Indigo Paints: Upcoming Star

[sahil_vi]

Business

1. [Market position]: Indigo is the fastest growing amongst the top five paint companies in India. They are the fifth largest company in the Indian decorative paint industry by revenue for FY2020. They have achieved this position by introducing differentiated products, building brand equity for the primary consumer brand of “Indigo”, creating an extensive distribution network across 27 states and 7 UTs as of Sep30, 2020, and installing tinting machines across the network of dealers.
2. [Business Strategy]: To create demand for their differentiated products, they initially tapped into Tier 3, Tier 4 Cities, and Rural Areas, where brand penetration is easier and dealers have greater ability to influence customer purchase decisions. They subsequently leveraged this network to engage with dealers in Tier 1 and Tier 2 Cities and Metros as well.
3. [Brand Building]: They engaged Mr. Mahendra Singh Dhoni as their brand ambassador, to enhance their brand image amongst end customers. They concentrated these branding efforts on their differentiated products and then leveraged these efforts to increase distribution and sale of their complete range of decorative paint products.
4. [Product Range]: They manufacture a complete range of decorative paints including emulsions, enamels, wood coatings, distempers, primers, putties and cement paints. They also identify potential product needs from customers and introduce differentiated products to meet these requirements, and create a distinct market for their products.
5. [Product Innovation]: For instance, They are the first company to manufacture and introduce certain differentiated products in the decorative paint market in India, which includes their Metallic Emulsions, Tile Coat Emulsions, Bright Ceiling Coat Emulsions, Floor Coat Emulsions, Dirtproof & Waterproof Exterior Laminate, Exterior and Interior Acrylic Laminate, and PU Super Gloss Enamel. These products are differentiated based on the end-use they cater to, as well as added properties that they possess. Revenue generated from Indigo Differentiated Products represented 26.68%, 27.58%, and 28.62% of total revenue in FY 2018, 2019 & 2020, respectively. As the first company in India to develop these products, they have had an early mover advantage in the markets we are present in, which has allowed them to realize relatively higher margins for these products compared to the rest of their product portfolio. As of March 31, 2018, 2019 and 2020, the total number of tinting machines that we placed across our network of dealers was 1,808, 3,143 and 4,296, respectively.
6. [Manufacturing]: As of Sep30, 2020, they own 3 manufacturing facilities located in Jodhpur, Kochi & Pudukkottai with an aggregate estimated installed production capacity of 101,903 KL per annum (“KLPA”) for liquid paints and 93,118 metric tonnes per annum (“MTPA”) for putties and powder paints. These manufacturing facilities are strategically located in close proximity to raw material sources that reduces inward freight costs, lowering their cost of raw materials.
7. [Capex]: Will expand their manufacturing capacities at the facility at Pudukkottai, by adding capacities to manufacture water-based paints to cater to the growing demand for these paints. The proposed installed production capacity of the expansion unit is 50,000 KLPA and it is expected to be 155 operational during Fiscal 2023. Will be funded through IPO proceeds.
8. [Products in the Existing categories]: Dirt-proof & Water-proof Exterior Laminate: Indigo Paints launched India’s first and only paint that gives equally effective protection from dirt as well as water; Acrylic Laminate: Indigo Acrylic Laminate is a premium quality emulsion; PU Super Gloss Enamels: an all-surface enamel paint that delivers superior gloss and protects wood and metal with its anti-fungal and non-yellowing properties; Polymer Putty: A white cement based putty with special polymers that gives double protection to the wall with a smooth and bright finish
9. [Unique Products disrupting market]: Metallic Emulsion (Walls): pioneered the Metallic Emulsion segment, which gives a designer finish with glossy metallic texture effect; Tile Coat Emulsion (Roof Tiles): provides unmatched gloss and sheen with excellent protection against algae and fungus; Bright Ceiling Coat (Interior Ceilings): offers unmatched brightness to the ceilings with a smooth matt finish to enhance the brightness of the room; Floor Coat Emulsion (Driveways): s India’s first Floor Coat Paint that offers a glossy finish while also protecting the terrace floor, driveways, walkways and cement surfaces
10. [Growth ambitions]: Indigo plans to grow revenues 5x to 3,000 cr in 5 years (by 2025 assuming washout FY21).

Financials

Some observations:

1. Revenue is growing well.
2. Gross margins are expanding as product mix changes.
3. PAT margins are improving.
4. ROCE is improving.
5. Debt is being repaid, this will further expand PAT margins.

Barriers to Entry

1. The Indian decorative paint industry presents significant entry barriers. These market entry barriers include the development of an extensive distribution network through relationships with dealers.
2. The ability to set up tinting machines with dealers. Many dealers are unable to install a new company’s tinting machine mainly due to space constraints. As a result, most dealers tend to install tinting machines of only recognized players. The large number of SKUs and product ranges in emulsions renders installation of tinting machines imperative for timely distribution of different shades and products.
3. Significant marketing costs and the establishment of a distinct brand to gain product acceptance

Industry Comparisons

4. (Key costs): Raw material sourcing comprises more than 60% of the input costs of paint manufacturing. Around 300 to 400 ingredients are used in the manufacturing of decorative paints, of which, Titanium Dioxide (TiO2), a white pigment, constitutes around 20% to 25%. The paint industry has historically been successful in passing on any significant price increases in inputs to the customers
5. (Global paint consumption trend):
   
6. (India Paint Consumption Growth): Compared to the global average consumption of approximately 14 kg to 15 kg per capita, the per capita consumption of paints and coatings in India is low, indicating a significant opportunity for market penetration in India.
   
7. (Paints Sector): By end user, the sector is split into Industrial and Decorative paints. The decorative paint segment constitutes around 74% of the total paint sales. By technology, there are water soluble, solvent soluble and solid paints. Water soluble paints are 46% of market whereas solvent soluble are 48% of the market. Water soluble paints are higher quality and more eco friendly. Organized sector comprises 67% of the sector versus 33% for the unorganized sector.
8. (Decorative paints market): There has been a higher growth of emulsion paints for interiors as compared to distempers, in line with an increase in the use of economy emulsions in place of lower-priced distempers. Seeking better products, consumers are also switching to marginally higher-priced emulsions with more durability and better-looking finishes in a wider range of colors
   
9. (Fresh vs Repainting): As we can see, repainting drives most of the painting demand and painting cycles are also becoming shorter.
   
   

Competitive landscape

Unlike the major entities, Indigo Paints entered the market of small cities, towns and Rural Areas (Tier 3 – 4) and effectively established itself as a market leader in selected categories within a short period of time, and is now venturing 137 into metros and Tier 1 Cities. Indigo paints only has 2% of the market share. Which demonstrates the opportunity size.

1. (Tinting Machine growth and penetration): Before 2000, machines used to cost approximately ₹ 1 million, due to being imported. With local manufacturing, the cost has decreased to ₹ 0.15 million, typically borne by the paint companies at least for Asian Paints and Berger Paints.
   
2. (Manufacturing Capacities and growth): Indigo Paints is doubling capacities in last 2 years which demonstrates strong demand for their products.
   
3. (Capacity Utilization): Due to aggressive capacity additions by Indigo Paints, their capacity utilizations are low, which is good since it leaves more room for growth.
   
4. (Terms of Trade): The companies mainly focus on dealer margins with Asian Paints offering the lowest margins. Berger Paints provides the highest margins among the top four with almost 10% to 15% and up to 18% for specific dealers. Asian Paints and Berger Paints also provide direct cash discounts ranging between 3% to 5% to the dealers in case of early payments. Indigo offers a wide range of incentives to its dealers such as cash discounts, annual turnover rebate, long-term dealer loyalty program, among others.
   
5. (Marketing And Ad Campaigns): The paint companies have continuously invested in brand building through increased marketing and sales promotion expenditure.
   
6. (Raw Ads Spends): We can see Indigo Paints spending on Brand building close to what other market leaders (Berger, Kansai Nerolac) are spending, despite being much smaller
   
7. (Revenue Growth): We can see Indigo being on a clear growth path (Revenue in Billions of Rupees)
   
   
8. (Gross, EBITDA & PAT margins): We can see that EBITDA margins for Indigo are at par with other market leaders although lower than Asian Paints. We can also see Gross margins improving over last 3 years as the product mix has changed. While the PAT margins are low right now, they are on the right trajectory and as they pay down debt, PAT margins would go up even more. Same with increasing capacity utilizations.
   
   
9. (Materials Cost): The material cost (excluding the freight cost) as a percentage of operating revenue is the lowest for Indigo Paints as the company is closely located to the source of raw materials. However, this leads to Indigo Paints spending greater amounts on outward freight charges to deliver the products to the consumption centers. The outward freight charges for its peers are comparatively lower as their manufacturing facilities are located close to the consumption centers. On combining the material costs and freight and forwarding charges, Indigo Paints is effectively at par with its peers with the range being comparable to the industry leader – Asian Paints and lower than Berger Paints and Kansai Nerolac.
   
   

Valuation

The IPO size is estimated to be 1,000cr as per the news. This includes 300cr of Fresh shares being issued by the company and also 700cr worth of existing shares (mostly belonging to Sequoia Capital) being sold. These are 5.8M shares. Pre-IPO there were 29M shares. This makes Indigo’s market cap to be 700*29/5.8+300 = 3800cr. With 19 cr of debt, EV is 3820 cr. At FY20 revenues of 620cr, it is available at EV/Sales of 6.16. We can see valuations of peers below:

The two market leaders are available at EV/sales of 11 and 12. Average EV/sales has been around 4-5. Relative to current peer valuations, Indigo is definitely undervalued. Relative to historic peer valuations, Indigo is marginally overvalued.

Risks

1. An inability to protect, strengthen and enhance the existing brand could adversely affect the business prospects and financial performance. Retail Decorative paint business is based on brand recall and word of mouth recommendations.
2. Engages in a highly competitive business and any failure to effectively compete could have a material adverse effect. Some of the competitors have larger business operations, are diversified with operations across India, have greater financial resources than Indigo does, have access to a cheaper cost of capital and may be able to produce paint more efficiently or invest larger amounts of capital into their businesses in terms of strengthening their brands, expanding their distribution networks and expending greater resources to populate tinting machines.
3. Ability to grow the business depends on the relationships with dealers and the community of painters, and any adverse changes in these relationships, or their inability to enter into new relationships, could negatively affect the business and results of operations.
4. On an absolute basis, valuations are very steep. Specially the P/E ratio is ~100. Entire industry has priced in decades of steady low double or high single digit growth with high terminal value. Any sector level disruption will impact Indigo’s ability to command premium valuations as well.

One para Investment Thesis

Indigo is the fifth largest paints manufacturing company with 2% market share. It is growing at quite a steady and fast pace, based on differentiated and innovative products (metallic emulsions, ceiling and floor paints, cement paints), high brand building & Ads spending, and differentiated business strategy: while top players started with metro cities and are now expanding to tier 3 and 4 towns, indigo has solidified their presence to some extent in smaller towns & villages and are now looking to expand to tier 1 and 2 cities. Company is able to successfully create demand for and sell their products, creating, expanding and utilizing larger manufacturing capacities (in fact all proceeds of Fresh IPO issue will go to capacity expansion). Given the very small size (2%) compared to opportunity size, high industry growth (10-13%) and reasonable valuations (6x EV/sales), Indigo is a reasonable investment candidate as per available information.

Next Steps

Some ways in which community can help is by scuttlbutting the nature of and pull of the end products. Are indigo paints of comparable quality to Asian Paints and Berger Paints? Are they available at attractive prices to Customers compared to other paints? How does Indigo treat their distributors?

Disc: Planning to invest in the IPO and possibly on listing depending on listing price.

Sources:

We are aiming for Rs 3,000 crore in five years: MD Indigo Paints - Times of...

https://www.sebi.gov.in/filings/public-issues/nov-2020/indigo-paints-limited-drhp_48167.html

[Rafi_Syed]

Thanks Sahil , their campaign is very unique ( other players might have done the same I am not sure )

[Rohit_Kadam]

Sharing my notes on Indigo:

About the business

• Fifth largest paint company in India with a low single digit market share. Started in early 2000s unlike other companies which started 50-75 years earlier.
• Paints Industry has 65% share among the top 4 players with Indigo taking the next 2%. There are a few more small organised players such as Shalimar, JSW and the rest about 30% industry is unorganised.
• Indigo was started by a first generation businessman Hemant Jalan and has become 5th largest in less than two decades. The company is now profitable (margins trending towards industry average) with high teens sustainable growth rate.

How did Indigo make a dent in an industry with such high barriers to entry?

• Indigo realised early on that selling absolutely ‘me too’ products in urban/ tier 1 areas which are well penetrated by the larger companies was going to be a very tough task.
• They key barriers to entry for new players in the paints industry are

1. lack of brand equity with end consumers and the applicators (painters) which leads to lack of demand
2. lack of selling space - all paint dealers typically stock only 1 or 2 leading brands with 1 or 2 tinting machines which are crucial to make all shades from base paints. Space is often a constraint in these shops.

• Indigo thus chartered a differentiated journey by 1) selling different types of paints for different applications (earlier ignored) and targeting tier 3/4 and rural areas for dealerships where focus was weak for the leaders.
• For example, Indigo launched a series of glossy coats for floor tiles, roofs and ceilings (backed up with promotions) for the tier 3/4 tastes. These clicked and did well. These make up 25% of sales today.
• On the back of these, Indigo also sells the usual paint products similar to other paint companies. Indigo exclusively focussed on tier 3/4 towns to add new dealerships.
• Once they become strong in these areas, they spread their tentacles to the more urban areas within the state. This has been the template followed in their stronger states such as UP, Bihar and some southern states.
• Indigo will continue to build on this strategy in the future: launch differentiated products and grow from smaller towns into large towns in newer markets.
• With Indigo at just 2% market share today and 30% of the market unorganised, there is enough headroom the grown and gain share at a fast clip in the coming years.
• The company purely focusses on B2C retail decorative paints (focus is an advantage for a fast growing small player) unlike large competition which focusses on water proofing, B2B and industrial segments as well.
• The above strategy adopted by Indigo goes to show that the company can think on its feet and is innovative.

Quality of management

• Stellar single man show of the founder Hemant Jalan who started from scratch just 20 years back. Have interacted with him at the Kotak Conference in mid 2020 and comes across as a very hands on business man with a high degree of humility and leadership ability.
• One gets the sense that Hemant has put together a decent team around him although there seem to be know high profile people from other larger paint companies.
• Hemant takes pride in hiring people young and grooming them to grow to take on larger responsibilities.

Risks for the business

• There is a clear key man risk here as Hemant has been the face of the company. He is 63 and his son is still 33 and not in the business. Not sure of any succession planning.
• The other risk is that as Indigo penetrates into larger towns in more stronger regions like the West, they will face stiff competition from incumbents. Finding dealerships to stock their products and tinting machines may be hard.
• The larger paint companies have also been venturing into smaller towns over the years and thus competitive intensity in smaller towns can go up.
• However, this industry has traditionally had a very strong pricing discipline with players competing via service quality, product offerings, brand building and distribution efforts.
• Seldom, have we seen rash price based competition. One reason for this is that customers look at the lifetime value when choosing a paint and the actual paint cost itself is a small portion of the overall cost, labour costs taking a fair chunk.
• For Indigo, the risk is more from the sustainability of the high growth rate and not from a risk to gross margins.

Do we want to own this business and what price?

• Indigo is a well run, fast growing and a profitable paint company in India. This is a company which can compound at high teens in an industry which has favourable characteristics.
• One can be reasonably confident of continued market share gains given the small base and ability to keep launching differentiated products.
• The challenge in owning this business will be the price at which it gets offered. All paint companies trade at very high valuations currently.

[sahil_vi]

Really good industry overview by PPFAS mf: https://youtu.be/9GKKa-blmlo

[Rafi_Syed]

[hash611]

A concern for me is the main promoter (Hemant Jalan) selling out completely from the business.

[Rohit_Kadam]

valid point. Are you sure of this? Its hard to believe he will be exiting completely.

[sahil_vi]

@hash611

A concern for me is the main promoter (Hemant Jalan) selling out completely from the business.

This is definitely of some concern if true, please share the evidence for backing this claim.

As per my understanding, this claim is false.

See total holding for Jalan family:

Total OFS is for:

Some of the OFS is the Sequoia capital shares, there is no way that Jalan family (or even Hemant jalan himself) is selling out completely.

[hash611]

Apologies. This is basis someone reading the prospectus wrong. He pointed out on page 19 of the prospectus that the selling shareholders’ shares and the pre-offer shares were the same in the case of Hemant Jalan, leading him to believe that there was a total sellout.
His understanding is incorrect and I wrote it here without checking facts. Apologies again.

What does the above line mean? It is stated on the same page 19 between subpoints a) and b).

[Investor_No_1]

I am not a paint market expert some basic observations…small paint companies market share gradually eroded like shalimar. Asian and Berger growth rates similar. Nerolac and Akzo have their own niches and market dynamics. Where does indigo fit in. Seems like it is developing its own niche via product innovation. Surprising when there is so much growth in niche paint segments where indigo operates, Asian is trying to look at Pidilite related adjacencies like Adhesives and water proofing rather than roof and floor paints, glossy paints for doors , rural India etc. My doubt is why Asian giving leeway for players like Indigo to grow at enormous pace when it itself is looking around at adjacencies to get some decent growth?

[Rafi_Syed]

[arjunbadola]

I was reading Sirca Paint’s Q4FY20 concall and came across a part where management talks about Indigo Paints.

Hope this adds value to the thread.

[sahil_vi]

Updated Valuation

My valuation working was a bit incorrect (due to incorrect number of total shares outstanding). Working with Ambit’s numbers, implied market cap is 5710cr. This gives a EV of 5740 cr which with FY20 revenues of 620cr is at EV/Sales of 9.25. This is still at a healthy 33% discount to the current nosebleed valuations of the average of 2 decorative paints players Berger and Asian paints (13.8 EV/Sales is the current average):

Buying at 1200 rupees, the biggest risk would be the entire paints sector losing fancy and the valuations mean reverting for entire sector. IMO if any paints player can justify a 9-10 EV/Sales valuation, Indigo Paints is the one due to the differentiated business model (tier 3/4 cities), the growth rates (20%+), the capex, the differentiated products, and the brand building.

I would personally be ok buying around 1200-1500 rupees but not with a big allocation due to the nosebleed valuations of the entire paints sector. Would try to build position over years, adding in each correction/dip.

Disc: Planning to invest in IPO, positively biased.

[Rafi_Syed]

Thanks Sahil IPODairy-AxisSec-20210103.pdf (1.5 MB) is some more for you from Axis

[Vishal_Vindoorty]

Indigo Paints generate 35% of the sales from Kerala, any idea why is this so. Why such a huge contribution from Kerala?

[sahil_vi]

Indigo Paints IPO : What will be the Favourable IPO Price : by CA Ravinder Vats

Very good risk highlighted:
There will be some equity dilution (30-40%) in next few years due to Cumulative Compulsory Convertible Preference Shares being issued to other shareholders. This would directly lead to EPS going down by 30-40% whenever this happens.

On a related note:

Indigo Paints Receives SEBI Approval To Float IPO

[vnktshb]

This dilution happens before the IPO. You buy post dilution. Dilution does not happen post IPO

[sahil_vi]

@vnktshb can you please add a more detailed analysis of what the EPS looks like pre IPO and post IPO? or if it’s already there in DHRP can you please add a screenshot?

[Vijay-Ayyappan]

Kerala homes & office use extensively wood / timber/ sheets for decoration, ceiling, etc., This wood work needs coatings which Indigo’s 2016 “Hi-Build Company” acquisition at Rs 110 cr took care of this market.

[sahil_vi]

R.K. (ipo_mantra)

The IPO price band is 1480-1490. The p/e ratio is 125 on annualized H1FY21 earnings since earnings are ~5.97 rs/share in. H1FY21.
disc: I would be applying in the IPO and possibly on day of listing for a small quantity not exceeding 2-4% of portfolio (given the very high valuations I find it difficult to make any meaningful allocation).