Higher costs take colour off Asian Paints

Muted volume growth accompanied by rise in raw material costs; longer term prospects remain healthy

The Asian Paints stock shed 1.4 per cent on lower than estimated June quarter results. Weighed down by a fall in volumes and higher raw material costs, the company disappointed the Street on all counts.

Volumes in the quarter were up only two per cent year-on-year, as estimated by analysts (the company does not disclose volume numbers), on the back of destocking of inventory at dealers, prior to implementation of the goods and service tax (GST). Analysts say volume growth was lower than in the December 2016 quarter, which was impacted by the note ban. This and a three per cent hike in prices helped a 4.9 per cent growth in consolidated revenue to Rs 4,228 crore.

The lower revenue growth, coupled with higher input prices, hit the gross margins. These, by the Ind-As accounting norms, fell by a little over 300 basis points year-on-year (30 bps sequentially) in the quarter. Input costs, especially of titanium dioxide, moving up over two quarters, rose 15 per cent over a year before and 446 bps higher as a percentage of sales. A report from JM Financial said gross margins were the lowest in six quarters; Ebitda (earnings before interest, depreciation, tax and amortisation) margins were the lowest in 11 quarters.

The fall in gross margin and lower volume performance was visible on Ebitda, down 18.5 per cent to Rs 665 crore. Operating profit margins were down 451 bps year-on-year (40 bps sequentially) to 15.7 per cent.

Given the higher costs and lower revenue growth, there was a 100 bps difference between gross and operating profit margins at the standalone level. Analysts at Ambit Capital believe the gap will worsen when 50 per cent new capacity comes on stream in FY19. Asian Paints could lose market share, as in the June quarter with Kansai reported 14 per cent volume growth. The company’s need to maintain higher prices for increased gross margins has allowed the competition to improve its margins and reinvest.

 

Given the performance analysts, have revised their FY18 estimates for revenue and profit growth down by three to four per cent. Despite the cut, analysts at ICICI Securities believe there will be annual revenue growth of 15 per cent, led by volume growth of 12 per cent and price hikes of three per cent during FY17-19. They are expecting volume growth to be driven by sustained demand from tier-II and tier-III cities, plus new capacity. A better monsoon, higher disposable income and a shift to the organised segment after GST are other factors that will benefit the company and the industry.

 

One reason the stock didn’t react sharply could be that the long-term prospects remain healthy and the consumer goods theme is currently in favour with investors. But, despite the headwinds, the stock is trading at about 45 times its FY19 earnings estimate, which is not cheap. Stability in margins, and increase in volume growth and market share are essential for such high valuations to sustain. Long-term investors, however, can look at the stock on meaningful declines, given the strong past record.