The study reveals that the paints sector reported a compounded annual growth rate (CAGR) of 10 per cent between FY1999 and FY2003 as against the FMCG sector's 4 per cent. The paints industry also reported more stable profitability.
Its performance was driven by the growing presence of the organised sector and low per capita consumption levels while FMCG players were hampered by the increasing market share of small, regional players and relatively higher penetration and per capita consumption levels.
Crisil expects the paints industry's revenues to grow steadily at 8-9 per cent per annum over the next three years, while profitability will remain stable. The growth in revenues will be driven by the decorative paints segment, which will not only post a sharper 10-11 per cent annual sales growth in this period as against the industrial paints segment's 5-6 per cent but also be more profitable.
Crisil's portfolio includes leading decorative and industrial paints players, which account for 70 per cent of the players in the organised paints segment and 85 per cent by value.
Crisil believes that the paint companies in its portfolio will maintain their strong credit profiles on the back of the steady demand growth, healthy demand-supply balance and their falling debt levels.
Crisil's paints portfolio had a modified credit ratio (MCR) of 1.12 x in the 1998-2003 period as against its manufacturing sector portfolio's MCR of 0.6 to 1x, indicating that paints was one of the few sectors to witness upgrades, in a scenario of deteriorating credit profiles in the manufacturing sector. Throughout the history of its ratings, Crisil's paints portfolio has not witnessed a single downgrade.
Paints Versus FMCG: Advantage Paints
Crisil has compared the growth rates of the paints companies in its portfolio (refer Table 1) with that of a set of 13 FMCG players between FY1999 and FY2003.
The comparison reveals that both sectors moved in the same direction in this period. But the FMCG one grew at a higher rate in FY1999, after which, the paints sector matched its growth rate for two years.
In FY2003, however, paints grew by 9 per cent while the large FMCG players' consolidated topline declined marginally. A further analysis of growth rates since FY1999, reveals that the topline of Crisil's portfolio of paint companies has grown at 10 per cent CAGR as against the FMCG companies' 4 per cent CAGR.
Paints and FMCG companies: Sales Watch The recent higher rates in paints is mainly because of:
Lower penetration levels
The country's per capita paints consumption is 0.8 kg as compared to the world average of 15 kg and South-East Asia's average of 4 kg (Source: Cris-Infac). Such low penetration levels are a key indicator of potential growth in this sector.
FMCG products, on the other hand, have much higher penetration levels in both urban and rural areas. For instance, the per capita consumption of soaps is 0.5 kg in India, as compared to 2 kg in USA; and a high penetration level of about 91 per cent in rural and urban India. (Source: Cris-Infac)
Declining presence of unorganised sector in paints
Shift from unorganised to organised segment: The organised segment accounts for 70 per cent of the paints sector in volume terms today. Unorganised players have been losing market share because of the:
* Reduction in excise duties on organised players from 40 per cent in the early 1990s to 16 per cent today, which has dented the unorganised sector's cost advantage
* Shift in demand to branded paints from limestone applications and low-quality enamels, which are offered by the unorganised sector, especially in rural areas.
* Entry of organised players into low-value distempers and exterior paints, which has further eroded the unorganised players' market share Crisil believes that this shift in demand from unorganised players to branded paints offers a large growth potential, at least in volume terms, for the large players.
David vs Goliath in FMCGs:
The scenario is quite the reverse in the FMCG sector, where small, regional players are eating into the large organised players' market share. For instance, brands like Ghari from Kanpur Detergents and Gemini refined oil from Parakh Foods have gained ground against larger established players.
According to an AC Nielson survey of the major FMCG players in India, the top players' market shares declined by 9 per cent in value terms in 2002.
Although the FMCG demand has been flat in the last two years, multinational and large national players have been hit by declining sales while regional players have enjoyed double-digit growth. This is because consumers have tended to shift to local, cheaper products to cut expenditure. Nevertheless, established FMCG majors are vulnerable in a downturn.
Lower But Stable Profits For Paints
On the profitability front, the FMCG sector continues to enjoy a marginal lead with higher average net margins of 9-10 per cent as against the paints sector's 8 per cent. But the paints companies' profitability has been more stable in comparison.
Crisil views the stability in the paints sector's revenue growth and profitability as a significant positive, which, coupled with the players' strong balance sheets, signals an improvement in their ability to weather economic downturns.
Strong Growth Rates In Decorative Paints Will Continue Over Medium Term
Crisil expects the decorative paints segment (80 per cent of the industry's volumes), to maintain its strong growth rate of 10-11 per cent per annum over the next three years. Crisil expects paint demand from new construction to grow at about 20 per cent per annum over the next two to three years, driven by increased residential construction to reduce the acute shortage in the housing sector. Along with the government's incentives for housing finance, this has kick-started a boom as is evident from the 30 per cent CAGR in overall housing finance disbursements between FY2000 and FY2003.
The growth in commercial construction, driven by increasing real estate demand from the business process outsourcing space and the need to decongest key business districts, will further push up paints demand. In future, Crisil expects the paints players' revenues to increase on the back of higher volume growth in low-value distempers and exterior paints. In the past, this has helped the leading players to maintain their operating margins despite a marginal fall in overall realisations.
Crisil estimates repainting demand, where growth rates are strongly linked to the performance of the overall economy, to account for over 60 per cent of decorative paints volumes. With the overall gross domestic product (GDP) expected to grow by 6-7 per cent per annum for the next three years, the repainting segment will make steady contributions to the paints sector's volume growth in the medium term.
Industrial Paints Catching Up
Crisil expects industrial paints demand to grow by about 5-6 per cent in the next three years with growth rates of 8-10 per cent in passenger cars, 5 per cent in consumer durables and 5-6 per cent in capital goods. Industrial paints volumes stagnated between FY2000 and FY2002 on account of the slowdown in key end-user industries like passenger cars, two-wheelers, consumer durables and capital goods. But growth rates have picked up with passenger car and two-wheeler volumes growing by 4-6 per cent and 15-16 per cent respectively in FY2003.
Ongoing Capacity Additions To Have Muted Impact
Crisil believes that the ongoing capacity additions by organised players will not adversely impact the industry's healthy demand-supply balance.
Crisil expects the top players in the organised sector to maintain their capacity utilisation levels at 80-85 per cent (see Colour Additions). This will enable them to maintain their current operating margins.
Savings on freight due to improved logistics and tax incentives in the form of excise duty, sales tax and income tax exemptions will further cushion operating margins.
Financial Profiles To Remain Favourable
The paint majors in Crisil's portfolio continue to enjoy strong accruals, low debt levels (in case of Asian Paints, consolidated debt amount is used for calculating industry gearing to capture borrowings in overseas subsidiaries as well) and ample liquidity.
The sector's low fixed cost intensity and the players' strong cash accruals in relation to their capital expenditure have helped them to reduce and maintain low debt levels. Consequently, the industry's consolidated gearing improved to 0.2x in FY2003 from 0.4x in FY2001.
Crisil expects the players to maintain their low debt levels in the medium term since they will fund their proposed capital expenditure through internal accruals, with capital expenditure/net cash accruals ratio for the top three at around 0.8-0.9 times in FY2004.
In the long term, however, a player's favourable capital structure could well be tempered by its management's risk appetite and propensity to leverage the balance sheet to fund acquisitions.