Kansai Nerolac Paints' Q3FY19 results (Outperformer) - Volume growth healthy…margins set to improve

Q3FY19 result highlights

• Standalone net sales increased by 18% yoy to Rs13.4bn (est: Rs13.1bn), EBITDA declined by 9% yoy to Rs1.7bn (est: Rs1.9bn), PAT decreased by 10% yoy to Rs1.1bn (est: Rs1.27bn).
• Decorative revenues increased by ~23-24% yoy aided by volume growth of 18-19% yoy and benefit of price hikes. Industrial revenues increased by 10-11% yoy with a volume growth of ~9% yoy
• Gross margins declined by 550bps yoy (down 90bps qoq) largely on account of higher input costs, lack of price hikes especially in Industrial segment and inventory loss.
• Staff costs increased by 17% yoy and other expenses increased by 6% yoy. Resultant EBITDA decreased by 9% yoy with a margin decline of 380bps yoy to 12.6%.
• Other operating income was up 22% while other income was flat yoy due to higher cash deployment behind capital expenditure. Depreciation was up 21% yoy resulting in PAT declining by 10% yoy

Key positives:  Healthy decorative volume growth

Key negatives:  Contraction in gross margins

Impact on financials: We cut our FY19/20/21E earnings by 10%/6%/5%

Valuations & view

KNPL’s 3QFY19 earnings was a mixed bag as strong decorative volume growth was offset by weakness in margins. We expect decorative business revenues to remain strong aided by improvement in overall demand, price hikes coupled with KNPL’s internal initiatives in terms of new launches and distribution expansion. We believe recovery in Industrial business (especially Automotive business) is likely to be more gradual. Also with price hikes in decorative segment and recent moderation in input costs and high COGS coming in base, we believe gross margins have bottomed out and expect overall margin trajectory to improve sequentially. We are factoring 14% revenue CAGR, a 200bp improvement in EBITDA margins for KNPL, resulting in earnings CAGR of 22% earnings CAGR over FY19-21E similar to APNT. We value KNPL at a 20% discount to Asian Paints & believe downside is limited at current valuations at 37x/31x FY20/21E. Maintain Outperformer