When Grasim Industries, the holding company of the Aditya Birla Group (ABG) announced its paints foray, there were several questions thrown about, like - Why now? Why at a holding company level and not at a subsidiary level? And last but definitely not the least, why paints?
The foray into paints seemed like the logical step for the Aditya Birla Group, given its strong financial position, adjacent business benefits, and the expected growth of the paints market. But for investors, the main benefit from this foray will not be limited to the stock of Grasim Industries, but also to its listed subsidiary - UltraTech Cement.
Cash-rich Conglomerate
Grasim Industries is a diversified conglomerate operating in several industries - cement, financial services, textiles, renewable energy, and chemicals.
The majority of its revenue comes from its cement subsidiary - UltraTech Cement. Grasim Industries holds a 57.2% stake in the market leader of the cement industry (24% market share in FY20).
To add a paints company to this mix, Grasim Industries has earmarked an initial investment of Rs 5,000 crore, for the next three years. This will be funded through the proceeds from the sale of its fertilizer business and internal cash accruals. In November 2020, Grasim sold the fertilizer business, Indo Gulf Fertilizer, for Rs 2,649 crore. It is also planning to use the cash on its books. It has a free cash flow of Rs 5,200 crore (as of 31 December 2020) after accounting for its planned capital expenditure (capex) in the chemical and textile businesses.
Aiming For Second Place
Grasim Industries aims to capture the expected growth in the paints industry as demand shifts from the unorganized to the organized sector. The unorganized and organized paints sector constitute 33% and 67% of the paints market respectively (as of FY20). The share of the unorganized sector was 35% in FY15. The decrease in the market share of the unorganized sector is because of the increased penetration of large paint companies in rural areas.
The five listed paints companies in India- Asian Paints, Berger Paints, Kansai Nerolac Paints, Akzo Nobel, and the newly listed Indigo Paints - make up 68% of the total organized market.
The listed paints companies specialize in decorative paints, which makes up 74% of the total paints market. Between FY14 to FY19, the decorative paints industry grew at a compound annual growth rate (CAGR) of 11.5% to Rs 50,000 crore. It is expected to grow at a CAGR of 13% to reach Rs 74,000 crore by FY24. Grasim Industries aims to capture market share in this tightly controlled market.
Berger Paints’ Scattered Dominance
The paints industry is oligopolistic, and Grasim plans to disrupt this dominance. Two companies - Asian Paints and Berger Paints hold 55% of the paints market. Grasim Industries does not want to challenge Asian Paints’ leadership. During a call with investors and analysts detailing its paints foray, Ashish Adukia, the chief financial officer of Grasim Industries said, “Our strategy includes becoming a strong number two player (in the paints industry).”
Asian Paints has a tight grip on the paints markets of metro and tier 1 cities for decades. Three of the four rivals to Asian Paints (Berger Paints, Kansai Nerolac Paints, and AkzoNobel) despite having been in the market since the 1950s have not broken the market leader’s dominance. Only Indigo Paints (formed in 2000) has managed to gain some market share by focusing primarily on tier 3 and tier 4 cities.
New entrants, even those with similar adjacent businesses like Grasim Industries, have steered clear of launching pan-India operations and instead opted to go after specific regions. One example is the JSW Group’s paints business - JSW Paints (formed in 2019). JSW Paints has set its sights on the south and west regions of Maharashtra, Karnataka, Tamil Nadu, Kerala, Andhra Pradesh, and Telangana. It has plans to acquire 5% of the south and west paints market (which comprise 62% of the domestic paints market) before expanding further.
However, Grasim’s management said their entry will be pan-India based. This is because paint companies have a scattered dominance across regions. Asian Paints leads the four regions (north, south, east, and west), but the market-runner up, Berger Paints lags behind in northern and western states. This is where Grasim sees an opportunity to displace the incumbent.
Adjacent Advantage
The reason for this scattered dominance is the fragmented distribution of paint companies. New companies can’t compete with established players because of inferior distribution channels. Due to this barrier, long-standing players have continued to dominate and new players have failed to take away the competition. But Grasim Industries has a trump card - UltraTech Cement.
Grasim Industries will work with its cement subsidiary UltraTech Cement on an “arm’s length basis” said the management. The key player in this arrangement will be Birla White, a producer of white cement and putties. White cement and putties are raw materials to produce decorative paints. Since white cement and putties are ancillaries to paints, paint companies incentivize distributors to sell the products with paints.
As of FY20, Birla White had 54,000 dealers, 74% of which distribute paints. Grasim Industries will use this distribution network to gain a head start. Birla White has 6,000 outlets in metro and tier 1 cities.
Grasim can leverage UltraTech Building Solutions, a construction solutions provider under UltraTech Cement. Tapping this resource will help Grasim Industries build its brand and disrupt the distribution of the number two player Berger Paints.
Ultratech Building Solutions directly sells construction products (like wires, pipes, and paints) to individual home buyers. It has 2,350 outlets (70% of which are in rural areas). Currently, its paint partner is Berger Paints.
UltraTech Cement, through its subsidiary Birla White, and its UBS division will be the main piece in Grasim’s paints success. Ashish Adukia said, “[The] critical success factor out here would be to see how we can leverage that distribution that exists in UltraTech.”
Grasim’s investment, UltraTech’s Gain
During UltraTech Cement’s Q3 earnings call, Atul Daga, the CFO was asked why the paints opportunity wasn’t housed within the subsidiary. He framed it as a chicken-and-egg problem. He said, if UltraTech Cement would’ve started a paints business, the question would have been - why paints and cement? Since the paints business is now under Grasim Industries, the question is - why not paints and cement?
At the end of Q3, UltraTech Cement was sitting on nearly Rs 13,000 crore in cash. It called off its capex plans earlier in FY21, despite many cement companies ramping up capex from Q2 due to recovering cement production. The cement major had the funds and Birla White’s distribution network to launch a paints business. But if it housed the paints business under its name it would’ve been a small entity within a large and specialized grey-cement company, said Daga.
This is why Grasim Industries is launching a paints business at a holding-company level. It will use the existing distribution network of Birla White to get its paints to dealers. This is likely to be effective since white cement and putties are sold by paint dealerships. Grasim will also use UltraTech Business Solutions to sell directly to individual home builders. This will be funded through its balance sheet, at a holding company level. UltraTech Cement, the subsidiary, with large cash reserves will not have to spend a penny or diversify from its specialized market. But since paints is an adjacent offering, cement sales are likely to benefit from the paints business.
The biggest losers from Grasim Industries’ entry into paints will be the number two player Berger Paints. But the biggest winner will be UltraTech Cement.