Kansai Nerolac Paints' Q3FY18 results (Outperformer) - Steady volume growth…price increases key to margin improvement

Q3FY18 result highlights

• Net sales increased by 13.4% yoy to Rs11.4bn (est: Rs11.7bn), EBITDA increased by 4.7% yoy to Rs1.86bn (est: Rs2.1bn), PAT increased by 1% yoy to Rs1.25bn(est: Rs1.4bn).
• Revenue growth of 13.4% yoy was led by double digit volume growth (~12%+) in the Decorative segment and pickup in growth to double digit levels in the industrial segment.
• Gross margins declined by 160bps yoy. Staff costs increased by 9.7% yoy and other expenses increased by 13.1% yoy. Resultant EBITDA increased by 4.7% yoy with a margin decline of 130bps yoy to 16.4%.
• Other income declined by 9% yoy, depreciation was up 10% yoy and effective tax rate was up 70bps yoy resulting in PAT growth being lower at 1% yoy.

Key positives: Double digit volume growth in the decorative segment.

Key negatives: Weakness in margins.

Impact on financials: Factoring weaker margin performance, we have reduced our FY18E earnings by 4%.

Valuations & view

The earnings miss during the quarter has been led by a weaker mix within decorative and the decorative and industrial segment growing at the same pace. Also, price increases have not come through as yet in either segments which have further pressurized margins. We believe that with industry leading volume growth continuing, the higher input cost pressure will be passed through in both segments through price increases over the next few months. We expect sequential margin recovery once price increases are effected which in an environment of strong revenue growth and overhead cost control will drive a 22% earnings CAGR over FY18-20E. We believe the current stock price correction of 20% provides a good opportunity to buy into KNPL for the longer term. Further, valuations at 33xFY20E earnings are reasonable. Maintain Outperformer.