Despite muted volume growth in Q2, strong margins a cushion for Pidilite

Cheaper VAM to help post Ebitda margin of 20-22%, but pricey valuation leaves no room to disappoint investors

Despite muted volume growth in the September quarter, the stock of Pidilite Industries has gained 6.4 per cent over the last month, outperforming the broader market indices like the S&P BSE Sensex, which is up 1.1 per cent during the period. A sustained strong margin outlook with supportive raw material inflation is keeping investor sentiments intact. In fact, stock valuation has remained high and is currently at par with that of companies like Asian Paints at around 50 times FY21 estimated earnings.

The southward trend in prices of key raw material, i.e. vinyl acetate monomer (VAM), has continued even in the December quarter, with the average VAM price down over 20 per cent year-on-year and 1.3 per cent sequentially. This provides strong margin comfort as VAM accounts for around 30 per cent of Pidilite’s overall raw material costs. Notably, input costs are likely to remain benign at least for the near term despite recent upswing in the crude oil price.

“Though the VAM price is linked to crude oil, any change in the oil price gets reflected on VAM typically with a 3-4-month time lag. Pidilite maintains 1-month VAM inventory and it also has good pricing power. Thus, at least for the next few quarters, Pidilite’s gross margin profile will remain intact,” says an analyst from a domestic broking house. A report by Narnolia Financial Advisors also indicates that the crude oil price is unlikely to see significant gains for some time because of supply outpacing demand.

Even in April-September 2019, Pidilite had witnessed a sharp 235 basis point year-on-year expansion in gross margin to around 52 per cent. Higher advertising spends had narrowed the margin benefits at the Ebitda (earnings before interest, tax, depreciation and amortisation) level. The Ebitda margin had improved by 40 basis points year-on-year to around 21 per cent. Consequently, analysts expect it to remain at 20-22 per cent for FY20.

 The caveat, however, is tepid demand. Factors, such as feeble GDP (gross domestic product) growth and sustained real estate stress, are likely to keep volume growth under pressure for Pidilite. Thus, the only supportive factor for the stock, for now, is strong margins. However, many analysts believe that the current valuation has priced in the potential margin benefits.

 In this backdrop, investors should wait for a correction in the stock as even a small disappointment on the margin front could hurt the sentiment significantly.