07 September 2020 Initiating Coverage Kansai Nerolac Joined at the hip with Auto ADD Kansai Nerolac (KNPL; #1/#3 in Industrial/Decorative Paints) remains joined CMP (as on 04 Sep 2020) Rs 485 at the hip with Auto OEMs, which are likely to see their 2nd straight year of Target Price Rs 500 16-18% volume declines (given Auto slowdown/COVID-19). Meanwhile, it has been beefing up its relatively less cyclical non-auto industrial portfolio. In NIFTY 11,334 Decorative, KNPL has outpaced bigger rivals over FY15-19, given its KEY aggressive marketing & distribution push. This trend, however, is unlikely to OLD NEW continue over FY20-23 as KNPL’s predisposition would likely be to safeguard CHANGES margins/restrict A&P spend amidst the demand destruction & until Auto Rating - ADD recovery is in sight. We build in Rev/EBITDA/PAT CAGR of 6/9/8% over Price Target - Rs 500 FY20-23E and initiate coverage on the stock with an ADD recommendation & FY21E FY22E DCF-based TP of Rs. 500/sh (implying 44x Sep-22 P/E, 12% discount to APNT). EPS % - - . Alpha hinges on Auto recovery pace, thrust on reducing cyclicality: KNPL’s high exposure (HSIE:25-28% of sales) to Auto OEMs, which are KEY STOCK DATA likely to see their 2nd straight year of 16-18% volume declines will translate into deeper topline cuts (vs APNT/BRGR) in FY21. Meanwhile, KNPL has Bloomberg code KNPL IN been subtly pivoting towards relatively less cyclical industrial portfolio such No. of Shares (mn) 539 as Auto-refinish, powder, coil, and protective coating). We build in a modest MCap (Rs bn) / ($ mn) 262/3,580 3.6% CAGR for its industrial business over FY20-23E. 6m avg traded value (Rs mn) 137 . Decorative salience increasing, albeit volumes to marginally lag Top 2: 52 Week high / low Rs 573/294 KNPL outpaced APNT/BRGR in decorative segment over FY15-19, given its aggression in both marketing (A&P spends clocked a 23% CAGR vs APNT/BRGR’s -2/-5% CAGR over FY15-18) and distribution (5-year active STOCK PERFORMANCE (%) dealers CAGR estimated at 13%+ CAGR). This outperformance is unlikely to 3M 6M 12M repeat itself over FY20-23 as KNPL’s predisposition would likely be to Absolute (%) 24.0 (1.1) 4.5 safeguard margins from the Auto onslaught by restricting A&P spends. Ergo, we expect KNPL’s decorative volumes to marginally lag Top 2 and Relative (%) 11.1 (1.0) 0.1 build in decorative revenue CAGR of 7% over FY20-23E. SHAREHOLDING PATTERN (%) . Well-covered to play the volume game, margins to improve over FY20-23: Even if overall volumes clock 9% CAGR over FY20-24, we estimate KNPL to Mar-20 June-20 hit a capacity utilisation of ~80% by FY24. Hence, KNPL seems well-covered Promoters 74.99 74.99 to play the volume game. While demand shock-led benign raw material FIs & Local MFs 7.82 7.77 costs/high GMs are likely to mean-revert, the reversion for KNPL is likely to be less steep vs peers, given the increasing decorative salience. Thus, we FPIs 3.93 4.37 build in a 120bp EBITDAM improvement to 16.4% over FY20-23E on the Public & Others 13.26 12.87 back of higher GMs and higher utilisation-led marginal cost savings. Pledged Shares 0 0 . Ranks low on fundamental anchors, ergo discount to peers: Higher Source : BSE industrial salience (lower GMs, higher capital intensity) warrants a valuation discount to Top 2. That said, increasing decorative salience will help RoICs improve from 10.8% to 14.5% over FY21-23. Swifter Auto recovery could offer higher upside. We initiate coverage on KNPL with an ADD Reco & DCF-based TP of Rs. 500/sh (implying 44x Sep-22 P/E). Jay Gandhi Financial Summary [email protected] (Rs. mn) FY19 FY20 FY21E FY22E FY23E +91-22-6171-7320 Net Revenue 54,243 52,800 46,762 56,194 62,759 EBITDA 7,525 8,045 7,122 9,082 10,284 APAT 4,477 5,158 4,264 5,691 6,415 EPS (Rs) 8.3 9.6 7.9 10.6 11.9 Varun Lohchab P/E (x) 57.3 49.7 60.2 45.1 40.0 [email protected] EV/EBITDA (x) 34.1 31.9 35.5 27.7 24.6 +91-22-6171-7334 Core RoCE (%) 12.8 13.6 10.7 13.8 14.0 Source: Company, HSIE Research HSIE Research is also available on Bloomberg ERH HDF <GO> & Thomson Reuters Kansai Nerolac: Initiating Coverage Focus Charts Industry paint volume forecasts Industry and Organised Paints revenue forecasts Total paints revenue Total Paint volume (mn Ltrs) Rs bn Organized paints revenue Organized players volumes (mn Ltrs) Org. Paints revenue growth (%) - RHS Org. Volume growth YoY (%) 1,500 25 10,000 25 20 20 20 8,000 19 15 15 1,000 12 12 12 11 10 6,000 10 9 9 9 9 9 8 5 4,000 5 500 - - 0 0 2,000 -4 -5 -5 -7 - -10 0 -10 FY19E FY21E FY22E FY23E FY24E FY25E FY30E FY20E FY19E FY20E FY21E FY22E FY23E FY24E FY25E FY30E Source: HSIE Research Source: HSIE Research Market share loss can primarily be attributed to higher Revenue mix (%): Decorative business’ skew inching industrial segment which has been under stress (%) up for KNPL Asian Paints Berger Paints -Decorative -Industrial Kansai Nerolac Azko Nobel 100% Others 90% 33 33 35 36 100% 80% 41 42 44 45 70% 80% 18 17 16 16 16 16 16 16 16 15 60% 60% 50% 40% 67 67 65 40% 64 30% 59 58 56 55 20% 20% 10% 0% 0% FY16 FY17 FY18 FY19 FY20 FY21 FY22 FY23 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 Source: Companies, HSIE Research Source: HSIE Research KNPL’s aggressive A&P spends (% of sales) over FY16- ...ensured it outpaced APNT/BRGR in decorative 18… volumes (% growth) FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 KNPL APNT BRGR 8.0 As % of sales 40 6.8 7.0 6.8 6.1 6.0 5.8 30 6.0 5.6 5.1 5.1 5.0 5.0 5.0 4.7 4.9 4.8 4.7 4.6 4.7 4.6 4.8 5.0 4.2 4.2 4.1 4.1 20 4.0 3.9 3.9 3.9 3.6 4.0 3.3 3.3 3.1 3.1 3.0 10 2.0 - 1.0 - (10) Asian Paints Berger Paints Kansai Akzo Nobel FY17 FY18 FY19 FY20 Nerolac FY16 FY21E FY22E FY23E Source: Companies, HSIE Research Source: HSIE Research Page | 2 Kansai Nerolac: Initiating Coverage Joined at the hip with Auto . Joined at the hip with Auto: KNPL remains joined at the hip with the fate of the Auto OEM industry (~25-28% of revenue – FY20) with a market share of nearly 60% (dominant category leader). This segment accounts for ~70% of KNPL’s industrial business. KNPL is likely to have its second straight year (FY20/FY21) of mid-teen growth declines in revenue of its Auto industrials business due to the double whammy of an already ongoing Auto slowdown and the demand destruction caused by the COVID-19 pandemic (HSIE). However, given its dominant business share in key auto accounts/market leaders, we believe the recovery could be swifter-than-industry as Auto market leaders typically lead the recovery given their strong distribution and after-sale touchpoints. Note: Key KNPL Auto accounts are Maruti Suzuki, Hero Motors, Honda Motors, Volvo, to name a few. We build in an 18% decline/14% revenue CAGR in FY21/FY21-23 respectively for the business). Auto OEMs account for nearly a fourth of the Rs. 150bn KNPL’s market share in Auto OEMs/Total industrials Industrial Coatings business in India Others, 8 70 Marine Protective 58 coatings , 4 Coatings, 60 20 50 Coil 40 coatings, 12 40 Powder 30 Coatings, 12 20 Automotive 10 Re-finish, 18 0 Automotive KNPL's Mkt share in Auto KNPL's Mkt share in Total OEM , 26 Industrials Industrials Source: Companies, HSIE Research Source: HSIE Research KNPL’s industrial performance has closely mimicked the fate of the Auto industry KNPL - Industrial growth (%) Auto sales growth (%) PV volume growth (%) 20 15 10 5 - (5) (10) (15) (20) FY15E FY16E FY17E FY18E FY19E FY20E FY21E FY22E FY23E Source: Companies, HSIE Research, SIAM Page | 3 Kansai Nerolac: Initiating Coverage . Subtly beefing up its non-Auto portfolio: Given the cyclicality of its Auto industrial vertical, KNPL is subtly reducing its structural exposure to its non- Auto industrial coatings business such as Powder Coatings, Auto Refinishes, General Industrial, Protective and Coil Coatings, which now account for ~30% of KNPL’s industrial revenues. KNPL: Estimated industrial revenue mix (%) Auto Industrial paints Non-Auto Industrial paints 100% 90% 27 30 30 80% 33 32 32 70% 60% 50% 40% 73 70 70 30% 67 68 68 20% 10% 0% FY18E FY19E FY20E FY21E FY22E FY23E Source: HSIE Research . Auto refinish coats (18% of the industrial coatings market): KNPL has identified Auto-refinish as a key growth driver for its industrial vertical. It has been consistently gaining market share in the Auto-refinish segment (6% market share within three years of launch) underpinned by (1) consistent new product launches, (2) enhancement of its retail and Body Shop network. Key product launches include: 1. Retan (in Premium Polyurethane (PU) Paints) in 2017 and has been received well by the market and approved by major automakers.