Analysts see rich valuations for paint, tyre stocks; time to book profit?

Amid cooling raw material prices, the crude-oil linked companies, which includes paint and tyre firms, have been on a roll over the past one year.

Shares of related companies have gained up to 84 per cent, as against a 14 per cent rise in the S&P BSE Sensex.

Analysts, however, believe stretched valuations in both these sectors could trigger a de-rating.

"Despite strong January-March quarter (Q4FY23) performance by paint and tyre companies, we believe that the positives are already priced-in, and foresee a near-term correction due to premium valuations.

"While the average valuation of paint companies stands around 55 times (x) trailing twelve months, tyre-makers trade at an average of 33x trailing twelve-month period," said AK Prabhakar, head of research, IDBI Capital.

By comparison, average valuation, historically, has been below 36x for paints, and below 12x for tyres.

Moreover, the possibility of a pricing war due to increased competition in the paints sector could also play a spoilsport in the long haul, said analysts.

Deepak Jasani, head of retail research of HDFC Securities opined that though earnings growth would brighten medium-term prospects of the paints industry, a structural de-rating of valuations are likely in the long-term for existing large players as new players like Grasim, JSW Group, Astral, and Pidilite make a foray.

Financial performance

In the March quarter of FY23, Asian Paints, Berger Paints, and Kansai Nerolac clocked revenue growth of up to 12.8 per cent year-on-year (YoY) in Q4FY23, while growth in net profit was seen up to 401 per cent YoY.

The deflation in the commodity cost basket, which includes crude (down 50 per cent YoY), and titanium dioxide (down 28 per cent YoY), helped paint companies expand Ebitda (earning before interest, tax, depreciation, and amortisation) margins up to 500 basis points (bps) YoY in Q4FY23.

Meanwhile, consolidated net profit of tyre companies Apollo Tyres, Ceat, and JK Tyre jumped over four-fold YoY, on lower input costs and higher demand.

Revenue from operations, on the other hand, increased up to 12 per cent YoY.

Despite this, brokerages remain cautious on both these sectors, and have downgraded price targets for related-stocks.

For Berger Paints, analysts at ICICI Securities said that though the near-term outlook remains healthy, the company's aggressive efforts to regain market shares through higher advertising spends would sacrifice margins in the long-term.

"We believe the stock price upside is limited at current valuations (48.7x FY25E EPS) and hence, maintain 'reduce' rating, with a revised target price of Rs 547," the brokerage firm wrote.

That apart, analysts at HDFC Securities have reduced FY24/FY25 EPS estimates for Kansai Nerolac by 3.3 per cent or 4.1 per cent, underlining higher marketing spend to fend off competition, and attempt to regain market share in the decorative segment to dull long-term margin outlook.

Tyre-maker Ceat, on the other hand, was downgraded to 'hold' by analysts of Nuvama Holdings as they forecasted mixed input costs (7 per cent rise in rubber prices since February 2023), and possible increase in competition from local players to keep FY24 margins in a broad-range.

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