Asian Paints' good performance for the December 2012 quarter saw its stock gain 2.4% to close at Rs 4,400 on Tuesday (Sensex was down 0.6%), adding to its outperformance since the start of 2012. While the company’s prospects remain healthy with raw material costs slipping and expected increase in demand, competition remains stiff.
Notably, stock valuations aren’t cheap and analysts believe the company would have to sustain its performance for further gains.
For December 2012 quarter, Asian Paints saw both, sales and margins increase. While consolidated sales growth of 19% was higher compared to 15% reported in first half of FY13, softening of titanium dioxide prices boosted operating profit margin (16.7%) by 102 basis points. Jump in other income (up 92%) and lower effective tax rate boosted profits further helping the company to report the highest profit growth (30.4%) in three quarters.
Volumes in domestic market (decorative paints), which form 83% of the company’s consolidated revenues, have seen a pick-up on account of festive season. Analysts estimate it to be around 7-10 compared to 5% reported in September 2012 quarter. Overall sales growth would have been better if the industrial paints segment was not impacted by poor demand from projects business and slowdown in OEM space.
The company’s raw material price index at 103 in December quarter was down from 108 in September quarter as titanium dioxide (a key raw material) prices were down 5% – it is off 20% from peak levels. Raw material as percentage to sales thus was down 110 basis points year-on-year to 59.7% in December quarter. Softness in titanium dioxide prices is expected to continue in the near-term, say analysts but rupee needs to be remain stable for further gains to materialise. The overall gains will also depend on the trend in advertising costs, given the stiff competition.
Overall, analysts expect better times to continue for Asian Paints. The company may go for price cuts in the event of continued softness in raw material prices (given no hikes in December quarter). This along with expected drop in inflation (leading to higher demand for discretionary items like paints) should boost volumes further and improve sales growth.
Increasing focus on high-yielding water based emulsions (45% of sales) should also support margins. Further, commissioning of the company’s Khandala plant in the current quarter though will increase depreciation costs, but will provide leeway on the volumes front. However, some analysts remain sceptical of significant gains from here on.
Says Aditya Mathur, analyst, Citi Research, in his post result note, “It is still early to call a recovery in demand in the context of a relatively slow economy. Moreover, price cuts / discounts could offset some of the potential commodity costs gains. Going forward, competition is tougher and margin gains are likely to be more modest.” Adds Amrita Basu, analyst, Kotak Institutional Equities, “Operating profit margin is likely to remain well below the peak of FY10.”
Moreover, the market seems to have factored in near-term positives as the stock trades above its average one-year forward PE target multiple of 27-28 times and way higher than its five-year historical average of 23 times. Thus, upside in the stock may be gradual from hereon, provided the good show sustains. Aditya Mathur is cautious as he feels valuation makes risk-reward unfavourable. According to Amrita Basu, justifying higher than sector average valuation multiples is challenging.