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While a behemoth rules the roost in the industry, Berger Paints is slowly clawing its way up to the top...

Berger Paints is the country's second-largest decorative paints manufacturer with 18 per cent market share in the segment. Formed in 1923, it is also one of the oldest paint manufacturers around. Today, Berger is readying itself to gain from its shift to premium paints category where margins are better than in the economy and industrial segment.



Talking about the paints industry, it is a playing ground for only a handful of incumbents. Asian Paints is followed by Berger, Kensai and Akzo Nobel (more commonly known as ICI Paints in India). Then there are a host of players in the unorganised sector. Importantly, almost 65 per cent of the paints industry is held by unorganised players.

For many years now, paint companies in India have remained under the shadow of industry heavyweight Asian Paints which has a 58 per cent market share. All companies felt the brunt between FY03-05 when Asian Paints decided to enter into the mass segment. Berger has since been clawing back. It changed tack to focus on decorative paints. New launches in exterior paints and premium emulsions have plugged the gaps in its product offerings. It has extensively built its dealer network which is now second-largest in India (just behind Asian Paints). By giving away higher discount to dealers, Berger has managed to gain around 0.6 per cent market share in the last two years. Berger has a stronger presence in North and Eastern India where 60 per cent of its distribution network lies.



Growth drivers
Transition to decorative paints: Berger has historically been strong in the industrial paints segment. Industrials constituted as much as 75 per cent of its sales in 1991. Today, decorative segment brings in 81 per cent of the company's revenues (December 2012 quarter).

What led to this change in product mix? Market dynamics. The market has moved away from distempers and economy paints. A large part of that change can be attributed to the marketing efforts of industry leader Asian Paints – whose advertisement spend puts to shame advertisement budgets of all the other paint companies put together.

But, the advertisement spend by Asian Paints brought gains for all the companies in the industry as it helped in popularising the decorative paints segment. Growth in decorative paints has been 28-30 per cent annually during the last three years; three times faster than the growth in industrial paints. And that is where Berger now wants to be. The company has recently made a more conscious transition towards premium product category. That means advertising spends will remain high for some time ahead.

Building water-based capacity: Water-based paint category was not one of the strengths of Berger but market dynamics have forced the company to move into that direction. Think about the strong smell of a freshly-painted room. That was oil-based paint. The biggest advantage with water-based paints is that they emit less smell and dry up faster too. But, Berger has a long way to go in this segment. Premium water-based paints comprise only 10 per cent of the company's sales. Berger is setting up a 3,20,000 tonne water-based paint plant in Andhra Pradesh. The addition of this plant would double its current capacity. The first phase is expected to be up and running by the first quarter of FY14 and should add 80,000 tonnes to Berger's total capacity.

Strong correlation with economy: The paints industry in India has historically had a strong correlation with the growth rate of the economy. The sector has typically grown at 1.5-1.6 times the GDP growth rate. Based on the assumption that the economy would grow at 5 per cent, the industry should grow at 7.5 per cent. Berger expects the company to grow volumes by 100-150 basis points ahead of the industry growth rate on the back of its focus on the high growth premium segment and extensive distribution network.

Margins on an uptrend: Berger's focus on the decorative segment has resulted in better margins. For the quarter ended December 2012, domestic gross margins expanded 2 per cent (y-o-y) to 38.1 per cent. According to the company the difference in gross margins between the decorative and the industrial segment now stands at as high as 5 per cent (as of December 2012).

Apart from improved product mix, what also helped was lower titanium dioxide prices which is the primary raw material and prior price hikes. Titanium dioxide prices have corrected from levels of Rs 290 per kg seen in January 2012 to around Rs 225 per kg in January this year. Ebitda margins expanded 140 basis points (y-o-y) to 12.2 per cent.

International business going strong: Berger's international businesses are on a strong wicket too. In the December 2012 quarter, international sales were up 22 per cent (y-o-y), led by Berger's subsidiaries Berger Nepal and Berger Becker Coatings. Ebitda margins in the international businesses expanded 4.6 per cent (y-o-y) to 16.9 per cent on the back of price increases undertaken by Bolix SA – Berger's Polish subsidiary. Bolix has decided to focus on profitability rather than volume growth which has remained flat but according to the company should see improvement ahead.



Concerns
No matter how much Berger ups its advertisement spend, it cannot contend with Asian Paints for a long time. What it can surely do for now is work towards increasing the brand recall of its products and hope to take share away from peers like Kensai and other smaller and unorganised players. The industrial segment brings in 19 per cent of Berger's revenues and it is losing momentum. The company itself does not see any significant improvement in this segment going forward especially after the weakness in auto sales. Infrastructure segment too has not shown any marked improvement yet.

Financials and valuations
In the nine months ended December 2012, Berger saw a topline growth of 15 per cent (y-o-y) while Ebitda was up 23.5 per cent. EPS jumped 28.8 per cent during this period. Berger's RoCE has averaged at 25 per cent in the last five years. Its transition to premium decorative paints will continue to positively impact the margins for a long time. A higher water-based capacity will keep it in good stead while outperformance of international businesses will be the icing on the cake. At the CMP, the stock trades at a PEG ratio of 1.15. Buy with a 5-year horizon.