Analyst Corner: Maintain ‘buy’ on Kansai Nerolac; FV reduced to Rs 450

Kansai Nerolac (KNPL) reported a 14/15% decline in revenues/Ebitda, largely due to Covid-led disruption and some underlying weakness in auto coatings. We model a 55% decline in revenues in H1, gradual recovery in H2 and normalcy by FY21E end; we cut FY21/22E EPS by 41/8% and revise FV to `450 (`485). The short-term environment is indeed extremely challenging, but notably, the company’s fundamentals and the category are intact with volume-led growth potential and stable/improving margin profile arising from rational competition. Maintain ‘buy’.

Revenue declined 14% y-o-y (KIE -10%) to Rs 980 crore; we estimated a 10% decline in decorative sales (60% of sales) and 20% decline in industrial coatings (40% of sales). The management maintains that decorative sales volumes grew double digits in January/February, followed by a Covid-led fall in March. Auto coatings (70% of industrial) witnessed acute weakness in demand.

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GM was up 220/100 bps y-o-y/q-o-q to 38.5% (KIE 38%); a q-o-q improvement in GM after unusual weakness in the Q3 is encouraging. Employee costs grew 7 y-o-y and other expenses were down 8% y-o-y (LFL). Ebitda declined 15% y-o-y (17% LFL adjusted for Ind-AS 116) and Ebitda margin was down 5 bps (down 35 bps on LFL basis). PBT declined 30% y-o-y to `98.5 crore owing to lower other income. Recurring PAT declined 23% y-o-y, partly aided by a reduction in ETR. FY20 round-up: Revenues were down 4.5% y-o-y (+2.5%/-14% in decorative/industrial as per KIE), GM rose 200 bps to 38.1%, Ebitda margin rose 150 bps and Ebitda rose 5% (+120 bps and +3% adjusted for Ind-AS 116), PBT declined 4% while PAT rose 15% on a lower tax rate.

We expect a 55% decline in sales in H1 as consumers likely defer discretionary activities such as repainting (to avoid close contact with labor due to health concerns). Lifting of the lockdown would release pent-up demand from incomplete repainting projects but we do not expect much new repainting work (especially in urban markets), nor a pick-up in fresh painting (construction activity). It is tricky to predict an outlook for auto coatings and rural markets. Overall, we expect gradual recovery in H2 and normalcy by FY21 end (base case). The sharp fall in crude would boost GM (~500-600 bps GM tailwinds if crude stabilises at $40-45/bl and currency at Rs 75/$). Of this, we expect 50/90% of RM savings in decorative/ industrial coatings to be passed on. We model a 300 bps increase in GM to 41.2% (FY20-22E; savings would reflect from H2–KNPL may need six months to exhaust high cost RM inventory.

We cut KNPL’s FY21-22E EPS by 8-41%, rollover and revise FV to Rs 450, implying 36XFY22E PE. We forecast 4.2/12.2% CAGR in revenues/Ebitda and 300/250 bps expansion in GM/Ebitda margin over FY20-22E. KNPL’s 15-20% discount to APNT is attributable to weak pricing power, higher capital intensity and weaker return ratios in the industrial segment.

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