Shares of paint makers gained after they reported a double-digit growth in volumes in decorative paints in the three months to March. But rising raw material prices due to higher crude and steep valuations are a risk to a further upside.
The possibility of a re-rating appears limited due to steep valuations, while a slowdown in volumes and a sharp rise in key inputs like crude oil and titanium dioxide pose as key risks to a further upside, according to Jefferies.
Sharp Rise In Input Costs
The paint industry uses crude oil derivatives such as monomers and titanium dioxide as raw materials, prices of which increased in the last six months on higher crude. Brent crude is trading around $77 a barrel, the highest level since November 2014. On a year-to-date basis, titanium dioxide prices are up 7 percent at Rs 257 a kilogram.
Costlier raw materials will put pressure on the gross margin, which represents the percent of total sales revenue that the company retains after incurring the direct costs associated with producing the goods and services it sells.
Steep Valuations Offer Limited Upside
Shares of paint companies rose between 5 and 8 percent following the March quarter results. Most of them trade at a significant premium to their two-year average price-to-earnings multiple.
“These are richly-valued stocks and as an investor if you are comfortable with a 10-12 percent kind of a return then it's okay,” said Deven Choksey, managing director at broking house KRChoksey. “In terms of top picks, I like Asian paints. Strong brand, capex plans over the next two-three years, among others, make for a good long-term choice.”
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