Analysis: Festive season hopes for Asian Paints

Demand is expected to see some pick up in festive season, margins may get support from soft input prices, stable currency, stock valuations are stiff

Despite a higher base, Asian Paints reported better than expected sales growth of 16.8% year-on-year in September 2012 quarter helped by price hikes (5-10%) executed in the previous quarter. However, analysts estimate volume growth to have come in single-digits (5-7%) due to the on-going economic slowdown affecting discretionary spending. In their preview note, Gautam Duggad, analyst, Motilal Oswal Securities had expected volume growth to be 4-5% while Sanjay Manyal (ICICI Direct) and Pritesh Chheda (Emkay Global Financial Services) had estimated it to be as low as 3%.

Unlike expectations, domestic business (80% of consolidated revenues) growth stood strong at 16% (better than 7% in June 2012 quarter), but sales growth of subsidiaries (including international business) slowed down to 20% (as expected) compared to past four quarter average of 31.7%.

Though the company has managed to deliver on the topline, profitability has lagged expectations. Operating profit margin has been maintained at 14.5% year-on-year, as against analysts’ expectations of an improvement of around 100 basis points due softening of titanium dioxide prices (20% of total raw material) and rupee appreciation in the quarter gone by.

Raw material (adjusted for stock) as percentage to sales remained firm at around 57% followed by other overheads. Despite a lower base (decline of 2.8% in September 2011 quarter), net profit grew by a disappointing 14.5% (Rs 239 crore) as compared to expectations of about 18% rise. This is largely due to interest and depreciation costs shooting up 36% and 19%, respectively.

Going ahead though, analysts expect some relief in the near-term. Says Abneesh Roy, analyst, Edelweiss Securities in his preview note, “We expect the current quarter to see demand pick up due to festive season, rebranding and margin expansion due to stronger rupee and weaker raw material prices.”

But, gains could be restricted as competition has heated up with another Bollywood actor, Katrina Kaif, roped in as brand ambassador of Berger Paints lately, after Shah Rukh Khan (Nerolac). Asian Paints is also reacting to the competitive pressures and is soon expected to launch a new range of products in order to fight volume pressure, which may keep other expenditure (includes advertising expenses) firm. Any rise in crude oil prices is also risk as although the company has passed on the rise in costs to consumers, volumes have been affected. The company had reported a year-on-year decline of two% in volumes in June 2012 quarter, according to Motilal Oswal.

The Asian Paints’ stock, which is up 13% in last six months against 9.5% rise in the Sensex, has underperformed BSE FMCG index, reflecting the impact of macro-economic pressures on household incomes and discretionary spend. However, the stock still trades at an expensive valuation of 32.6 times and 27.6 times FY13 and FY14 estimated earnings, respectively. Any disappointment in the festive season (slower than estimated off-take) should result to a correction.

Says Duggad of Motilal Oswal, “Asian Paints’ current valuation adequately capture the positives, namely strong long-term growth visibility, dominant market positioning, and thought leadership in the paints industry. However, the current macroeconomic environment presents near-term challenges for decorative paints demand.” Also, most of the geographies (Middle East) in the international business continue to see demand pressure, point out analysts. In this backdrop, most analysts are neutral to bearish to the stock.