Kansai Nerolac Paints' Q2FY19 results (Outperformer) - Weak quarter all round

Q2FY19 result highlights

• Standalone net sales increased by 10.7% yoy to Rs12.8bn (est: Rs13.5bn), EBITDA decreased by 14% yoy to Rs1.87bn (est: Rs2.3bn), PAT decreased by 16% yoy to Rs1.2bn (est: Rs1.5bn).
• Overall volume growth was ~9.5% yoy for the quarter.
• Gross margins declined by 500bps yoy (down 280bps qoq) largely on account of higher input costs, rupee depreciation and lack of price hikes especially in Industrial segment.
• Staff costs increased by 8% yoy and other expenses increased by 7% yoy. Resultant EBITDA decreased by 14% yoy with a margin decline of 420bps yoy to 14.6%.
• Other operating income was up 2x while Other income declined by 1% yoy due to higher cash deployment behind capital expenditure. Depreciation was up 23% yoy and effective tax rate was up 110bps yoy resulting in PAT declining by 16% yoy

Key negatives: Lower volume growth, decline in gross margins

Impact on financials: Factoring weak performance we have reduced our FY19/20/21E earnings estimate by 8%/7%/7%.

Valuations & view

KNPL reported disappointing set of results with volume growth as well as margins being below our estimates. Volume growth outlook in the decorative business remains strong though the industrial business could face a near term slowdown, primarily in the automotive business.  While challenges in terms of higher input cost & rupee depreciation remain, we believe gross margins are near to bottoming out and expect margin trajectory to gradually improve on sequential basis as benefit of price hikes in the decorative business & likely hikes in industrial segment start to kick in. We are factoring 16% revenue CAGR, a modest 110bp improvement in EBITDA margins for KNPL, resulting in earnings CAGR of 18% earnings CAGR over FY19-21E similar to APNT. We have cut our target multiple to factor in the overall correction in the sector and value KNPL at a 20% discount to Asian Paints, which is higher than its 3, 5 or 10 year average discount to Asian Paints’ target multiple.  However, the stock trades at 31.5xFY20E, below its 5 year average thereby restricting downside from current levels. Hence we maintain our Outperformer rating on the stock.