Effect of GST on paint stocks

There is not much for paint firms to cheer about as far as the goods and services tax (GST) is concerned. For them, the process of GST implementation brings along a near-term supply chain disruption at dealer and vendor levels, which could hurt their volume growth and operating margin.

The March quarter of fiscal 2017 was a dull one for paint companies. While volumes in the decorative segment recovered from the demonetization impact, the industrial segment remained subdued. Operating margin fell from their peak, dented by escalating raw material prices.

While the GST-led disruption is unlikely to last for more than a quarter, its spillover effect would be visible in earnings in forthcoming quarters, analysts cautioned.

Paint and adhesives makers are in for a marginal increase in tax outgo. Paints have been classified in the GST tax rate slab of 28%, higher than 24-27% currently paid out by them in the form of excise, value added tax (VAT) and entry taxes. Analysts expect this to prompt a further price hike of nearly 2% based on maximum retail price. But there is some relief from the increase in transitional credit limit from 40% to 60%.

However, the sector doesn’t benefit from a key feature of GST i.e. shift in business from unorganized to organized sector. Since the paint industry is highly organized, there is not much companies will get in terms of market share boost. According to analysts, nearly 75% of the paint industry is in the organized sector.

On the brighter side, some cost savings on the logistics and transportation front are anticipated due to a consolidation of warehouses in the GST era, and that would aid margins. According to K. Ravichandran, senior vice-president, corporate ratings, at ICRA Ltd, an Ebitda margin push of 100 basis points is anticipated for larger firms from this. However, it should be noted that this gain will reflect only over a couple of quarters. Ebitda stands for earnings before interest, taxes, depreciation and amortization.

Meanwhile, shares of paint companies continue to outperform key benchmark index Sensex on a year-to-date basis. On the valuation front, too, shares of Asian Paints Ltd, Berger Paints India Ltd and Kansai Nerolac Paints Ltd trade at rich multiples of more than 40 times.

Clearly, given the aforementioned factors, GST won’t be a game changer for this sector. Also, since raw material prices continue to surge, the days of elevated margins are now behind paint companies. Simply put, valuations need to correct.