Despite strong Q3 hopes, upsides for Asian Paints' stock could be capped

Pandemic related restrictions, rural slowdown and input costs are key concerns

From its lows earlier this month, the stock of the market leader in decorative paints, Asian Paints, is up nearly 11 per cent. Recent price hikes, expectations of a strong October-December (third quarter, or Q3) quarter results, and sustained market share gains were the factors that drove the gains for the stock.

While the current levels of hikes by Asian Paints should be enough to neutralise commodity costs, the Street will keenly watch the input cost trajectory, given the recent surge in crude oil prices.

The near-term trigger for the stock would be the Q3 results. Vishal Gutka and Binay Shukla of PhillipCapital expect a strong Q3, with volumes moving up 25 per cent (on a high base of 33 per cent), while revenue growth is estimated at 37.5 per cent year-on-year (YoY). 

The gains, according to them, will be led by an increase in market share, ongoing trends in premiumisation, and stocks being added at the dealer level due to sharp price hikes. Smaller segments, such as putty and waterproofing solutions, too, are estimated to have registered good growth.

After a 38 per cent fall in the first quarter of 2020-21 (FY21) due to a nationwide lockdown, volume growth trajectory has been strong, registering a growth upwards of 33 per cent in each of the last five quarters. The company is expected to maintain/gain market share as other players, too, have initiated price hikes.

The impact on volumes, given the 20-22 per cent price hikes since the start of 2021-22 (FY22) needs to be tracked, especially at the lower end of the portfolio. This could have a bearing on future price hikes. Any adverse impact of Omicron on construction activity and the slowdown in the rural sector are headwinds which could crimp volumes.

The other metric the Street will focus on is margins. Commodity pressures had led to a sharp 966 to 1,100-basis point (bps) YoY drop in gross and operating profit margins (OPM), respectively, in the July-September quarter. While OPM is expected to move to 20-per cent-plus levels in Q3FY22, (from 12.7 per cent in the second quarter), it will still be 500-600 bps lower than the margins in the year-ago quarter (Q3FY21).

Brent crude oil prices are hovering over the $80-per-barrel levels and will have a bearing on the prices of titanium dioxide - a key input for the paint sector. In a report last week, analysts at Motilal Oswal Financial Services had highlighted that prices for titanium dioxide had risen 61.2 per cent YoY and 28.6 per cent in the October-December quarter.

Given the uncertainty on the progress of the Omicron variant and various restrictions imposed, investors should await demand trends before considering the stock trading at 64x its 2023-24 earnings estimates.