Anubhav Sahu Moneycontrol Research
The quarterly performance of Asian Paints beat expectations, particularly on the topline front. Decorative volume growth rebounded but this was lower than what was reported by its peer Kansai Nerolac. While post GST transition, sales have picked up towards the end of Q2, inventory levels are still below normal levels. So, investors need to watch out how end market demand picks up from hereon. Elevated raw material prices are expected to weigh on margins in the near-term.
Quarterly result update
Asian Paints Q2 2018 consolidated sales (+15 percent YoY) was ahead of Street expectations aided by price hikes earlier in the year and high single digit volume growth in the domestic decorative paints business. EBITDA margin contracted by 23 basis points (YoY) on account of higher raw material prices, partly offset by lower employee cost. Further, higher interest expense and lower other income led to lower pace for net profit growth (8 percent YoY).
Titanium di oxide pricing pressure continues
Raw material prices (59 percent of Q2 2018 sales vs. 57 percent in Q1 2018) have edged higher on account of a rise in prices for both crude derivatives (solvents) and titanium di oxide (TiO2), drawing a similar take as witnessed by Kansai Nerolac. We noted in our earlier article that supply constraints in the TiO2 market along with a spike in raw material costs (petcoke and Ilmenite/rutile mineral ores) would keep the TiO2 prices firm. This remains a key factor to watch out for in the near future.
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Volume growth
Though company posted a rebound volume growth (8 percent vs 2 percent in Q1 2018) for the domestic decorative paints business, it is way behind the volume growth posted by its peer Kansai Nerolac (20 percent volume growth in the decorative coatings). Having said that management asserted that in the areas they are operating they have not lost market share. The automotive coatings JV, however, witnessed subdued demand from auto OEM while performance of industrial coatings JV was satisfactory.
GST transition and restocking
Management noted that majority of the dealers have already migrated to GST network and hence a major part of GST transition is over. Industry-wide restocking was visible mainly from the month of September which was also aided by the early onset of festive season. However, dealer-level inventory is still below the normal levels.
International operations
The company reported that currency devaluation in Egypt and unavailability of forex in Ethiopia impacted international operations.
Home improvement and adhesives businesses
The home improvement business of Asian Paints (~ 1 percent of Q2 2018 sales), though a miniscule part of overall business could be an important diversifier in future. However, recent performance has not been encouraging particularly on the EBIT front (loss of Rs 7.8 crore in Q2 FY18 vs. loss of Rs 3.3 crore in Q2 FY17) mainly on account of GST transition. Similarly, its recent foray into adhesives business (effectively pilot level) is another strategic step that needs to be closely monitored.
Capacity expansion
The company has budgeted Rs 1200 crore for the FY18, of which Rs 1000 crore would be for the greenfield expansion at Mysuru and Vizag. New plants are expected to commission by FY19.
Elevated valuation
Going forward, near-term factors to watch out for the company is volume growth, particularly in the automotive sector and raw material cost pressure. Any traction from company’s diversification initiatives would be interesting to look at as the urban discretionary spending improves. However, the stock is currently trading at 45x 2019e earnings which doesn’t provide valuation comfort, in our view.
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