Good execution record in a difficult industry, but need to be wary of frenzied valuations on listing
Valuation and view: Company is targeting a market cap of Rs 7100crs at the issue price which implies a P/E multiple of 66x FY22 and 44x FY23 earnings assuming an earnings CAGR of 50% over FY20-23E, which we believe is possible given the low base and improving distribution for the company. With Asian Paints and Berger currently trading at 62x and 73x FY23 earnings, Indigo can also command a multiple of 60x translating into a fair value of Rs 2,050 vs IPO price of Rs 1,490, implying a 37% upside. As current GMPs are implying an even higher upside on listing day, we would suggest booking profits on listing day if the stock opens significantly above our fair value as we are capturing in 3x earnings growth in 3 years apart from ascribing a multiple similar to the sector leader despite the inherent risks associated with a smaller player giving it the benefit of a good historical track record in a difficult industry.
Indigo Paints (started in 2000) has been able to become the No. 5 and fastest growing player in India's oligopolistic decorative paints market reaching a market share of about 2.5% by selling differentiated products to gain dealer access, aggressive marketing, focusing on Tier 3,4 and rural markets and investing aggressively in ramping up dealer and tinting machine network post investment by Sequoia.
Its strategy of focusing on differentiated products (28% of sales) has worked by giving it shelf space with dealers which has enabled it to push mainstream products as well; it has also given better margins.
Its slow and steady distribution which meant addition of only one state every year and focusing on smaller markets has helped build a decent dealer network of 11,000 dealers vs 25-30k for Berger and Kansai.
It has spent a massive 12.7% of sales on A&P vs 4-5% for other players which has helped build brand equity especially for specialized products; MS Dhoni has brand ambassador has helped; absolute marketing spends are now similar to Berger and Kansai and well ahead of Akzo.
Tinting machine expansion has picked up in last 3 years as company is offering a built-in computer; sales per dealer have been moving up because of that; currently have 4600Â machines vs 17/20k for Kansai/Berger.
Indigo has had lower impact of COVID given its larger presence (85%) in smaller cities which recovered faster and also that it is 100% focused on decorative paints.
Growth at 40% plus over last 5 and 10 years has been well ahead of peers given distribution ramp-up and should continue that way from FY22 as the company still has to expand in many large cities and states which means 7-8 years of above industry growth rates.
Margins have already inched ahead of Berger and Kansai as company has better gross margins given lower trade discounts on the differentiated portfolio and lower overhead costs; gross margins are highest in industry given it has only 3 plants near RM sources.
Margins can improve in future with rising scale which will mainly reduce A&P and freight costs; return ratios are already comparable to top peers given best in class working capital.