Future not so bright

Asian Paints has been the biggest loser among the frontline FMCG (fast moving consumer goods) companies, as its stock has fallen 10 per cent in the last one month, as against a decline of four per cent and 1.7 per cent, respectively, for the Sensex and BSE FMCG indices.

The company is witnessing a double whammy of a demand slowdown and continued rise in input costs. Analysts, who had tweaked their earnings estimates after disappointing performance in the September quarter, do not see fundamentals improving for the rest of the year.

Says Abhijeet Kundu, analyst, Antique Stock Broking, “Neither do not see any case of re-rating in the short-term, nor any surprises in earnings over the next year.” Valuations are also high. At Rs 2,855, the stock trades at 23 times FY13 estimated earnings.

Demand slowdown
Asian Paints reported a volume growth of less than 15 per cent in first half of the financial year compared to 17 per cent last year, thanks to price increase to the tune of eight per cent and 12 per cent, respectively. The management expects demand to remain robust across segments and regions, supported by new launches. However, Himani Singh, analyst, Elara Capital is sceptical. She says, “One needs to wait for the December quarter results to confirm if the deviation in revenues is merely due to monsoons or the paint volumes are witnessing slower off-take due to a broader macro slowdown.”

Hemant Patel, analyst at Enam Securities, says, “Our interaction with distributors points to slowing volume off-take due to inflation and lower discretionary spends.”

Even the industrial paints segment is witnessing demand pressure. The weak global business environment will continue to affect the company’s overseas operations (20 per cent of consolidated revenues). West Asia, which forms 50 per cent of revenues and more than 65 per cent of profit of international operations, is witnessing uncertain political and an unstable economic environment.

Margin pressures
The company reported significant margin pressure in the September quarter, with the consolidated gross profit margin and operating profit margin (lowest in last 10 quarters) tanking 370 basis points and 400 basis points year-on-year, respectively.

Titanium dioxide (20 per cent of input costs) is trading at life-time high levels of Rs 250 a kilogram and has risen over 40 per cent in last one year. While crude oil prices have jumped 30 per cent in one year, around 10 per cent depreciation in the rupee has added to the woes, given that about 30 per cent of raw materials are imported. Says Amnish Aggarwal, analyst, Motilal Oswal Securities, “A higher-than-expected increase in input cost and currency depreciation are risks to our earnings estimates and margin recovery, respectively.”

The trend in input prices continues to be bullish, say analysts. After July, despite a continued rise in input costs, the company has not raised prices till date, indicating weak pricing power, even for the market leader. Increasing the prices looks difficult, thanks to competition and already slowing demand. Besides, stiff competition means ad spends may remain at elevated levels, as seen in September quarter.

MARGIN RISK
(Rs  crore)	FY11	% change*	FY12E	% change*
Net sales	7,706	15.3	9,392	21.9
Operating profit	1,313	6.9	1,507	14.7
Net profit	843	1.0	981	16.3
Earnings per share**	87.8	0.9	102.0	16.2
Consolidated figures    * y-o-y    E: estimates Source: Company, analysts’ estimates; ** in Rs

Analysts expect margin pressure to continue (due to input costs and currency depreciation), which is a bigger risk than demand slowdown. Says Hemant of Enam, “We have lowered our estimates for decorative paint volume growth to 13 per cent (15 per cent earlier), gross margin to 40 per cent (41.3 per cent earlier) and operating profit margin to 16 per cent (17.2 per cent) for FY12 due to a continued rise in input costs, coupled with rupee depreciation.”

However, the silver lining is that other than titanium dioxide, input costs are showing signs of stabilising (up three per cent sequentially in the second quarter).

High valuations
In this backdrop, the stock could remain under pressure or be range-bound, at the most. Says Himani of Elara, “In the near term, we see limited catalysts for the stock in terms of surprise factors — either volume growth (already at the upper end for our paints universe) or margin expansion.” Positively, commissioning of the Khandala plant phase-I (3,00,000 litres) and Rohtak phase-II (50,000 litres) after March 2013 will boost financials, but only in FY14.