In a lacklustre market, Asian Paints puts up a bright show in Q1FY20

Volumes grew by an estimated 17 per cent, operating profit margin was at a 12-quarter high

At a time when markets have been volatile with a downward bias, Asian Paints’ June 2019 quarter (Q1) results were good news for investors with the company outperforming the Street’s expectations on all key parameters. While consolidated topline of India’s largest paints maker grew by 16.6 per cent year-on-year to Rs 5,130.6 crore, its net profit (after minority interest) rose by 17.7 per cent year-on-year to Rs 655.4 crore. According to Bloomberg consensus, analysts had pegged revenue and net profit way lower at Rs 4,886 crore and Rs 550 crore, respectively.

A sturdy performance on the volume (despite higher base) and margin fronts drove the overall numbers. This also wooed investors given that many major consumer companies are feeling the heat of a consumption slowdown. Not surprisingly, the Asian Paints stock gained about 4 per cent on Wednesday in an otherwise weak market; taking its total gains in July month to over nine per cent.

The company’s topline performance was driven solely by the strong double-digit volume growth (estimated at 17 per cent) in the decorative paints business. Analysts had estimated volumes to grow by 8-13 per cent in Q1. Market share gains (including from unorganised players), mainly in low-cost products due to lower goods and services tax, innovative schemes and, faster growth of rural business propelled overall volumes. Notably, the good growth in rural India is in sharp contrast to other consumer majors which have witnessed a slowdown in hinterland sales.

What’s supported volumes as well as overall performance is pricing action. According to the management, the company took 0.4 per cent price cuts (on average) on select solvent-based products. This, at a time when input costs were benign, protected gross profit margin despite higher share of low-cost products in overall volume mix. Prices of key raw materials such as titanium di-oxide (TiO2) and crude oil were either flat or down year-on-year and sequentially in Q1. While TiO2 accounts for 20 per cent of raw material costs, crude oil derivatives are key for packing materials. Thus, gross profit margin were maintained on year-on-year basis at 43.5 per cent, while they jumped by 198 basis point sequentially.

Coupled with operating leverage, it led to a sharp 136 basis points year-on-year expansion in EBITDA (earnings before interest, tax, depreciation and amortisation) or operating profit margin to 22.5 per cent. Lower advertising spends (in Q1 these are usually lower) kept a lid on other operating overheads. While the Q1 EBITDA margin is highest in the last 12 quarters, around 120 basis point gains were also led by the new IND-AS 116 accounting standard. Yet, the profitability improvement was a positive surprise.

However, the question is if the company can sustain these strong operating margin going ahead. Some analysts though believe that it will be tough. “We think advertising and promotional spends will trend higher and the ramp up in overheads from new plants commissioned in second-half of FY19 (October 2018 to March 2019), will weigh on EBITDA margin,” says Lakshminarayana Ganti, co-head of research at SBICAP Securities. Ganti foresees around 20 per cent EBITDA margin levels and 16 per cent earnings growth for Asian Paints in FY20.

Overall, Asian Paints is an outlier so far in the consumption space, in terms of Q1 numbers. The jury is out on whether other players such as Berger Paints follow suit. For now, at 46 times FY21 estimated earnings, the Asian Paints stock trades at 14 per cent premium to its 5-year historical average, leaving little upsides in the near term. Long-term investors could await correction to consider it.