INDIGO PAINTS:

Indigo Paints is the fifth largest paints manufacturer in India with a 2% market share and is the latest company to join the IPO frenzy. At first glance, the IPO seems like an opportunistic one that is taking advantage of the sheer liquidity and the high investor appetite for IPOs.

The company’s tagline is ‘Be Surprised!’. Well, it’s definitely surprising to see that their headquarters is in a pretty unassuming building that I’ve passed by thousands of times without having a clue! (For all the Pune folks, just Google their HQ location and I’m sure you have passed by it too!)

About:

Indigo Paints was founded by Hemant Jalan in 2000 and is backed by Sequoia Capital. The company started off as a lower-end cement paints manufacturer establishing a presence primarily in Southern India (Tier 2, 3, and 4 cities + Rural areas). Its operations are majorly in India (over 99%).

It focuses on delivering ‘Value for Money’ paints at the base of the price pyramid as well as highly differentiated high margin products.

Asian Paints too begun its journey via the rural / semi-urban route thereby avoiding head-on competition from existing players during its time such as Shalimar Paints etc (Do check out my Asian Paints article here https://aalokbhatawadekar.in/2020/07/23/asian-paints-painting-your-dreams/).

Today, Indigo Paints has become a full-fledged paint manufacturer competing with the larger players like Asian Paints, Berger Paints, Akzo Nobel, and Kansai Nerolac.

Indigo Paint’s Positioning Relative to its Competitors:

A paint manufacturer’s success is reliant directly on its dealer network since most of their sales come through dealers pushing out their products. A great product with a poor underlying dealer network is bound to fail. Hence, we will attempt to understand the relationship between a paint manufacturer and its dealer network.

A paint manufacturer incentivizes dealers to stock ‘their’ product by offering either higher margins, cash discounts, or loyalty programs to these dealers. Beyond these basic incentives, the manufacturer attempts to capture the dealer by placing a tinting machine at the dealer’s shop. These machines are used to create ‘tints’ of base colors at the dealer’s end thereby reducing the need of maintaining a larger inventory. These machines occupy large amounts of space and hence dealers generally have a maximum of two machines at any given point of time.

Due to the constraint on the number of tinting machines deployed at the dealer level, the dealer will always choose the hottest selling brand. Furthermore, there is a feedback loop: a large dealer network ensures high product visibility thereby strengthening brand equity.

Asian Paints is a master at this craft and enjoys a large efficient captive dealer network.

Notes for Understanding the Table below:

Dealer Inventory Days: Number of days it takes the inventory to be converted into sales at the dealer level

Replenishment Cycle: Amount of time it takes for the dealer’s inventory to be replenished by the manufacturer

Dealer Type:

• Exclusive Dealer Network
  • Dealer stocks only a single manufacturer’s products
  • Arrangement works only when brand equity is incredibly strong and ‘critical mass’ is reached (by critical mass I mean that the single brand sells significantly more than all the other competitors combined. This ensures that the dealer is happy to stick to the dominant brand and is willing to accept slightly lower incentives since the dealer knows that sales will be a lot higher {Low Incentives but Higher Sales})
  • Requires a higher level of trust between manufacturer and dealer (leads to better long-term relationships and this can allow cross-selling of newer products)
• Multi-Brand Dealer Network
  • Dealer stocks multiple competing products
  • Incentivizing the dealer is key to success since they are the point of sales

Market Share by Region of Top 3 Players: AP- Asian Paints, BP- Berger Paints, KN- Kansai Nerolac

• North – 84% market share (AP-48%, BP-14%, KN-22%)
• South – 86% market share (AP-41%, BP-38%, KN-7%)
• East – 90% market share (AP-32%, BP-30%, KN-28%)
• West – 72% market share (AP-33%, BP-26%, KN-13%)

Now that we have covered the dealer network, let us try to understand where Indigo Paints is positioned.

Indigo Paints is a small player that has been in existence for the past 20 years. It has attempted to differentiate itself in a fairly saturated market by:

• Focusing on the smaller towns (Tier 2, 3, and 4) and rural areas of Southern India where local regional players exist. The company has found it easier to grab market share from these unorganized regional players.
• Focusing on innovative new products and being highly flexible in its ways of doing business. It was the first company to introduce coatings for ceilings, tiles, and floors. However, innovation is a weak competitive advantage in this industry and dynamism in operations fades as the company gets larger.

Indigo has focused its marketing and advertisement expenditure around its differentiated products to define the Indigo brand. It spends around 11-12% of its revenues on Marketing and Advertisements whereas its larger competitors spend between 3-5% of their revenues (these revenues are much larger).

Today, the company has three manufacturing facilities located at Jodhpur (Rajasthan), Kochi (Kerala), and Pudukkottai (Tamil Nadu).

The rapid expansion of their dealer network in Southern India is now slowing due to saturation. The company is looking to expand into newer geographies such as Western India.

What does the Company intend on doing with the IPO proceeds?

The IPO makes way for Sequoia Capital as well as the Promoter to encash some of their gains.

IPO Price Band – INR 1488 to INR 1490

The IPO proceeds would be used for:

• Expanding the capacity at the Tamil Nadu facility to manufacture water-based paints
• Expanding distribution and dealership network by procuring Tinting machines and Gyroshakers
• Repayment of a part or all the debt
• General Corporate Purposes

What is working well for Indigo Paints?

High Revenue Growth and Operating Leverage

The company has enjoyed stellar growth over the past few years easily beating its larger peers. However, much of this growth comes from the fact that the company is growing from a much smaller revenue base (2020 – Asian Paints had Sales of INR 20,211 Crs against Indigo Paint’s INR 626 Crs).

Margins and profitability metrics have improved drastically as operating leverage starts playing out.

Differentiated and Superior Products Contribute a Sizeable Amount to Sales

The company’s high margin unique differentiated products make up about 28-30% of the company’s overall turnover. The focused Marketing and Advertisement expenditure around these products could help the company maintain above average profitability.

Strategic Location of Manufacturing Plants

The company’s plants are strategically located closer to their raw material sources, thereby reducing transportation costs. However, a significant part of these savings are lost due to higher transportation costs while forwarding their products to the dealers.

Relatively Clear and Defined Pathway for Growth

The company operates in Tier 2, 3, 4 cities, and rural areas in Southern India. It has been successfully gaining market share from the regional and local players in these areas, avoiding a head-on conflict with its much larger organized competitors. This non-confrontational approach should allow the company to grow fairly well in Southern India.

They intend to expand into Western India which is extremely competitive with organized players, regional players, and other newer entrants (JSW) fighting it out.

Ability to Establish a Strong albeit Local Distribution Network

The company has done exceptionally well in rapidly growing their distribution network in Southern India, and as such have successfully crossed one of the key barriers to entry.

Upcoming and Fresh Brand Equity/Image

The company has got its foot in the door when it comes to building a brand around its products. Only time will tell how it fares going forward.

What may not work for Indigo Paints?

Raw Material Volatility and Lack of Backward Integration

The company is reliant on imports for some of its raw materials and does not undertake long-term contracts with its suppliers. Its key raw materials include Titanium Dioxide, White Cement, Lime, Dolomite, Calcite, Talcum, and Crude oil derivatives.

The paints industry has largely been successful in passing on raw material volatility to the end consumer.

Considering the company’s size today, backward integration would not make sense for them due to the high initial costs and the need for high volumes to truly take advantage of the integration. To put things into perspective, only Asian Paints and Berger Paints are backward integrated (they make their own emulsions).

If the company is to truly have a pan-India presence, it would need to undertake backward integration exercises.

Small Scale of Operations

The company’s operations are small scale and hence prolonged economic slowdowns could really hamper the company a lot more than its competitors. Its cash buffer is meagre, and a large chunk of the IPO proceeds will be reinvested into the business. Furthermore, heavy discounting by competitors as a retaliatory measure could lead to subdued performance for the company.

Lack of Long-Term Relationships with Dealers

The company does not have long-term relationships with its dealers. We have already covered how a robust dealer network is quintessential for a paint manufacturer’s success and hence the lack of long-term contracts/relationships is a big risk going forward.

Geographical Concentration

The company derives over 34% of its revenues from the state of Kerala and hence there is significant geographical risk. However, the company is attempting to spread its outreach across other geographies.

Growth Drivers for the Paints Industry:

• Government Policies
  • Affordable Housing and ‘Housing for All’ schemes under Pradhan Mantri Awas Yojana
  • Smart Cities Implementation
  • AMRUT (Atal Mission for Rejuvenation and Urban Transformation) scheme for aiding urban planning
  • GST on Paints has been slashed from 28% to 18% and paint companies have passed on the benefit to consumers
• Urbanization of India
• Real Estate sector seems to be on the verge of coming back strongly which would boost the demand for fresh painting (Fresh Painting contributes 22% of the industry while Re-Painting contributes 78% of the industry)
• Increasing affluency is leading consumers to upgrade from basic paints to more value-added products as well as leading to a shortening of the re-painting cycle

Market Size:

Indigo Paints operates in the ‘Decorative’ Paints space which comprises of around 10-12 organized players controlling 77% of the market. Going forward, the organized players should gain further market share from the unorganized.

Intrinsic Valuation:

Conclusion:

I believe that my intrinsic valuation (INR 464.06) of Indigo Paints is conservative, and it confirms my belief that this IPO is incredibly opportunistic.

The IPO price of INR 1490 implies that the IPO is overvalued by a massive 321%.

While well-established competitors like Asian Paints and Berger Paints do trade at similar exorbitant valuations, they offer a long proven history of robust and steady performances, something that Indigo Paints is yet to deliver and prove!