MC EXPLAINER Can India’s paint giants protect margins as crude oil prices rise amid Iran tensions?

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• Paint prices may rise if Mideast crisis boosts crude costs
• Asian Paints, Berger, and Kansai Nerolac shares fell on oil surge
• Firms face margin pressure as competition delays price hikes

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Indian paint giants like Asian Paints, Berger Paints, and Kansai Nerolac, maybe forced to raise prices to accommodate any hike in crude costs as crisis simmers in the Middle East, analysts said.

The development is crucial as the paint makers have so far benefitted from the benign raw materials costs, shielding their bottom lines even as competition intensity was rising in the industry.

Brent crude climbed over 6 percent to around $77-78 a barrel after briefly topping $82 earlier in global trade, amid deepening US-Israel and Iran conflict. Oil prices surged as military tensions threatened to disrupt global supply, with particular focus on the Strait of Hormuz, through which roughly 20 percent of global oil flows pass.

Further upward pressure on oil prices

Further upward pressure on oil prices may occur due to insurers either cancelling or significantly hiking premiums for war-risk insurance for oil tankers and other vessels passing through the Strait of Hormuz in the wake of recent clashes.

Asian Paints shares fell 2.84 percent to Rs 2,307.9, Berger Paints declined 0.7 percent, and Kansai Nerolac dropped 3.4 percent as of 3:17 pm at the NSE on March 2. Akzo Nobel India also slipped 1.17 percent. Paint manufacturers are directly exposed to crude-linked derivatives, such as solvents and resins, which constitute between 40 percent and 60 percent of total raw material expenses. Even as some paint makers are shifting towards water-based paints, where solvents are replaced with water, the binding agents continue to be derived from petrochemicals.

Currently, the industry is seeing at least 4-5 percent of volume versus value gap as the industry, as a whole, has not seen much price changes. As raw material prices have softened in the last one year, it has been passed on in the form of higher discounts. As a result, gross margins are broadly maintained, analysts said.

“It remains to be seen how companies react, given the current competitive intensity in the industry. Historically, cost increases have been passed on with a lag. However, with competition at elevated levels, companies may be slower to raise prices, which could lead to near-term margin pressure as they absorb part of the cost increase," said Amit Purohit, Vice President at Elara Capital.

He added that even when crude oil prices are soft, there is no gain for the companies as they quickly pass it on to the consumers, amid the heightened competition for market share.

According to a senior paint industry observer, a prolonged conflict may force paint makers to a raise prices moderately. In the near-to-medium term, however, the firms may choose to wait and watch and keep prices as they are, to maintain market share and stabilise supply chains.

Raw material concerns

"Generally, paint firms keep around a quarter's supply of raw materials, such as solvents and binding agents. That stock should help them sustain operations in the near-to-medium term, without taking a price increase in a competitive market. They will wait and watch if it is a short conflict, or it will stretch for a longer period. If they increase prices on their products, taking a cue from oil prices, it may completely upend their supply chains as well, as they have to recall products and increase prices. This will definitely face pushback from dealers and customers," the observer said.

Berger undertook a product price decrease of 4-5 percent in earlier quarters amid discounting and lower demand. However, the reduction was a primary driver of the current "volume-value gap," where volume growth significantly outpaces value growth. The market leader, too, reported a 5 percent gap and expects a similar divergence to persist in the coming quarters.

For Asian Paints, despite higher discounting and an unfavourable mix, gross margins improved, aided by raw material deflation. The management does not plan any near-term pricing actions, given the input cost volatility.

Indian paint companies are caught between a shift in  discretionary spending, wherein consumers are delaying the repainting cycle, ratcheting up pressure on the sector, which is reliant on a high-frequency and repeat purchase. Analysts say that repainting cycles have increased from 5- 6 years to nearly a decade, owing to slow wage growth amid a continued consumption slowdown in Tier-I markets.

Executives at the top two companies, Asian Paints and Berger Paints, acknowledged more demand come in from the high-volume, low-value products, such as texture paints, construction chemicals, and admixtures, than the traditional volumes from sale of decorative paints.

The pressure on demand comes at a time when new entrants and well-funded players, like Birla Opus and JSW Paints, are aggressively expanding their footprint through heavy discounting and marketing-led initiatives. According to industry estimates, Birla Opus has already garnered an estimated 3–3.5 percent market share in the mass decorative paints segment.

After an initial period of competitive prices to gain market share, Birla Opus, promoted by Grasim Industries, raised prices on some product categories by 2 percent to 6 percent in January and February, in order to "test channel and consumer reaction", according to Himanshu Kapania, Grasim's managing director and head of its paints vertical, in an investor call in February.