Auto paint: Kansai Paint had good Q1

by SR on July 16, 2012

Kansai Paint 4613 sales and operating profit by quarter (billion yen)

Positive signals from management

For all its faults, it’s hard to ignore the Nikkei newspaper in Japan because it dominates corporate news flow and because sales traders and traders do actually care about the noise that the newspaper can generate. In addition, there is a long and ignoble tradition of corporate managements phoning up the Nikkei and giving them a heads-up on results before they are announced. That’s the sort of thing that can and does move markets. Unfortunately, in my experience the Nikkei can and does present its own opinion on forthcoming results in a way that makes it look as if it came from management, so it’s often hard to tell whether the source is the company or not. It comes down to knowing your managements. In my sectors I am aware that some of the companies are a bit leaky and I know that others don’t comment ahead of time.

Kansai Paint isn’t one of the companies I follow that closely, but on Saturday 14 July the Nikkei reported that Kansai Paint’s operating profit for the April to June 2012 quarter “likely doubled” compared to the previous year to about 6 billion yen due to “bullish demand for automotive and building paints”. Although I don’t know the company well, having only visited it once, I do know two things independently:

  1. Auto production in Japan has been unusually strong in the April to June quarter.
  2. The post-earthquake rebuilding effort in Northern Japan is driving demand for construction materials.

One would therefore expect the company to be doing pretty well at the moment. In that sense the article passes the litmus test of common sense. Because of the disruption caused to auto production last year by the earthquake and tsunami, the year-on-year change is not meaningful. Still, a level of 6 billion yen would suggest that profits were not much changed from the previous quarter (see chart) above. Given that the January to March quarter was the second-best quarter ever for Kansai Paint, that would be another excellent performance.

The article mentions 70 billion in sales for the quarter. Management guidance for the first half (April to September) is for 140 billon yen in sales and 12 billion in operating profit, so a first quarter of the kind suggested by the article would put them well on the way to achieving that. Is it better than usual? I would imagine that it is, because in the domestic auto industry the April to June quarter is usually weaker than the January to March quarter. Still, looking at the past few years of quarterly sales, that pattern doesn’t come out clearly. Overall a good quarter if the article is accurate.

What the company does

Kansai Paint is a leading supplier of specialist paints. The auto industry is the biggest driver of sales for the company and – although disclosure here is limited – I estimate for profits as well. As the chart below shows, the Auto industry (OEM in Japan, OEM overseas and aftermarket) made up 37.3% of total sales in FY3/12. Industrial applications were the next largest category (26.1%) and Construction came in third at a surprisingly high 23.9%. Kansai Paint claims a market share of more than 50% for the domestic auto industry, with the next largest supplier being Nippon Paint. Between them these two have a market share of 90% in Japan.

Kansai Paint FY3/12 sales by end industry (%)

The auto paint industry has high barriers to entry due to the need for tough, reliably paint and the tendency of auto OEMs to specify heavily customised mixes for different vehicles. The ingredients of the paint itself are straightforward – resin, pigment, thinners and additives – but the added value lies in the precise ingredients and their proportions. Overseas competitors include DuPont, BASF and PPG, although the latter is actually a production partner for Kansai Paint in the US and Europe. The other big player is Akzo Nobel.

Revenues in Japan are driven by auto production and production of other equipment. Construction demand seems to be a function of rebuilding and replacement activity in Japan, which is already a very mature market. On the other hand, developed markets are also natural candidates for new and more sophisticated (and thus higher value added products). In developing markets (see below) revenues are driven by the rapid modernsation of Asian economies.

Kansai Paint annual sales and operating profit (billion yen)

On the cost side, higher feedstock prices have been a headache for Kansai Paint due to rising costs for resin, which are heavily influenced by the price of naphtha. Although naphtha remains well above long-term average price levels, it has come off sharply over the past 12 months, as this chart on Bloomberg shows. Generally speaking, Kansai Paint seems to have done a decent job of controlling costs but the operating margin in FY3/13 is not expected to get back above 9%, which is what is managed a few years back – see below.

Kansai Paint annual operating profit margin (%)

An India play

One reason that investors like Kansai Paint is that it has solid exposure to emerging market auto demand. Japan still dominates the revenue structure with 56.6% of total sales in FY3/12. However, India and Asia (including China) accounted for 16.4% and 14.3% of sales respectively in FY3/12. Together that makes a solid 30.7% of revenues from emerging markets as shown in the chart below (click on the chart for a larger image).

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On the profits side the contribution is even more marked. See how India accounted for 22.9% of profits in FY3/12 and Asia for 14.9%. Combined that’s nearly 38% of profits from emerging markets.
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India’s auto market is not having a great year, although in cumulative terms the passenger car market is still up 9.3% YoY. In the chart below the red line shows 2012 sales, which are well ahead of 2011 (the blue line) and 2010 (the purple line). However, it’s not just autos. Interestingly, Kansai Paint’s own materials suggest that construction materials account for slightly more than half of revenues in India.

India passenger car sales, cumulative (thousand units)

The stock

It’s a sensibly managed company, but I’m finding it hard to get excited about the stock. Based on management guidance of 60.3 yen per share it’s trading on a forward PE multiple of 14x and a price-to-book ratio of 1.3x. And performance this year so far has been surprisingly good…

Kansai Paint share price performance

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