Asian Paints, Berger, Nerolac: Morgan Stanley Expects Derating To Continue

Morgan Stanley expects volume growth to improve in the third quarter, aided by an extended pre-festive painting window, the wedding season and deferred demand due to the monsoon.

However, the Ebitda margin, which saw high levels in the first half of the fiscal after benefiting from easing commodity inflation, should reduce due to the recent uptick in crude prices, it said.

Morgan Stanley expects existing players will be building strong levers to strengthen and protect their market positions. Excessive discounting on consumer prices is unlikely, but the competitiveness around credit terms and dealer compensation, as well as marketing intensity, is likely to go up for the industry.

"We expect heightened focus on driving volumes, possibly in the lower-margin economy segment, in a bid to maintain market share," it said. "As a result of this, we expect margins for existing players to settle lower than in the past."

Investors have pushed back on the valuation premium that Indian consumer stocks trade at.

The paints sector has also enjoyed a similar positioning due to disciplined category dynamics, but Morgan Stanley said the increase in competitive intensity is changing this and poses medium-term risks to margin and return ratios. "This, in our view, will act as a drag on valuations until the dust settles."

• The research firm reiterates 'underweight' on Asian Paints with a price target of Rs 2,600 from the earlier Rs 2,702.

• The stock is trading at 50 times consensus 12-month forward earnings-per-share estimates at par with its historical average multiples.

• While it has corrected from peak levels and relative to its discretionary peers, the research firm thinks the correction is due to Asian Paints' relatively weaker topline growth versus Berger.

• "As the operating environment for paint companies becomes more challenging, we expect Asian Paints' multiples to derate further," it said.

• Morgan Stanley downgrades Berger Paints to 'underweight' with price target of Rs 479 from earlier Rs 546

• The stock is trading at a 4% discount to Asian Paints' price-to-earnings multiple, down from an average 20% discount in July–December 2022, Morgan Stanley said.

• This explains its higher topline growth versus the market leader.

• Berger Paints' management strategy is to gain market share in the near term.

• The research firm reiterates 'underweight' on Kansai Nerolac with price target of Rs 250 from the earlier Rs 246.

• The stock trades at a 35% discount to Asian Paints' P/E multiple. While this is at the higher end of its 25–35% discount range in the past three, five and 10-year periods.

• "We believe this higher discount is justified by the changing category dynamics (the market leader is relatively better positioned than smaller players in the competitive environment) and the company's relatively weaker topline performance (losing market share in the decorative segment)."

The research firm expects Grasim Paints to continue to invest heavily for a prolonged period to build a position and existing players will likely fight back hard to protect their share. While market share losses remain highly probable, profitability margins will become more volatile for incumbents.

"Our scenario analysis indicates Grasim Paints could achieve 2.5–12% market share by FY30," it said. "These gains would result in combined loss of share for organized and unorganized players."

Forays into new categories could support top-line growth on a headline basis for paint companies, but the profitability support is unlikely to be meaningful to offset negatives in the core business, according to Morgan Stanley.

• Branding and media strategies will be important to track.

• As aggression and investments from all large players increase, Morgan Stanley expects the pace of unorganised to organised market share shift to accelerate as seen in the past few years.

• Overall, the research firm expects the market share move to be gradual but margin pressure could be visible much earlier if commodity prices remain stable.