Grey Market Premium as on 20th Jan – INR 700
Price Band : INR 1488-1490
What does it mean?
Indigo Paints made a humble start in FY2000, when it set up a cement paint manufacturing unit in Jodhpur, Indigo has become the fifth largest decorative paint manufacturer in India. The company has three manufacturing facilities – in Jodhpur, Kochi and Pudukkottai, strategically located in close proximity to the company’s raw material sources. As of FY20, the company had a distribution network of 36 depots and 11,230 active dealers and a tinting machine population of 4,296 across India. Indigo is currently present in 27 states (it is yet to enter Himachal Pradesh) and 7 union territories as of date. For FY18-20, company reported sales, PAT CAGR of 26%, 104% respectively, supported by EBITDA margin expansion of ~800 bps during the same period. Indigo has lean balance sheet with D/E 0.2x and RoE, RoCE of ~28%, ~22% respectively.
To create demand for differentiated products, it initially tapped into Tier 3, Tier 4 Cities, and Rural Areas, where brand penetration is easier, and dealers have greater ability to influence customer purchase decisions. It subsequently leveraged this network to engage with dealers in Tier 1 and Tier 2 Cities and Metros as well.
Financials
The company has clocked 47% sales CAGR over FY15-20 (organic growth CAGR: 40%+; relative market share has moved from near-zero to ~2.5% over FY15-20 in decorative paints). Interestingly, revenue ramp-up has been smartly executed with consistently improving unit economics, which is amply reflected in the company’s steadily improving fundamentals – (1) LTL revenue/dealer grew at 11% CAGR, (2) EBITDAM up 15pp+ at 14.6%, (3) cash conversion cycle halved and (4) RoICs improved from -13% to 25% over FY17-20. The pandemic-led demand destruction is likely to have the least impact (within peer set) on Indigo Paints as its exposure to big cities is negligible (Predominantly operates in Tier 2-4 cities).
Within Tier 2 paint companies, Indigo Paints has outpaced peers by a stretch , profitability has continuously improved.
Cash generating power and margin has been consistently improved.
Indigo has more than halved its cash conversion cycle over FY17-20; more importantly, the quality of WC has consistently improved with a reduction in receivable days as well as reducing vendors/creditors support. Note: Other Tier 2 paint companies have had to increase their support from payables.
Industry Commentary
The Indian Paint industry is valued at INR 54500 crore and it is expected to grow at 12% CAGR in next five years. The decorative paint segment constitutes ~74% of total paint sales (i.e. ~INR 40,300 crore) and is likely to grow at CAGR 13% to INR 74300 crore by FY24E backed by shortening repainting cycle, rising urbanisation and aspiration level of middle class household in India. With oligopoly in nature, the domestic decorative paint industry is largely dominated by organized players with ~67% market share, while unorganized/regional players hold rest 33% market share. Until 2015 the unorganized sector had a market share of approximately 35%, which has been penetrated by the organized sector due to challenges faced by smaller players in the form of demonetization and implementation of GST. The organized players are likely to further gain the market share from unorganized players by increasing their presence into rural and semi urban regions through their strong supply chain networks. On the other hand, Industrial paint category (which includes automotive, performance coatings/ general industrial and powder coating) contributes rest ~26% in total paint sales and it is likely to grow at CAGR of 10% to INR 22800 crore by FY24E supported by favourable base and revival in the automotive industry.
Per capita paint consumption in India has increased by ~7% over the last seven years. Compared to the global average consumption of ~14 kg per capita, the per capita consumption of paints in India is low, indicating a significant opportunity for market penetration going forward.
- Demand for decorative paints in India has been very resilient on the back of repainting (which is 78% of demand vs fresh painting) and reduction in repainting cycle.
- Emulsions comprise ~50% of the market whereas enamels comprise ~20% of the market.
- Paint industry has adopted a direct distribution model and cannot employ a two-tier distribution model (stockists/wholesalers), which is done by most FMCG companies in India on account of large number of SKUs handled (3,000-4,000).
- As per the management, capacity utilization is a misleading parameter to track, as the paint manufacturing business is seasonal. While the months of June, July and August witness significant dip in utilization for the industry, the demand for paints doubles just before Diwali (especially in the northern regions) and in the months of March & April (pan-India). Hence, on an annual basis, average capacity utilization for any paint company will generally be low.
- Dealers across India offer multi-brand products (not loyal to one brand).
- Management believes that paints in India cannot be sold by reducing prices since it is not an everyday commodity (painting is done once in ~5 years). Also, actual cost of paints is only 40% of the overall painting cost.
- Competitive intensity in small towns is as high as in urban areas.
- Wood paints is quite a tough market since players have to deal with polishers (not painters), and thus creating brand equity is not easy. However, Indigo is seeing traction in this category in a few states.
Valuation
The IPO is priced at P/E ratio of ~ 130 of FY – 20 earnings while industry PE is 100. while P/B ratio is 30, the top 2 players Asian paints and Berger paints have P/B ratio of 26 and 24 respectively.
However Indigo Paints is growing at a rapid pace since last 5 years and this trend seems to be continuing, hence this valuation is justified.
Investment Rationale
i. Continue to focus on developing differentiated products to grow market share
Indigo Paints was the first company to launch various new product categories which is known as premium category products. Those products are Metallic Emulsions, Tile Coat Emulsions, Bright Ceiling Coat Emulsions, Floor Coat Emulsions, Dirtproof & Waterproof Exterior Laminate, Exterior & Interior Acrylic Laminate and PU Super Gloss Enamel. The revenue from premium products categories have registered CAGR of 30% in FY18-20, while the revenue contribution from the same has increased from 27% in FY18 to 29% by FY20. Further, these products command superior EBITDA margin (~10 percent points higher than normal products). The company has further planned to increase revenue contribution of premium products through dealer additions across newly entered geographies.
ii. Revenue from premium products and gross margin movements in last 3 years
iii. Capacity additions in next three years to boost volume growth:
In last 3 years capacity has gone up by 43% CAGR, through this IPO company will incur capex of 150 Cr in Tamil nandu and will grow capacity in next 3 years.
iv. Strong presence in the semi urban and rural markets
The company has a significant presence in the semi urban and rural markets which contributes ~85% of total revenue. According to the company, the tinting machine to dealer ratio for Indigo is on lower side i.e. ~38% by FY20 as compared to a range of 37% to 67% of top four paint companies and it is continuously seeking opportunities to improve ratio.
v. Extensive distribution network for better brand penetration
Paint companies are required to spend significant to develop their distribution network to increase reach of their products. Currently for Indigo, southern regions dominates in terms of revenue contribution (~46%). However, company has recently entered Punjab and Uttarakhand, and Jammu & Kashmir to expand its reach into northern markets. The industry leader had the largest dealer network of ~70,000 dealers, compared to 11,230 Active Dealers of Indigo. Therefore, the company sees a significant growth opportunity in its dealer networks in the new markets it targets.
vi. Focus on rationalise advertisement expanses going forward
The company has one of the highest advertisement and promotion expenditures as a per cent of sales. Over the past three years, company has gradually increased its media advertising spends. However, company is now planning to rationalise future media advertising expenses to drive profitability going forward.
Key Risks and Concern
- Delay in passing of higher input price
- High dependence on Southern regions
- Inability to increase number of tinting machines
- Delay in expansion plans
Based on above and Grey market premium of 700 as on 20th Jan 2021 one should apply for IPO from a long term perspective (>2 years) and for listing gains
References:
- DHRP
- ICICI Research
- HDFC Research
- Nirmal Bang Research
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