Kansai Nerolac Paints' Q2FY20 results (Neutral) - Steady deco. volumes, Industrial continues to disappoint…

Q2FY20 result highlights

• Standalone net sales declined by 3.8% yoy to Rs12.4(est: Rs13.5bn), EBITDA increased by 10% yoy to Rs2.06bn (est: Rs2.2bn), PAT increased by 58.5% yoy to Rs1.9bn (est: Rs1.8bn)
• Decorative volumes grew in double digit but value growth was 8% yoy. Automotive business saw 22% yoy decline.
• Gross margins increased by 300bps yoy to 38.1% led by benign input cost. Staff cost was up 10% yoy, other expenses were down 3% yoy. Resultant EBITDA margins increased by 210bps yoy to 16.7%. Adjusting for IND AS impact of Rs38m in other expenses, EBITDA increased by 8% yoy with margin expansion of 180bps yoy to 16.4%.
• Depreciation was up 24% yoy, other income down 52% yoy. Tax credit of Rs64m vs tax outgo of Rs639m in base resulted in higher PAT growth

Key positives: Double-digit growth in decorative segment. Healthy gross margins

Key negatives: Continued weakness in industrial segment.

Impact on financials: Factoring weak 1H, we have cut our sales/EBITDA estimates for FY20/21E by 4-5%. However, earnings estimate for FY20/21E are up 15%/9% due to benefit of lower tax rate.

Valuations & view

KNPL’s 2QFY20 results were below expectations with continued weakness in automotive segment offsetting double digit decorative volume growth.  Management commentary remains cautious with near term challenges in automotive & slowdown in decorative business, which is likely to keep overall volumes/sales trajectory lower compared to peers. We remain positive on KNPLs decorative business & factor in double digit volume growth for FY20/21E. We are also factoring recovery in automotive segment in 2HFY20 & FY21E, resulting in overall sales CAGR of 9% over FY19-21E, which coupled with benign input cost & cost control measures will result in EBITDA CAGR of 18.6% over the same period. Given the steady performance in decorative & likely recovery in Automotive, we now value the stock at 15% discount to APNT’s target multiple compared to 25% earlier to arrive at revised target price of Rs570. Valuations at 44x/40x FY20/21E, provide limited upsides & we would  monitor the pace of recovery in industrial segment to change our stance. Maintain Neutral.