasin Construction / Infrastructure / Cement (022) 30433241 [email protected]

Pankaj Agarwal, CFA NBFCs (022) 30433206 [email protected]

Parita Ashar Metals & Mining / Media / Telecom (022) 30433223 [email protected]

Rakshit Ranjan, CFA Mid-Cap (022) 30433201 [email protected]

Ritika Mankar Mukherjee Economy (022) 30433175 [email protected]

Ritu Modi Cement / Infrastructure / Healthcare (022) 30433292 [email protected]

Shariq Merchant Consumer (022) 30433246 [email protected]

Sales

Name Regions Desk-Phone E-mail

Deepak Sawhney India / Asia (022) 30433295 [email protected]

Dharmen Shah India / Asia (022) 30433289 [email protected]

Dipti Mehta India / Europe (022) 30433053 [email protected]

Pramod Gubbi, CFA India / Asia (022) 30433228 [email protected]

Sarojini Ramachandran UK +44 (0) 20 7614 8374 [email protected]

Production

Sajid Merchant Production (022) 30433247 [email protected]

Kausalya Vijapurkar Editor (022) 30433284 [email protected]

Berger Paints


Explanation of Investment Rating

Investment Rating Expected return

(over 12-month period from date of initial rating)

Buy >5%

Sell <5%

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