We are not changing our position on Asian Paints, see no reason to worry: Marcellus’ Rakshit Ranjan

He reaffirmed Marcellus’ and its celebrated founder Saurabh Mukherjea’s long-held stance that in the long term or over three to five years, stock price compounding mirrors free-cash flow (FCF) compounding. “We expect Asian Paints to maintain its historical run rate in FCF, so the stock price compounding will match that,” he said. Asian Paints’ FCF, like other stocks in Marcellus’ Consistent Compounder Portfolio, has seen around 25 percent CAGR for the past 20 years, according to Ranjan. 

But right now, Ranjan said that they are really looking at the fundamentals of the company and if that will be affected by Grasim’s plans. They see no reason why they would be affected in the next two to three years. 

Also read: Jefferies maintains underperform rating for Asian Paints

Asian Paints' biggest strengths are delivering high inventory turns and its demand forecasting ability, which makes its high inventory turns possible. He does not see Grasim developing both in the next few years. 

“Paint is a voluminous product. Asian Paints sells it through 1.5 lakh dealers without intermediaries. The end dealer does not make more than a low single-digit margin (approximately 5-7 percent). For the end dealer to make a return on working capital and fixed-asset investment, the dealer will need high inventory turns. In any industry, this would be possible to deliver, but in the paints industry, it is extremely difficult for two reasons,” he said.

“One the inventory turn needs to happen directly (at the retailer’s end) without a wholesaler or a distributor. If a company brings in a wholesaler or a distributor, and Grasim will probably have to bring them in, it will eat into their unit economics. Secondly, even if the company is willing to take a hit on its unit economics because it has a large balance sheet, it must have an incredible demand-forecasting ability to deliver (on inventory turns). Otherwise, the working capital drag for a voluminous product can be very, very high,” he said.

“It can hit the company’s working capital really hard, if demand forecasting doesn’t drive inventory turns because margins are very very thin here,” he added. Asian Paints’ demand-forecasting ability has a long history. It invested in a supercomputer in the early seventies and has since been collecting data on purchases across geographies, and this helps it predict what product will sell well and where. 

Won’t a large company like Grasim be able to beat down the prices? Pricing is less important in this industry than delivering inventory turns, said Ranjan. “Customer relies on the painter’s recommendation, the painter recommends based on what is readily available with the dealer and the dealer stocks what delivers the highest inventory turns,” he said. A price difference of 5% does not matter much to the customer nor the dealer, he said. 

True, Grasim may be able to develop these capabilities–of delivering better inventory turns and demand-forecasting ability–in several years but certainly not overnight. “Then the question is if Asian Paints will remain today’s company or will it be one with a deeper competitive advantage or one with a bigger barrier to entry,” he said.

Marcellus sees Asian Paints as evolving far beyond a paints company by adding more products, and moving beyond products and adding services as well. “We expect a healthy cash flow compounding, like it has delivered in the last 5 to 10 years,” he said.

The worst case scenario would be if the management loses focus. “Then things can go downhill pretty quickly. We don’t see that happening (at Asian Paints),” he said. 

“In the long run, we expect the management to be agile, awake and fanatical about deepening their capabilities. If we see the management not doing all this, becoming complacent, losing their focus, then we will take corrective action,” he said.