Berger Paints: Buy

Investors with a long-term perspective can consider buying shares of Berger Paints India, the country's second largest decorative paint maker. Expectations of healthy volume growth, the company's increased focus on premium paints, its big-ticket expansion plans, and the push to enhance presence in high-potential markets support our recommendation.

At its current price of Rs 98, the Berger stock trades at around 22 times its trailing 12-month earnings. While slightly higher than the 21 times of its nearest competitor Kansai Nerolac, Berger's earnings multiple is much lower than the 33 times earnings commanded by market leader, Asian Paints. Berger's initiatives to improve product mix, and increase its scale and reach should help it narrow the gap.

Robust volume growth

Similar to other paint makers, Berger has been witnessing robust product off-take due to favourable demand dynamics in the country. Increasing incomes, growing construction activities, and industrial growth at a healthy clip have been important drivers. Berger has also been taking price hikes periodically to pass on rising input costs. Driven by robust volume growth (around 20 per cent), price hikes (totalling to around 12 per cent) and changes in the sales mix, the company's FY 11 consolidated sales and profits grew by a strong 23 per cent and 25 per cent year-on-year to Rs 2,328 crore and Rs 151 crore respectively.

The recent June quarter too saw consolidated top-line grow by an impressive 30 per cent, driven by volume growth in excess of 15 per cent and price hike of around 9 per cent in decorative paints. Yet, bottom-line grew at a slower 16.4 per cent, primarily due to the rapidly rising cost of inputs such as titanium dioxide and crude oil based derivatives.

While prices of decorative paints was raised, there was a lag in increasing prices of industrial paints, which led to a drag in margins. Operating margin declined to 10 per cent in the June 2011 quarter from around 12 per cent in the year-ago period.

Berger's volume growth is expected to be healthy, even if it has a muted September quarter due to monsoons. Margins in the near term may continue to be pressured with rising cost of inputs and greater marketing spends. However, the improved contribution from premium paints on which the company is increasing focus should mitigate the impact to some extent.

With decorative paints contributing almost 80 per cent to the company's sales, projections of increased demand for housing units in the country bode well. Cushman and Wakefield estimates that residential demand in India is expected to be over 4 million units during 2010-2014. This, combined with increased frequency of repainting in Indian homes should aid the company's volumes.

In the industrial paints segment, the company is a market leader in protective coatings which should benefit from expected increased spends on infrastructure. Compared to the Government's XI plan, outlay for infrastructure projects in the XII plan has been doubled to $1 trillion. Though growth in this segment may be muted in the near-term due to ongoing economic uneasiness, long-term prospects appear good. On the international front, Bolix, the subsidiary in Poland, is expected to benefit from some countries in Europe making external insulation mandatory.

Premium focus

In the decorative paints segment, Berger's product portfolio has traditionally been tilted heavily (almost 80 per cent currently) in favour of economy paints such as enamels and distempers. With a view to capturing the fast-growing demand for premium paints such as emulsions, Berger has been launching new products in the category and has stepped up marketing efforts. Consequently, premium paints have been improving share in the company's sales and aiding margins. The focus on water-based premium paints is expected to continue, with much of the ongoing expansion plans of the company being in this category.

To boost volumes and to garner a bigger share (currently 19 per cent) of the fast-growing Indian paints market, Berger Paints plans to more than double its capacity over the next three years. Expansion plans include both brown-field expansions (at its plants in Goa and Rishra, West Bengal) and a green-field project in Hindupur (Andhra Pradesh).

The expansions at Goa and Rishra (at an outlay of Rs 130 crore) which are expected to be completed this calendar will see Berger's capacity increase from 250,000 tonnes to 370,000 tonnes. In addition, Phase-I of the new plant in Hindupur being set up for Rs 160-170 crore is expected to go on steam by FY 2014 and will add 160,000 tonnes. This could further be scaled up to 320,000 tonnes.

Berger Paints is also stepping up its presence in South and West India. These two regions, where demand for paints is among the highest in the country (about 60 per cent share), account for only 35 per cent of Berger Paints' sales. The company has opened around 30 exclusive stores on franchise basis in Tamil Nadu and Andhra Pradesh to improve visibility and volumes. More stores are on the anvil.

The company's good cash position (Rs 127 crore) and low debt-to-equity (0.44 times as on March 2011) give it sufficient headroom to fund expansion plans. ROE is healthy at around 22 per cent.

COMMENT NOW