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Equity Research August 30, 2020 BSE Sensex: 39467

ICICI Securities Limited is the author and distributor of this report

Sector update

Asian Paints (ADD) TP: Rs1,900 Berger Paints (HOLD) TP: Rs510 Kansai (HOLD) TP: Rs460 Akzo Nobel (BUY) TP: Rs2,350

Consumer Staples & Discretionary Deep Dive #3: Primer (long-term) opportunity for paint companies

Research Analysts:

Manoj Menon manoj.menon@icicisecurities.com +91 22 6637 7209 Aniruddha Joshi aniruddha.joshi@icicisecurities.com +91 22 6637 7249 Vismaya Agarwal, CFA vismaya.agarwal@icicisecurities.com +91 22 2277 7632 Karan Bhuwania karan.bhuwania@icicisecurities.com +91 22 6637 7351

INDIA

Deep Dive is our new series in which we will explore long-term category opportunities. Our endeavor is to bring alive I-Sec Consumer team’s cumulative experience of >100 years. We recently presented Waterproofing and Adhesives in our Deep Dive 1 & 2. Primer, an ancillary product, offers growth potential in-line with paint industry, or a tad lower. A highly synergistic product for paint companies, the ratio of primer to paints’ industry size is ~1:3. While primer is ‘must-use undercoat’ for emulsions and premium enamels, it is ‘nice-to-use undercoat’ for distempers and value-for-money enamels. Benefits of primers are (1) it’s an undercoat for dry surfaces and reduces volume of paint required and (2) entire surface becomes white which makes it easier to paint. Premium primers offer benefits such as (1) protection from dampness, efflorescence and alkalinity, (2) protection from fungus and (3) fast drying which reduces time and hence, labor cost. Paint companies have introduced differentiated primers such as (1) combination product of putty + primer, (2) primer with waterproofing benefits and (3) universal primer which can be used on multiple surfaces. Primers are synergistic to paints as (1) companies use same brands, (2) same distribution network and (3) same supply chain for raw material sourcing. Premium primers are essential as better undercoat for premium/luxury paint. Top picks: Asian Paints (ADD) and Akzo Nobel (a long-gestation turnaround; BUY). Primers growth in FY2007-2020 (13% CAGR) has been in-line with paints:

Primers are undercoats. It is used before emulsions and premium enamel paints. However, some consumers of distempers and value-for-money consumers do not use primers. The primers growth is directly co-related with paint market and its expected to grow in-line or a lad lower than paints.

Usage of primers and differentiated products: Dry surfaces soak the first coat. Hence, usage of primer as an undercoat helps to reduce cost. It also paints the surface with white colour which is helpful before paint coats. Some primers also offer anti-microbial properties. Premium primers offer protection from dampness, efflorescence and alkalinity. Primers can also be divided as fast drying (it saves time and hence, labour cost) and regular primers. Asian Paints and Kansai have introduced combination product of ‘putty + primer’. Kansai has introduced universal primer which can be used on most surfaces before enamel paints.

Geographical revenue mix: The geographical breakup of primers is similar to paints. However, as distemper and value-for-money enamels are used more in rural India, we believe primers generate higher revenues from urban markets compared to revenue share of paints in urban markets.

Logical extension to paints: Paint companies are leveraging the logical extension of primers to offer better value to consumers. Premium primers are better undercoats for premium/ luxury paints. There is also scope to differentiate in primers than primers offered by smaller /unorganized players. As primers are launched under same paint brands and also use same distribution network, we note there are synergies with paint business. Primers also use same raw materials like paints such as crude oil and titanium di-oxide (TiO2).

Stock Calls: Primers offer healthy growth (in-line with paints) as well as return ratios > Cost of capital. Investors can get exposure to primer growth story via investments in paint companies. We note Asian Paints and Berger are more aggressive in primer market than others and are expected to gain market share in next 2-3 years. Top picks: Asian Paints (ADD) and Akzo Nobel (a long-gestation turnaround; BUY).

Consumer Staples & Discretionary sector, August 30, 2020 ICICI Securities

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Analyzing the primer market in India The primer market is crucial for the paint industry and is estimated to be c.30% of total paint volumes in India. We expect it to grow in-line with paint industry. Most of the distemper users and some enamel users do not use primers. However, primer is crucial for all emulsion paints. As the paints provide most benefits such as shine, waterproofing, the primers largely act as undercoats.

Primer growth is directly linked to paint industry growth We note (1) every emulsion and enamel paint requires an undercoat (i.e. primer). However, some consumers using distempers and enamels don’t use primers and (2) some consumers use only primer as paint by mixing color shades in primer.

Chart 1: Paint market growth - Primers have grown in-line with paints

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FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20

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mn)

Source: Company data, I-Sec research

Chart 2: Must-use vs nice-to-use market for primers

Premium emulsions

25%

Value-for-money emulsions

15%

Premium enamels15%

Value-for-money enamels

25%

Distempers20%

Must useNice to use

Source: Company data, I-Sec research Sub-segments of primer The primers can be divided in three major segments as wall primers (interior and exterior), wood primers and metallic primers. The interior and exterior primers can be

Consumer Staples & Discretionary sector, August 30, 2020 ICICI Securities

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further divided in water based primers and solvent based primers. We believe the largest segment is interior primer followed by exterior primer, metallic primer and wood primer.

Some companies have also introduced bio-wash which is fortified with broad spectrum biocides and fungicides. It gives protection against various microbial activities.

Chart 4: Sub-segments of primers Primer

Wall Universal Metal Wood

Interior Exterior Primer & Putty

Premium With waterproofing benefitsVFMPremiumVFM

Source: Company data, I-Sec research Primers as per benefits Main benefit of primer is undercoat. Dry wall or wood soaks in first coat. Hence, instead of using expensive paint, primer is used. Primer also provides white surface which makes painting easier.

While the primer serves as undercoat for paints, we note there are other benefits too. Premium primers serve the purpose of protection against dampness, efflorescence and alkalinity.

Primers can also be divided as (1) Fast drying primer which reduces overall painting time and hence, labour cost and (2) regular drying primers which are available at relatively lower costs.

Table 1: Primers as per benefits Primer Benefit Premium primer Undercoat with benefit of protection against dampness, efflorescence and alkalinity Value-for-money primer Only usage as undercoat but available at low price Fast drying primer Dries fast and hence reduces overall time to paint, hence reduces labour cost Regular primer Requires regular drying period

Source: Company data, I-Sec research Primer cum putty Paint companies such as Asian Paints and Kansai Nerolac have introduced primer cum putty combination product which offers both the benefits. It helps to save time as well as labour cost. This innovative product is largely used as undercoat for interior emulsions.

Chart 3: Bio-wash launched by Kansai

Source: Company data, I-Sec research

Consumer Staples & Discretionary sector, August 30, 2020 ICICI Securities

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Chart 5: Primer cum putty combination product by Asian Paints and Kansai

Source: Company data, I-Sec research Universal primer can be used on multiple surfaces Some paint companies have introduced universal primers which can be used on all surfaces such as walls, wood and metals. However, it can be used only for enamel paints.

Chart 6: Universal primer by Kansai Nerolac

Source: Company data, I-Sec research Primer with waterproofing benefits There are primers with waterproofing benefits too. Asian Paints has introduced Smartcare Terrace tile primer which can be used on porous and non-porous terraces. This primer provides strong adhesion to Smartcare Damp Proof waterproofing products.

Chart 7: Asian Paints SmartCare Terrace Tile Primer

Source: Company data, I-Sec research

Consumer Staples & Discretionary sector, August 30, 2020 ICICI Securities

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Presence of key companies across sub-segments All four paint companies have presence in all types of primers. A buyer of premium paint will also buy premium primer. However, we note a buyer of value-for-money paints will buy value-for-money primers or may not buy primers.

Table 2: Presence of key companies across primer sub-segments Asian Paints Berger Kansai Akzo Interior primer Exterior primer Metal primer Wood primer Putty with primer Universal primer Primer with waterproofing Bio-wash

Source: Company data, I-Sec research Geographical revenue breakup similar to paints Considering primers are sold along with paints, we believe the geographical breakup of primers is similar to paints.

Chart 8: Geographical revenue breakup of primers is similar to paints

East23%

West25%

North24%

South28%

Source: Company data, I-Sec research ‘Necessary/ essential’ product, low cost is important Our channel checks indicate the trade margin in primers is c.5% (similar to paints). We note there are negligible promotions in primers as it is considered as a commodity. However, it is a ‘necessary/ essential product’ and hence, important for consumers.

We note paint companies have launched primers under their key brands, instead of selling primers as pure commodities. The consumers are encouraged to buy premium primers when they are using premium/ luxury paints.

Consumer Staples & Discretionary sector, August 30, 2020 ICICI Securities

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Chart 9: Berger has basic primers as well as premium branded primers

Source: Company data, I-Sec research Key raw materials used in primers The major raw materials used in primers are crude oil as well as crude oil derivatives. We do not expect any material cost pressure in the short term on primers given lower crude oil prices and strong pricing power of the incumbent players.

Chart 10: Crude oil Chart 11: HDPE (packaging material)

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Chart 12: Titanium Di-oxide prices Chart 13: Packaging material - Tin prices

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Consumer Staples & Discretionary sector, August 30, 2020 ICICI Securities

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Revenues of paint companies from primer business While all paint companies have introduced primers, we note companies such as Asian Paints and Berger have increased the efforts to gain market share in primers from smaller / unorganized players. We believe paint companies generate 25-30% of volumes from primers. However, we believe the revenue contribution is relatively lower as primers have lower realization than paints.

Portfolio of paint companies

Asian Paints Asian Paints, market leader in paints has strong product portfolio even in primers. Apart from basic primers, it has introduced primers with waterproofing benefits, putty and primer mix and bio-wash products. It has also introduced premium primers for luxury coats.

Table 3: Primers by Asian Paints Segment Variant Comments

Interior primer Decoprime advanced interior wall primer Undercoat for interior paints

Decoprime interior wall primer Effective primer for luxury paints Wood primer TruCare wood primer Primer for wooden surfaces Exterior primer

Decoprime advanced exterior wall primer Undercoat for exterior paints

Putty primer mix Trucare Primer putty mix Combination product of primer + putty. Economical for

consumers Biowash SmartCare Bio block Anti-fungal product

Metallic primer

Utsav metal primer For ferrous metal surfaces Decoprime premium metal primer Provides anti-corrosion properties Trucare yellow metal primer Provides excellent adhesion of paints to surfaces Trucare red oxide metal primer For ferrous metal surfaces Grey 1 pack Epoxy primer For steel surfaces (Interior & exterior)

Source: Company data, I-Sec research

Kansai Nerolac

Kansai Nerolac has large product range of primers. It has introduced basic as well as premium primers. It has also introduced putty and primer mix and has also introduced universal primer which can be used on most surfaces before the enamel paints.

Table 4: Primers by Kansai Nerolac Segment Variant Comments Interior primer Cement primer Value-for-money primer Wood primer Wonderwood Wood primer as well as sealer Universal primer Goody universal primer Can be used on most surfaces

Exterior primer Exterior primer Water based exterior primer Nerolac Excel Premium exterior primer Italian white primer Premium primer

Biowash Nerowash Anti-fungal solution Metallic primer Red oxide primer Tobe used on metallic surfaces

Source: Company data, I-Sec research

Consumer Staples & Discretionary sector, August 30, 2020 ICICI Securities

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Berger Paints

Berger too has large product portfolio of primers. It has product portfolio of value-for-money as well as premium primers. It has also introduced bio-wash, an anti-fungal undercoat.

Table 5: Primers by Berger Paints Segment Variant Comments

Interior primer

BP Cement primer (WT) Prepared with 100% Acrylic binder and micro fined pigments

BP Cement primer (ST) Manufactured with special synthetic alkyd binder and micro fined pigments

BP White primer (ST) Oil modified alkyd based primer with micro fine pigments and extenders.

BP White primer (WT) Uses special type of acrylic binder and micro fined pigments along with extenders and additives.

Wood primer Parrot Prepared with acrylic binder and micro fined pigments along with

extenders and additives.

Exterior primer

BP Exterior cement primer Reduces porosity of walls and efflorescence

Weathercoat exterior primer Provides extra whiteness and with opacity

Seal-O-Prime It provides triple protection. Fights against dampness, efflorescence and alkalinity.

Biowash Weathercoat biowash Protects walls from microbial activity

Metallic primer

BP Zinc yellow primer Withstands high degree of corrosion. Ideal for saline weather. Butterfly A/C metal primer Quick drying metallic primer.

Red oxide primer Oil modified primer for ferrous metal surfaces WT= Water thinnable, ST= Solvent thinnable Source: Company data, I-Sec research

Consumer Staples & Discretionary sector, August 30, 2020 ICICI Securities

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Valuation summary

Table 6: Key financials of paint companies

Company CMP

(Rs) TP

(Rs) Upside

(%) Rating PE (x) EV/EBITDA (x) ADTV Market Cap

FY21E FY22E FY21E FY22E (US$ mn) (Rs bn) (US$ bn) Akzo Nobel 2,139 2,350 10 BUY 46 37 31 23 0.5 96 1.3 Asian Paints 1,958 1,900 (3) ADD 70 55 44 36 60.2 1,919 25.6 Berger Paints 564 540 (4) HOLD 95 77 57 49 12.1 551 7.4 Kansai Nerolac 488 460 (6) HOLD 57 43 35 27 1.8 253 3.4

EV/ sales (x) P/B (x) P/CEPS (x) RoE (%) RoCE (%) CAGR (FY20-22E) (%) Company FY21E FY22E FY21E FY22E FY21E FY22E FY21E FY22E FY21E FY22E Revenues EBITDA PAT Akzo Nobel 4.1 3.4 7 7 34 28 16 18 16 18 1 1 5 Asian Paints 9.2 7.5 17 14 54 44 25 28 22 25 12 12 12 Berger Paints 9.7 8.1 18 16 71 59 20 22 17 19 4 4 4 Kansai Nerolac 5.6 4.5 7 6 42 33 12 14 11 14 5 10 9

Source: Company, I-Sec research

Price chats Akzo Nobel Asian Paints

1,3001,5001,7001,9002,1002,3002,5002,700

Aug-

17

Feb-

18

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18

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19

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19

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20

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600800

1,0001,2001,4001,6001,8002,0002,200

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100200300400500600700

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250300350400450500550600

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20

(Rs)

Source: Bloomberg

Consumer Staples & Discretionary sector, August 30, 2020 ICICI Securities

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New I-Sec investment ratings (all ratings based on absolute return; All ratings and target price refers to 12-month performance horizon, unless mentioned otherwise) BUY: >15% return; ADD: 5% to 15% return; HOLD: Negative 5% to Positive 5% return; REDUCE: Negative 5% to Negative 15% return; SELL: < negative 15% return

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