Return ratios to support valuations of Pidilite

Focus on growth in core adhesives business, water-proofing and innovations to aid prospects

Amid expectations of continued softness in input costs, the trend of margin expansion for Pidilite Industries is likely to continue in FY17 as well. Most analysts are factoring in a 100-basis point expansion in this metric in FY17 over FY16. Pidilite had witnessed strong margin gains in FY16 (up 600 bps to 22 per cent), thanks to benign input costs inflation.

Stronger margins, coupled with healthy momentum in earnings, flattish capex and working capital, will aid its return ratios. Avi Mehta, analyst at IIFL, expects Pidilite's return on invested capital (ROIC) ratio to improve from 35 per cent in FY16 to 37 per cent this financial year.

  Strong brand positioning of Fevicol, which is synonymous with the adhesives category in India, is a major positive and enables it to enjoy premium pricing, besides acting as an entry barrier. Recently, paints major Asian Paints entered the category, giving rise to concerns about increasing competitive intensity. The management, however, remains confident, as it is already competing with MNC competitors in this segment. Pidilite has expanded the category meaningfully and has a bouquet of offerings to cater to various user segments, such as carpenters, students, industries, artists, amongst others. The Street though will closely watch Asian Paints' progress, given its strong distribution network and enough financial muscle. However, Pidilite's strong market share of 70 per cent, each in adhesives (Fevicol) and sealants (M-seal), provides some comfort.

Pidilite plans to grow its international business (10 per cent of overall revenue) via acquisitions and is looking to set up manufacturing plants and sales offices in key locations. While domestic demand remains unexciting, Pidilite leadership position enables it to grow at a good pace and management aims to grow its revenues in mid-teens. Consumption demand is likely to get a boost from implementation of wage hikes for government employees, One Rank One Pension and a likely pick-up in urban areas. Pidilite also stands to gain from implementation of goods and services tax (GST), which will aid conversion of unorganised to the organised segment. A GST rate of 18 to 20 per cent will be another positive, given that Pidilite currently pays a combined indirect tax rate of 23 per cent.

Currently, the stock trades at 43 times the FY17 estimated earnings, which seems to adequately capture most positives. However, these valuations are unlikely to come off in a rush, given the strong earnings prospects and expansion in margin and return ratios.