Indian Paints Sector Deep Moat Vs Rich Valuations

WITHER proof

Its a famed saying in the sports world that A team of superstars doesnt necessarily make a winning team, but a Paints Thematic
winning team can make many superstars. Since our initiation on the Indian paints sector (February 2012), we have
maintained that the Indian paints sector is a winning sector which has potential to throw many BIG superstars. We Date October 4th, 2016
continue to maintain that the Indian decorative paints sector is one of the most insulated consumption sectors across
the Indian staples and discretionary consumption landscape. Though, the wealth creating nature of the sector has
remained intact across cycles (slide 22 & 23) but the same has got appreciated more secularly and overwhelmingly in Stock performance (%)
the last 4-5 years. Gradually, the moats of the paints sector vs the traditional consumption basket at large started
getting recognised and captured in the valuations; consequently, currently the sector has assumed the valuation 1m 3m 12m
leadership (slide 2 & 3) of the whole consumption basket. The sector evolved from being a chemical with some
brands to the stature of brands with some chemicals After reassessing the growth runway, strength of the entry APNT IN 2% 19% 42%
barriers and the capital efficiency discipline of the sector we retain our positive stance on the sectors fundamentals. BRGR IN 2% 32% 70%
Though current steep valuations and historically high margins restrict our enthusiasm to get converted into the table
thumping recommendations on the sector, but would definitely put it on the top of our BUY on DIPS list. KNPL IN 2% 22% 58%

Growth runway remains lucrative: Indian paint industrys volume growth rate has remained steady over the last ~2 AKZO IN 1% 10% 25%
decades. Even in the current slowdown witnessed by the consumer sector at large, decorative paints continued to
deliver double digit volume growth. Led by clear and loud trends like rapid urbanisation, better living aspirations, low Nifty -1% 4% 10%
per capita consumption (~3.4kg) and share of organised segment (currently at ~75%) the growth drivers remain firmly
Sensex -1% 4% 8%
in place to continue the growth momentum.
Decorative paints; Cosy Oligopoly: In the decorative paints segment (~75% of the India paint industry), entry BSE CONSDIS 4% 13% 26%
barriers viz. distribution infrastructure, tinting machine network, portfolio of strong brands, others - are strictly defined
and impregnable in the near to medium term, at least not organically. Hence, in spite of the influx of global coating
companies in India in the recent past, competitive threat from new players remains negligible in the decorative paints Tejash Shah
segment. We believe, number of key participants in the decorative paint segments wont change in the foreseeable tejash@sparkcapital.in
future. And this yields immense pricing power for the sector participants. +91 22 4228 8155

View and Recommendations: We continue to maintain our long term bias for the decorative led revenue models in Madhav PVR
the paints segment, while recommendation on the non-decorative heavy revenue models remain tactical in nature. madhav@sparkcapital.in
Our current views on paint stocks: ADD rating on Asian Paints (TP: Rs.1,209), ADD rating on Berger Paints (TP: +91 44 4344 0060
Rs.280), BUY rating on Akzo Nobel (TP: Rs.1,869) & REDUCE rating on Kansai Nerolac (TP:Rs.342).
Near Term Risks: Though the risk to the current revenue growth momentum remains minimal, pressure on margins Gnanasundaram S
led by the input basket inflation remains the key monitorable. Any negative surprise on the GST front can adversely gnanasundar@sparkcapital.in
impact. +91 44 4344 0062

Find Spark Research on Bloomberg (SPAK <go>), Page 1

Thomson First Call, Reuters Knowledge and Factset
Indian Paints Sector Deep Moat Vs Rich Valuations
Shift in Valuation leadership from safe consumer staples sector to insulated paints category

Healthy growth in a deflationary environment coupled with its inherent robust pricing power ability led to shift in
1,100 350 41x 4,000
Hindustan 45x
1,000 45x 37x
Unilever Dabur India 3,500 Britannia Industries
900 40x 33x 39x
3,000
800 35x 250 29x 33x
2,500
700 27x
CMP (Rs.)

CMP (Rs.)

CMP (Rs.)
30x 25x
2,000
600 21x
25x 1,500 21x
500 150
20x 15x
400 1,000

300 500
200 50 0
Aug-11
Dec-11

Aug-12
Dec-12

Aug-13
Dec-13

Aug-14
Dec-14

Aug-15
Dec-15

Aug-16
Apr-12

Apr-13

Apr-14

Apr-15

Apr-16

Apr-12

Apr-13

Apr-14

Apr-15

Apr-16
Aug-11
Dec-11

Aug-12
Dec-12

Aug-13
Dec-13

Aug-14
Dec-14

Aug-15
Dec-15

Aug-16
Dec-15
Aug-11
Dec-11

Aug-12
Dec-12

Aug-13
Dec-13

Aug-14
Dec-14

Aug-15

Aug-16
Apr-12

Apr-13

Apr-14

Apr-15

Apr-16
Source: Bloomberg, Spark Capital Research

valuation leadership from safe consumer staple category to a relatively recession insulated paints sector over the last 12 months to 18 month period

52x 290 43x

1,200 Asian Paints Berger Paints 50x 350 Kansai Nerolac
46x 38x
240 43x
1,000 33x
40x
190 36x
250 28x

CMP (Rs.)
800 34x
CMP (Rs.)

CMP (Rs.)

29x
140 23x
28x
600 22x
150 18x
22x 90
15x
400
40
200 50

Aug-11

Aug-14
Aug-12

Aug-13

Aug-15

Aug-16
Feb-12

Feb-13

Feb-14

Feb-15

Feb-16
May-14
May-12

May-13

May-15

May-16
Nov-11

Nov-12

Nov-13

Nov-14

Nov-15
-10
Aug-11

Aug-12

Aug-13

Aug-14

Aug-15

Aug-16
Nov-14
Nov-11

Nov-12

Nov-13

Nov-15
Feb-13
Feb-12

Feb-14

Feb-15

Feb-16
May-12

May-13

May-14

May-15

May-16

Apr-12

Apr-13

Apr-14

Apr-15

Apr-16
Aug-11
Dec-11

Aug-12
Dec-12

Aug-13
Dec-13

Aug-14
Dec-14

Aug-15
Dec-15

Source: Bloomberg, Spark Capital Research Aug-16

Page 2
Indian Paints Sector Deep Moat Vs Rich Valuations
Valuation leadership transition from consumer staples category very pronounced over last 12-18 months

Stagnation in HUVR & Dabur with APNT upgrade clearly showcases valuation leadership transition to APNT, while re-rating in BRIT slightly offset the shift

Source: Bloomberg, Spark Capital Research

with the same phenomena broadly following with BRGR too as against the same said stocks

Source: Bloomberg, Spark Capital Research

Page 3
Indian Paints Sector Deep Moat Vs Rich Valuations
Critical Factors that led to Paint Sector Re-rating

#1 Superior,
recession
proof growth
trajectory

#2 Enviable
Moat

#3 Remarkable
Pricing power
showcased
across cycles

#4 Robust
Margin profile
featuring in top
decile margin
profiles across
industries

#5 Healthy
capital
efficiency

Page 4
Indian Paints Sector Deep Moat Vs Rich Valuations
#1 Indian paints sector has a superior GDP accelerator of ~1.1x to ~2.5x even over a 10 year timeframe

Indian Paints sector witnessed a non-linear growth of ~1.7x Vs GDP with market leader APNT having a median beta of ~2.4x
3000
30.0%
24.0% 24.7%
2000
25.0% 21.5% 22.3%
1000 20.1%
20.0% 16.2%
0 15.6%
13.6%
FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 15.0% 11.5%
India GDP (Current US Billion $) 9.5%
500 10.0%
10.3%
9.3% 8.6% 8.5%
5.0% 7.2% 7.6%
6.6% 6.6%
5.6%
0 0.0% 3.9%
FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16
Indian Paint Sector Market Size (Rs.Bn) India GDP Growth % Asian Paints Growth (%)

Source: Spark Capital Research; India GDP growth refers to real GDP Source: Spark Capital Research; India GDP growth refers to real GDP

...followed by Berger Paints median acceleration of ~2.2x ...while industrial specialised KNPL average acceleration was at ~1.9x

30.0% 30.0%
25.9% 25.5%
23.8% 24.1%
25.0% 25.0% 21.1% 21.4%
19.0%
20.0% 16.2% 16.5% 16.0% 20.0%
14.5%
15.0% 11.7% 15.0% 12.2%
13.1% 10.8%
9.8%
10.0% 7.2% 10.0% 8.0% 7.9%
10.3% 4.1% 10.3%
9.3% 8.6% 8.5% 9.3% 8.6% 8.5%
5.0% 7.2% 7.6% 5.0% 7.2% 7.6%
6.6% 6.6% 6.6% 6.6%
5.6% 5.6%
0.0% 3.9% 0.0% 3.9%
FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16

India GDP Growth % Berger Paints Growth (%) India GDP Growth % Kansai Nerolac Growth (%)

Source: Spark Capital Research; India GDP growth refers to real GDP Source: Spark Capital Research; India GDP growth refers to real GDP

Page 5
Indian Paints Sector Deep Moat Vs Rich Valuations
#1 Both on a five and ten year timeframe, Paint sector has outperformed consumption peers

The Indian paint sector has clearly outgrown both staples and both over a five year and ten year period
discretionary categories in the consumption spectrum

Paints 18.8% Paints 17.3%

Packaged Foods 17.7% Packaged Foods 16.6%

Beauty & Personal Care 16.5% Beauty & Personal Care 15.0%

Footwear 15.8% Bags & Luggage 14.4%

Bags & Luggage 15.6% Footwear 13.6%

Apparel 14.0% Apparel 13.0%

Home Care 11.1% Home Care 10.1%

0.0% 5.0% 10.0% 15.0% 20.0% 0.0% 5.0% 10.0% 15.0% 20.0%

5 Year CAGR (FY11 - FY16) 10 Year CAGR (FY06 - FY16)

Source: Bloomberg Business Intelligence, Spark Capital Research Source: Bloomberg Business Intelligence, Spark Capital Research

Page 6
Indian Paints Sector Deep Moat Vs Rich Valuations
#1 Paint companies growth trajectory clearly among the highest across peers in the consumption universe

Of the top 10 consumer companies (classified by market capitalization), Paint while over a longer timeframe, they have been over the median despite
companies on a 5 Year timeframe have outperformed a relative higher base

Pidilite 15.1% Titan 20.6%

Asian Paints 15.0% Emami 18.5%

Berger 14.6% Pidilite 17.6%

Marico 14.0% Asian Paints 17.4%

Emami 13.9% Marico 16.2%

Dabur 13.8% Dabur 16.0%

Britannia 13.4% Berger 16.0%

Titan 11.6% Britannia 16.0%

ITC 11.3% ITC 13.0%

Hindustan
10.6% Hindustan Unilever 10.2%
Unilever

0% 2% 4% 6% 8% 10% 12% 14% 16% 0% 5% 10% 15% 20% 25%

5 Year Revenue CAGR 9 Year Revenue CAGR

Source: Spark Capital Research; Top 10 companies by market capitalization picked from Source: Spark Capital Research; Top 10 companies by market capitalization picked from
Spark Coverage Universe for comparison purposes Spark Coverage Universe for comparison purposes

Page 7
Indian Paints Sector Deep Moat Vs Rich Valuations
#1 Healthy growth drivers to keep robust growth trajectory of both decorative & Industrial paints intact

Decorative paint demand outperforms broad macro growth while industrial segment mirrors overall economic condition

Further to volume growth

sustaining at low teens for last
ff Pent Up demand ff three quarters, upcoming festive
Growth in domestic
User production of
season to reflect pent up demand Automotive Industries- automobiles to

Conversion to paints
Rapid urbanisation is ensuring
f Coatings f Automobiles
industry
f service domestic
and overseas
D high rate of conversion from lime
Repainting
ff from low end ff wash to distempers and more to I demand.
E products
C ff (~70% of
total
emulsions. N
D
O demand) Increasing purchasing power is
ff Better livings U
R aspirations ff ensuring high growth rate for high-
S
A end paints. User
T Protective Industries- Increased thrust on
T & General Power Plants, core infrastructure
I
ff
Others Festivals,
Occasions, f
Continuing cultural habits that
R
I
f Industrial
Coatings
f Oil & Gas
industries,
f (Power, Ports, Oil &
V mandate re-painting during key Gas, etc.)
E
expanding reach,
festivals/occasions . A etc.
etc.
L
P
A P
I A User
Easy availability of housing loans Industries-
N New Construction ensured robust demand in last I
White goods, Growth in demand
N Powder
T
S
ff
(townships, housing
colonies, etc.) f
decade. Revival in real estate
sector can further surprise T f Coatings f Brown goods,
etc. (mainly
f for consumer
durables.
positively
S Consumer
durables)
D Urban population share
Fresh ff Rapid pace of
1971 20%, 2001 28% D
E
Painting Urbanization f
M 2011 34% E
A ff (~30% of
total Unaffordability of big houses in
M
Growth in
N demand)
A
Trend of Nuclear job centres, increasing social User construction
D ff ff N Coil Industries- industry and
Families acceptance of nuclear families,
etc. D f Coatings f Construction ,
Consumer
f higher
infrastructure
Investment in - IT/ITES parks, durables, etc. spend.
Commercial
ff construction growth
f organised retail sector, general
investment environment, etc.
Outlook for medium term
Outlook for medium term

Source: Industry Sources & Spark Capital Research Source: Industry Sources & Spark Capital Research

[Growth function of (f)] Page 8

Indian Paints Sector Deep Moat Vs Rich Valuations
#2 Competitive Intensity Unlike in other countries, global Peers have not able been to crack the secret sauce in India

Active in paint space in India

Not active in paint space in India

Exited India
BASF
Global Ranking 5
In India Since 1943
Entry Mode Subsidiary
Plant(s) 9

Sherwin Williams
Global Ranking 3
In India Since 2007
Entry Mode Inorganic
Plant(s) 1 AkzoNobel
Exited in 2013
Global Ranking 1
In India Since 2008
PPG Entry Mode Subsidiary
Global Ranking 2 Plant(s) 3
In India Since 1997
Entry Mode JV with AP RPM Inc.
Plant(s) 1 Global Ranking 6
In India Since 2006
Entry Mode Kemrock JV
DuPont Plant(s) 2
Global Ranking 4
In India Since 1994
NIPPON PAINTS
Entry Mode Subsidiary
Global Ranking 10
Plant(s) 1
In India Since 2006
Entry Mode Subsidiary ; Currently
have a JV with Berger
Source: Spark Capital Research
Plant(s) 1 (one under construction)

Page 9
Indian Paints Sector Deep Moat Vs Rich Valuations
#2 Incumbents continue to thrive at a faster pace than Indian Paints industry

Despite being the top four companies in the India Paint industry, the incumbents continue to..

Revenue (In Rs. Mn) FY10 FY11 FY12 FY13 FY14 FY15 FY16 5 Year CAGR
Asian Paints 66,809 77,223 96,322 1,09,386 1,27,148 1,41,828 1,55,341 15.0%
Growth % 22.3% 15.6% 24.7% 13.6% 16.2% 11.5% 9.5%
Berger Paints 18,913 23,407 29,477 33,346 38,697 43,221 46,341 14.6%
Growth % 16.5% 23.8% 25.9% 13.1% 16.0% 11.7% 7.2%
Kansai Nerolac 17,064 21,413 26,006 28,566 31,640 35,491 38,302 12.3%
Growth % 24.1% 25.5% 21.4% 9.8% 10.8% 12.2% 7.9%
Akzo Nobel 9,386 10,968 19,878 22,320 24,179 25,270 27,401 20.1%*
Growth % 4.3% 16.9% NA 12.3% 8.3% 4.5% 8.4%

Source: Spark Capital Research; *Optically higher on account of Akzo acquiring ICI India

Outpace other players in the sector despite them operating on a low base

Revenue (In Rs. Mn) FY10 FY11 FY12 FY13 FY14 FY15 FY16 5 Year CAGR
Nippon India 1,560 NA NA NA NA 5,100 6,750 26.7%
Growth % - - - - - - 32.4%
Jotun India 2,108 2,567 3,045 2,802 2,914 3,584 NA 11.2%
Growth % - 21.8% 18.6% -8.0% 4.0% 23.0% -
Shalimar Paints 3,656 4,072 4,947 5,416 5,208 4,713 4,309 1.1%
Growth % - 11.4% 21.5% 9.5% -3.9% -9.5% -8.6%
Jenson & Nicholson India 365 447 615 674 615 600 365 -0.8%
Growth % - 22.3% 37.6% 9.7% -8.7% -2.5% -28.5%
Source: Spark Capital Research;

Page 10
Indian Paints Sector Deep Moat Vs Rich Valuations
#2 Economic moat index of respective business segments

Economic Moat Index Decorative segment Economic Moat Index- Industrial Segment
140
E
N 120 Tinting machines are E
T also a key part of dealer N
R 100 retention strategy T
Y R
80 Y
B 60 B Distribution Brands Capacity Parentage In-house Relation with
A A Network R&D /Tech Clients/OEMs
R 40 R Tie-ups
R R
20
I I
E E Economic Moat - Industrial Segment
0
R R
Capacity Technology Product Brand(s) Distribution
Portfolio Positioning Network CRITICAL SUCCESS FACTORS

Source: Spark Capital Source: Spark Capital

Decorative Segment Strengths are strongly defined by incumbents,
difficult to replicate in near to medium term Atleast not Organically
Product Portfolio -In the last decade or so, Indian paint industry has witnessed a huge
growth in the premium products compared to the economy ones. This trend is
homogeneous across the market including small centres. Hence portfolio of premium
products along with economy products (for new rural markets) is imperative for growth.
In Brands we trust Paints are becoming high involvement purchase by the end
consumer, hence portfolio of strong brands and high brand recall are critical for
growth in the decorative segment. Indian consumers are becoming less price
sensitive and are ready to pay premium price for better products and brands.
Distribution Network India with its diversity of geography, people and language is a very
complicated place to do business, especially B2C. Over the years, all the current
incumbents have invested heavy resources, (human, funds and time) in expanding their
distribution network, particularly in rural India.
Tinting Machine Network As per our understanding, dealer tinting system (colour
dispensing machine) does not only minimizes dealers inventory and offers wide
choices to customers, but also provides strong resistance to competition in
poaching existing dealers and also creates inertia for dealers to switch or
accommodate other brand(s) on the shop floor.
Industrial Segment: Barriers are strong but not invincible Foreign
players and domestic players with tech-tie ups to gain market share
Distribution and Brands Unlike decorative, Industrial segment is B2B, hence does not
rely much on distribution strength. However, basic network is required to meet customers
demand and provide after sale service. Auto re-finish and some applications of powder
coatings still rely on traditional distribution channel for small SKUs based application
Capacity Good facilities, both in terms of capacity and quality are imperative to
engage with high end clients especially, in automotive.
Parentage Global OEMs and manufacturers who are setting-up shops in India, also bring
along their globally preferred vendors list. Hence, it makes it easier for MNCs paint
companies to break into such accounts.
R&D, Tech Tie-ups Industrial clients demand very high-end quality and applications.
Strong internal R&D and/or technical collaborations with foreign majors is one of the critical
success factors in this segment
Relation with Clients/OEMs Partnering with Clients/OEMs in developing paints as
per their application need commands huge customer loyalty from OEMs and such
relations are generally strong enough to resist competition threat

Page 11
Indian Paints Sector Deep Moat Vs Rich Valuations
#2A While Distribution Moat of FMCG has been threatened in recent past, Paint sector faces no such issues

IndianDistribution
FMCG Distribution
Structures
Structure Paints Distribution Structure

Impact of Modern Trade Affect of CSD Channel

Factory
Factory

Depot

Regional Depots

Super Institutional
Stockists
Stockists Stockists
Modern
Trade
Stockist Dealers/Hardware Shops
Sub
Stockists

Wholesalers

End User Customer

Institutional Painter/Consumer
Retail Trade Rural Trade
Customers

Relatively Ring
Shoppers & Consumers
Fenced Distribution

CSD Channel CSD Channel

Emergence of Cult distribution
Threat of E-Commerce
channels

Source: Company filings, Spark Capital Research

Page 12
Indian Paints Sector Deep Moat Vs Rich Valuations
#2A Though distribution is the moat in Indian paints sector, reach needn't be as deep as the STAPLES category

Owing to ticket size & partly B2B nature of the business, reach of paint is not even one tenth of the average FMCG companies in India
companies in terms of total outlets
Relaxo Footwear 50 Retail Outlets reach (in mn)
Page Industries 44
HUL
Asian Paints 38
Berger Paints 19 P&G

Kansai Nerolac 12 ITC

Titan Industries 12.7 Dabur
Akzo Nobel India 11
Retail Touchpoints/ Colgate
La Opala 10 Point Of Sale
GCPL
VIP industries 10
Arvind Ltd Nestle
8
Dealers
Aditya Birla Fashion & 7 Marico
Pidilite 4 Brittannia
Bata 2 Bajaj Corp
Indian Terrain Fashion ltd 1
Jyothy Lab
0 10 20 30 40 50 60
Thousands Reckitt Benckiser
Mondelez India
40000 38000
L'Oreal
35000
29500
30000 Heinz India
25000 Beiersdorf
20000 19000
J&J
15000 11000 12000
18000 GSKCH
10000 8000 7800
Emami
5000
0 Zydus Wellness
Asian Paints Akzo Nobel India Berger Paints Kansai Nerolac Abbott
Dealers Tinting Machine 0.0 2.0 4.0 6.0 8.0

Source: Spark Capital Research Source: Spark Capital Research

Page 13
Indian Paints Sector Deep Moat Vs Rich Valuations
#2B With relatively lower A&P outlay, Paint players have created a larger Brand Play in the Indian context

Despite having created great brands in the country, A&P outlay of paint as reflected in the five year average A&P spend of ~5% for paints vs
companies is still lower when compared to FMCG players above ~10% for the staples category

HUL 45,952
Zydus Wellness 21%
Asian Paints 9,049
Emami 17%

ITC 8,713
Dabur 13%

Marico 7,861 HUL 12%

We note that APNT has the
Dabur 7,716 second highest A&P outlay
Marico 12%
across the consumption
Britannia spectrum (in our coverage
7,378 Jyothy Labs 9%
Industries
universe) beating all FMCG
Britannia
Emami 4,305 companies barring HUVR. 8%
Industries
Further, while companies like
Berger Paints 3,199 HUVR etc have numerous Bajaj Corp. 7%
sub-brands across which A&P
Berger Paints 6%
Kansai Nerolac 2,289 outlay has to be shared, APNT
has relatively lesser number of
Asian Paints 5%
Jyothy Labs 2,016 sub-brands highlighting the 5 Year Average A&P as % of Sales
deep A&P focus of the Akzo Nobel 5%
Akzo Nobel 1,332 companies in a low
Zydus
involvement consumer Kansai Nerolac 4%
1,020 category.
Wellness
DFM Foods 4%
Bajaj Corp. 550
Manpasand
FY16 A&P Outlay 3%
Manpasand Beverages
283
Beverages
ITC 2%
DFM Foods 146
0% 5% 10% 15% 20% 25%
0 10,000 20,000 30,000 40,000 50,000

Source: Spark Capital Research; In Rs.Million Source: Spark Capital Research

Page 14
Indian Paints Sector Deep Moat Vs Rich Valuations
#2B Continuous celebrity engagements has evolved this low involvement consumer category into an aspirational brand play...

Deepika Padukone & Saif Ali Khan endorse Asian Paints among others while Katrina Kaif has been endorsing Berger Paints

Source: Company, Spark Capital Source: Company, Spark Capital

Farhan Aktar & Shradda Kapoor endorse Akzos Dulux brand in India while Shah Rukh Khan has been Nerolacs face for more than five years
now

Source: Company, Spark Capital

Source: Company, Spark Capital

Click on Picture for advertisement Page 15

Indian Paints Sector Deep Moat Vs Rich Valuations
#2B.And NOW the brands are being extended to capture the whole value chain and drive deeper engagement

Express painting initiatives by Berger Paints & Asian Paints have started meaningfully contributing to the respective company sales

Page 16
Indian Paints Sector Deep Moat Vs Rich Valuations
#2C Paint companies have outpaced their consumption sector peers in R&D spends

Research & Development as a percentage of net profits for paint

Paint companies have however efficiently utilized R&D outlay for
players is significantly higher than FMCG players
backend purposes
% of Net Profit
Emami 222
4.1% Asian Paints: For technology road mapping, APNT initiated platform
based technology development approach few years ago to drive
Britannia
438 innovation and build healthy new product pipeline, the benefits of which
Industries 5.3%
are clearly visible from the stream of several new product introductions
Dabur 266 2.1% during the past three years. To speed up innovation process and reduce
cycle time of new product development, your Company adopted a new
ITC 1.7%

1554
Hindustan
396 1.0% Akzo Nobel: Akzo Nobels research centre has developed close to
Unilever
175,000 colour formulas apart from colours for original equipment
manufacturer approvals from global car manufacturers and aerospace
Marico 275 3.8%
customers worldwide.

Jyothy Labs 15 1.0%

Berger Paints: Development of new products and up gradation of

Akzo Nobel 113 5.8%
existing products, Reformulation for cost optimization without
compromising quality, Development of environment friendly products,
6.4%
Kansai Nerolac 226 Collaborative work with suppliers and academic institutes &
Development of new resins and Emulsions
3.6%
Berger Paints 132

4.3%
Asian Paints 752
Kansai Nerolac: KNPL is setting up a world-class R&D facility at Navi
Mumbai in order to develop cutting-edge and futuristic product offerings
0 500 1000 1500 2000
to customers.
R&D Outlay (In Rs.Mn)

Source: Spark Capital Research Source: Spark Capital Research

Page 17
Indian Paints Sector Deep Moat Vs Rich Valuations
#2C and through R&D have continuously offered better value proposition, tempting consumers to premiumize

What led to growth in the past decade? What we believe will drive growth in the next decade?

From Conversion From From Conversion From

Emulsion
Solvent Based Water Based

Enamel Emulsion
Chuna Enamel
Enam Water Based
el Enamel

Distemper Industrial Paint Distemper

In FY15 , APNT launched sixteen (16) new

products in the decorative segments and seven (7)
in the industrial segment
In FY16, Royale basket has been enhanced with
the launch of a revolutionary new product called
Royale Atmos that absorbs odour and unhealthy
chemicals and emits fragrance.
In FY16, Many products were launched during the
year to expand the SmartCare range in the market
to address a variety of waterproofing problems of
customers.
KNPL launched the all New KNPL Impressions with Berger launched Tartaruga Hi-Build, an exterior
High Definition Colour Technology (HD). Keeping textured wall coating, incorporating a selection of
the consumer interest at the centre, KNPL launched coloured grits with silicon for water resistance
2 new products Excel Rain Guard and Statue
Paint during the year.
In FY17, the company is expected to launch
KNPL also enhanced its range of colors for Car paintable wallpapers.
Interior Coatings, which are eco- friendly, free of
Hazardous Air Pollutants (HAPs) and meet
international coating standards..

Page 18
Indian Paints Sector Deep Moat Vs Rich Valuations
#3 Robust pricing power majorly owing to oligopolistic nature of business

Paint prices over a five year timeframe have increased by ~40% while major RM prices have been broadly flat.

160 Indian Paints Price Index 350

150 300
250
140
200
130 150
120 100

110 50
0
100

Aug-12
Aug-11

Aug-13

Aug-14

Aug-15

Aug-16
Feb-12

Feb-13

Feb-14

Feb-15

Feb-16
May-11

May-12

May-13

May-14

May-15

May-16
Nov-11

Nov-12

Nov-13

Nov-14

Nov-15
90
Apr-10

Oct-10

Apr-11

Oct-11

Apr-12

Oct-12

Apr-13

Oct-13

Apr-14

Oct-14

Apr-15

Oct-15

Apr-16
Jul-10

Jul-11

Jul-12

Jul-13

Jul-14

Jul-15

Jul-16
Jan-11

Jan-12

Jan-13

Jan-14

Jan-15

Jan-16
Titanium Dioxide (INR/KG)

Source: Spark Capital Research

...in comparison FMCG market leader prices have only increased by ~15% over the same time period
9%
140.0 10% HUL Price Mix
HUL Index 4% 5%
5% 3%
120.0
0%
100.0 -5% -2%
-4%
80.0 -10%
FY11 FY12 FY13 FY14 FY15 FY16
60.0
17% Asian Paints Price Mix
20%
40.0 9%
4% 5%

20.0 0%
-1%
0.0 -20%
FY11 FY12 FY13 FY14 FY15 FY16 FY12 FY13 FY14 FY15 FY16

Source: Spark Capital Research

Page 19
Indian Paints Sector Deep Moat Vs Rich Valuations
#4 Robust Operating Margin profile leading to a higher profitability delta

Median industry margin of paints category is robust... though lower than average operating margin of staples category
FY10 FY11 FY12 FY13 FY14 FY15 FY16
FY10 FY11 FY12 FY13 FY14 FY15 FY16 ITC 34% 35% 35% 36% 37% 37% 37%
DFM Foods 10% 12% 12% 9% 9% 11% 12%
Zydus
Akzo Nobel 12.5% 12.1% 8.8% 8.4% 7.9% 10.3% 11.1%
Wellness 25% 25% 23% 25% 22% 22% 21%
Emami 24% 20% 20% 20% 24% 24% 29%
Berger Paints 10.5% 10.7% 10.3% 11.1% 11.1% 11.8% 14.1% HUL 15% 14% 15% 16% 16% 17% 18%
Dabur 19% 19% 17% 16% 16% 17% 20%
Asian Paints 18.4% 17.2% 15.7% 15.8% 15.7% 15.8% 18.1% Britannia 5% 5% 6% 7% 9% 11% 14%
Bajaj Corp. 33% 30% 25% 28% 28% 29% 34%
Jyothy Labs 15% 13% 10% 12% 12% 11% 13%
Kansai Nerolac 15.5% 13.6% 13.0% 11.8% 11.4% 12.5% 14.9% Marico 14% 13% 12% 14% 16% 15% 17%
Source: Spark Capital Research Source: Spark Capital Research

However, delta in profitability was higher in paints pack ...than the FMCG pack during recent raw material down cycle

7.0x 4.0x 3.7x

5.7x 5.7x 3.5x
6.0x
3.0x 2.9x
5.0x 4.6x 4.4x 3.0x 2.7x
3.8x
4.1x 2.4x 2.5x 2.4x 2.4x
2.5x
4.0x 3.3x 3.1x 1.9x
2.7x 2.8x 2.9x 2.0x 1.7x 1.8x 1.7x
3.0x 2.4x 2.4x
2.0x 1.5x 1.2x 1.1x 1.2x1.2x
2.0x 1.4x1.2x 0.9x 0.9x
0.9x 1.0x 1.0x
1.0x
0.5x
0.0x
1QFY15 2QFY15 3QFY15 4QFY15 1QFY16 2QFY16 3QFY16 4QFY16 1QFY17 0.0x
1QFY15 2QFY15 3QFY15 4QFY15 1QFY16 2QFY16 3QFY16 4QFY16 1QFY17
P&C EBIDTA Delta P&C PAT Delta
FMCG EBIDTA Delta FMCG PAT Delta

Source: Spark Capital Research Source: Spark Capital Research

Page 20
Indian Paints Sector Deep Moat Vs Rich Valuations
#5 Healthy ROCE though not as robust as Indian FMCG Staples pack

Indian paint companies capital efficiency remains strong

FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 Average

Akzo Nobel 16.2% 16.3% 15.6% 15.2% 16.6% 14.2% 19.0% 21.6% 16.9%

Berger Paints 15.3% 16.0% 17.3% 18.3% 17.9% 17.2% 16.5% 20.2% 17.3%

Asian Paints 29.4% 48.4% 37.5% 34.4% 31.8% 29.3% 27.9% 30.0% 33.6%

Kansai Nerolac 13.9% 20.4% 19.6% 19.5% 16.3% 13.8% 16.4% 17.1% 17.1%

Source: Spark Capital Research

...though lower than the consumer staples pack, still healthy given other positive factors

FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 Average

ITC 23.7% 27.6% 31.6% 33.9% 34.5% 34.3% 32.0% 27.7% 30.7%
DFM Foods 10.6% 17.1% 26.6% 20.1% 12.6% 15.8% 18.2% 25.2% 18.3%
Zydus Wellness 54.4% 55.1% 49.1% 41.1% 43.8% 33.1% 27.5% 23.0% 40.9%
Manpasand Beverages - - - 21.6% 25.7% 19.2% 17.4% 12.4% 19.3%
Emami 20.1% 27.4% 25.9% 33.1% 37.5% 43.8% 42.9% 34.3% 33.1%
HUL 109.9% 74.5% 72.8% 77.5% 83.6% 84.8% 77.3% 75.7% 82.0%
Dabur 45.4% 47.2% 33.2% 25.2% 25.6% 28.1% 28.6% 27.7% 32.6%
Britannia Industries 15.5% 15.8% 16.4% 25.4% 34.6% 41.8% 48.9% 50.0% 31.0%
Bajaj Corp. 91.0% 211.0% 49.1% 29.9% 36.7% 34.4% 41.5% 48.1% 67.7%
Jyothy Labs 11.0% 19.5% 11.9% 5.6% 6.2% 10.6% 9.6% 14.1% 11.1%
Marico 31.1% 28.3% 20.5% 19.9% 17.9% 22.2% 29.1% 33.0% 25.2%

Source: Spark Capital Research

Page 21
 Indian Paints Sector Deep Moat Vs Rich Valuations
Paint stocks have historically generated healthy returns across cycles leave alone outperforming market

In Bad Times (FY00-04) In Good Times (FY 04-08)

Revenue CAGR PAT CAGR Revenue CAGR PAT CAGR

25% 30%
19% 24%
20% 17% 18% 25% 20%
19%

FY04-08 CAGR (%)

17% 18%
20% 15%
15%
FY00-04 CAGR (%)

10% 11% 10% 14%

9% 15% 11% 10%
10% 6% 6% 9%
10%
5%
5%
0% 0%
-5% -5%
-10% -6% -10%
-15% -15%
-14% -14%
-20%
-20%
Asian Paints Berger Paints Kansai Akzo Nobel Sensex EPS GDP (Real,
Asian Paints Berger Paints Kansai Akzo Nobel Sensex EPS GDP (Real,
Nerolac Nominal)
Nerolac Nominal)

Source: Bloomberg, Spark Capital Research Source: Bloomberg, Spark Capital Research

Outperforms Markets in Bad Times ... Matches Market in Good Times

40% 45%
35% 40%
40% 38%
35%
30% 35% 31% 31%
30%
FY00-04 CAGR (%)

FY04-08 CAGR (%)

30%
25%
25%
20%
15% 20%
15% 11% 15%
9%
10% 10%
5% 3%
5%
0% 0%
Asian Paints Berger Paints Kansai Nerolac Akzo Nobel Sensex Return Asian Paints Berger Paints Kansai Nerolac Akzo Nobel Sensex Return

Source: Bloomberg, Spark Capital Research Source: Bloomberg, Spark Capital Research

Page 22
 Indian Paints Sector Deep Moat Vs Rich Valuations
Paint stocks have historically generated healthy returns across cycles leave alone outperforming market

In Other Times (FY 08-12) and challenging times (FY13-15)

35% Revenue CAGR (%) PAT CAGR (%) Revenue CAGR (%) PAT CAGR (%)
20%
29% 17%
30% 18%

FY12-15 CAGR (%)

FY08-12 CAGR (%)

24% 16% 14% 14% 14%

25% 22% 21% 20% 14% 12% 12%
20% 18% 18% 12% 10% 10%
10%
16% 16% 10%
15% 8%
6% 7%
10% 8% 7% 4%
5% 2%
0%
0% -2% -1%
Asian Paints Berger Paints Kansai Nerolac Akzo Nobel Sensex EPS GDP (Real, Asian Paints Berger Paints Kansai Nerolac Akzo Nobel Sensex EPS GDP (Real,
Nominal) Nominal)

Source: Bloomberg BI, Spark Capital Research Source: Bloomberg BI, Spark Capital Research

Continues to outperform the market so in challenging times

60% 40% 38%

54%
49% 35%
50% 47%

FY12 - 15 CAGR (%)

30%
FY08-12 CAGR (%)

40% 25%
25% 22%
30% 26% 20%
19% 14% 13%
15%
20%
10%
10%
5%
0% 0%
Asian Paints Berger Paints Akzo Nobel Kansai Nerolac Sensex EPS Asian Paints Berger Paints Akzo Nobel Kansai Nerolac Sensex EPS

Source: Bloomberg BI, Spark Capital Research Source: Bloomberg BI, Spark Capital Research

Page 23
Indian Paints Sector Deep Moat Vs Rich Valuations
Moat Vs Valuation The Game is On!

Pros Vs Cons in a nutshell

Negatives Positives

Source: Spark Capital Research

Page 24
Indian Paints Sector Deep Moat Vs Rich Valuations
Huge growth runway if past trends of other BRIC nations are of any precedence

Chinese per capita paint consumption by value is ~9x Indian while in volume terms is close to ~4x
consumption
14.0 12.8 India Per
India 12.1
50.0 45.9 Capita:
43.5 Per 12.0
39.8 3.4kgs
Capita: 9.4 9.6
40.0 36.2 10.0
32.8 $5
8.0
29.8 7.3
30.0 8.0
25.4
21.7 5.7
6.0
20.0 17.2
13.9 3.2 3.3
4.0 2.7
10.0
2.0

0.0 0.0
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Chinese Per Capita Consumption (In $) Chinese Per Capita Consumption (Kgs)

Source: Industry Sources, Spark Capital Research Source: Industry Sources, Spark Capital Research

Brazil per capita paint consumption is also ~3x to ~4x Indian consumption while volume terms around ~1.7x India per capita volume consumption
by value...
India 8.0
25.0 22.5 6.8 7.0 6.9 7.0 6.8 India Per
21.2 Per 7.0 6.4 6.3
20.5 19.8 6.3 Capita:
19.6 Capita:
20.0 6.0 5.4 3.4kgs
$5 5.1
16.4
15.4 14.7 5.0
15.0 12.7
10.7 4.0
10.0 3.0
2.0
5.0
1.0
0.0 0.0
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Brazil Per Capita Consumption (In $) Brazil Per Capita Consumption (Litres)

Source: Industry Sources, Spark Capital Research Source: Industry Sources, Spark Capital Research

Page 25
Indian Paints Sector Deep Moat Vs Rich Valuations
Coverage Paints stock Investment thesis in a nutshell
Asian Paints Market leader with growing Moat
Consistency in the safest consumer play: On deeper analysis we can fairly say the
paints sector in India is as safe or even safer then the staples category in the country
given its growth trajectory and its performance during down cycles and recessions. APNT
being the market leader and maintaining that status quo for over decades, cannot be
ignored by an investor if he wants to play the India story. We believe, with the consensus
view of macro improving from here, APNT with a well-established product portfolio, well
entrenched distribution network and enviable balance sheet is rightly poised to make
most of the opportunities present.
Decorative paints category, a growth canvas : We foresee a tremendous growth
opportunity for the decorative paints category in India. Again, at-least for the near to
medium term, we fail to spot any noteworthy threat to APNTs market leader status in the
category.
Other growth engines to aid growth: Industrial paints segments, International
operations, Construction chemicals would continue to aid growth and with the expected
pick-up in economic cycle in the domestic and key overseas market, growth is expected
to gather momentum. Along with the existing growth drivers, APNTs endeavours to
diversify and expand the area of operation under the wide umbrella of HOME
IMPROVEMENT should not only deliver growth in the longer term but would change the
dynamics of the industry and would yield invincible moat to APNT.
Kansai Nerolac Best placed to play industrial cycle revival
Dj vu of macro indicators: We believe the industrial climate should revive over the
medium term, though is taking loner than expected. Though no improvement in ground
level industrial activity is yet reported, readings of our infrastructure desk indicate that a
wave of optimism as witnessed in 2004-08 is brewing and that good times are around for
players hinged on industrial activity recovery. KNPL with significant contribution from
Industrial paints should be the key beneficiary of the trend reversal.
Pent-up automotive demand to play out: Backed by a slew of development measures
targeted by the government on urban infrastructure and planning, organized sector
employment and wage growth are exhibiting signs of improvement which we believe is
leading to a consumer confidence climate is very similar to 2004-08, which saw
passenger vehicles growing at ~14% CAGR. Given the positive correlation between
passenger car offtakes, white goods demand and KNPL revenues, we believe the current
cycle should benefit KNPL immensely.
New Margin trajectory: With paint players indicating that FY16 operating margins are
expected to be the new normal we believe KNPL too would protect margins. Though
these benefits are not sustainable on account of the B2B segment of the business model,
we believe definite operating leverage opportunity is looming large as revenue
momentum gathers pace.
Berger Paints Playing the BETA for medium term
Decorative paints; Cosy Oligopoly: Our penchant among paint companies is aligned
towards players who have higher contribution from decorative paints segment given that
superior pricing power and robust demand drivers makes decorative paints a safe bet
across economic cycles. We believe that the crux of sectoral moat comes from current
distribution structure and unless any disruptive innovation happens, the incumbents will
continue to enjoy the ever expanding pie of the Indian decorative paints market.
Benefit from solvent to water changing preference: With consumption of water
based paints in India on the rise, BRGR had undertaken a massive rebranding initiative
to promote premium water based paints. Having been a late entrant into the decorative
paints market, the rebranding and fresh positioning assisted BRGR in cementing a place
for its own in the decorative paints market.
Premiumising portfolio: BRGR over the past 5 years has increased its focus on
premium offerings enabling significant gross margin expansion which has further been
complemented by benign raw material environment over the past 18 months.
Distribution expansion & focus on supply chain: ERP implementation, better
incentive programs for sales force, improving links with painters and initiatives as
express painting has enabled BRGR deepen relationship with stakeholders.
Akzo Nobel India Playing out for operating leverage
Uptick in Urban spending to lead to better decorative paints growth: Uptick in urban
consumer spending that accords very much with AKZOs product portfolio should enable
a revenue offtakes in decorative paints to rebound sharply in medium term. Further,
AKZOs commitment to brand investments through its holistic marketing plans should
assist the decorative paint brands performing better. Revival in urban offtakes should
also lead to favourable product mix which should assist in margins in decorative paints
improving.
Signs of revival visible in industrial paints: Post years of subdued performance,
industrial paint offtakes are expected to improve over medium term with signs of revival in
infrastructure cycle. We apprehend that there are visible upticks in Industrial paint
offtakes and we believe prolonged steady volume growth should enable pricing power
and ease concerns of liquidity that has been plaguing industrial paints growth.
Committed to strive towards industry average operating margins: Gross margins are
expected to revive with better product mix and price increases affected in industrial
paints. With Akzo Nobel NV (Parent) indicating to align Akzo Nobel India operating
margins with that of other emerging geographies, we believe operating margins should
structurally expand to around ~13% to ~14% levels despite committing to high A&P
through focussed cost control initiatives.
Page 26
Indian Paints Sector Deep Moat Vs Rich Valuations
Valuation & Financials

Sales (Rs. mn) EBITDA (Rs. mn) PAT (Rs. mn) EPS (Rs.)
Company
FY16 FY17E FY18E FY16 FY17E FY18E FY16 FY17E FY18E FY16 FY17E FY18E

Asian Paints 1,42,811 1,62,336 1,90,273 27,685 31,244 36,378 17,793 20,637 24,475 18.5 21.5 25.5

Berger Paints 46,341 48,331 58,035 6,554 7,903 9,719 3,661 4,831 6,265 3.8 5.0 6.5

Akzo Nobel 27,401 30,961 35,230 3,049 3,715 4,415 1,954 2,355 2,879 41.9 49.9 61.5

Kansai Nerolac 38,193 42,618 48,859 5,723 6,668 7,603 3,558 4,484 5,070 6.6 8.3 9.4

P/E (x) EV/EBITDA (x) ROE(%) ROCE(%) Target

CMP Mkt Cap
Company Rating
(Rs) (Rs. bn)
FY16 FY17E FY18E FY16 FY17E FY18E FY16 FY17E FY16 FY17E P/E Price

Asian Paints 64.3 55.5 46.8 40.5 35.7 30.5 34.4% 33.6% 29.8% 29.9% 1,193 11,44,323 47x 1,209 ADD

Berger
70.0 53.0 40.9 38.8 32.0 25.8 26.7% 29.9% 20.2% 25.3% 264 2,56,115 43x 280 ADD
Paints

Akzo Nobel 40.4 33.8 27.4 24.3 20.0 16.5 23.7% 29.9% 21.6% 27.3% 1,690 81,039 30x 1869 BUY

Kansai
57.2 45.4 40.2 33.7 28.9 25.2 18.3% 18.3% 17.1% 17.4% 378 2,03,577 36x 342 REDUCE
Nerolac

Page 27
Disclaimer
(1/2)

Stock expected to provide returns of <5% -10% over a 1-year

Absolute BUY Stock expected to provide positive returns of >15% over a 1-year horizon REDUCE
horizon
Rating
Interpretation Stock expected to provide positive returns of >5% <15% over a 1-year
ADD SELL Stock expected to fall >10% over a 1-year horizon
horizon

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Disclaimer
(2/2)

Spark Capital and/or its affiliates and/or employees may have interests/positions, financial or otherwise in the securities mentioned in this report. To enhance transparency,
Spark Capital has incorporated a disclosure of interest statement in this document. This should however not be treated as endorsement of views expressed in this report:

APNT, BRGR,
Disclosure of interest statement
KNPL, AKZO
Analyst financial interest in the company No
Group/directors ownership of the subject company covered No
Investment banking relationship with the company covered No
Spark Capitals ownership/any other financial interest in the company covered No
Associates of Spark Capitals ownership more than 1% in the company covered No
Any other material conflict of interest at the time of publishing the research report No

Receipt of compensation by Spark Capital or its Associate Companies from the subject company covered for in the last twelve months:
Managing/co-managing public offering of securities
No
Investment banking/merchant banking/brokerage services
products or services other than those above
in connection with research report

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Page 29