Easing material costs to aid Pidilite margins, near-term pressures weigh

Upsides from current levels may be capped due to higher valuations

Pidilite Industries posted a weak operating performance in the September quarter as it was weighed down by multiple headwinds. Though raw material costs have come down, there could be near term pressures on profitability given higher priced raw material stocks.

The company reported a 440 basis points y-o-y gross margin contraction in the September quarter as it was weighed down by rising cost of inputs, unfavourable currency and high cost inventory.

Raw material costs as a percentage of sales, according to the company, wwere up 436 basis points YoY and 74 bps sequentially. Improved product mix and pricing action helped restrict the gross margin impact QoQ to 70 bps.

On the demand front, the company indicated that it is on the softer side with inflation impacting consumption. It reported a consolidated topline growth of 15 per cent YoY, aided by price hike and better mix. While urban markets are doing better than rural, consumer sentiment remains weak. The positives, according to the company, are softening of commodity costs, a good monsoon and pick up in construction activity.

While the street will keep an eye on demand, the impact of a raw material price volatility will also be tracked. Operating profit margins for Q2 was down 433 bps to 16.6 per cent with operating efficiencies helping it to restrict the fall. Going ahead, the price movement of key raw material vinyl acetate monomer (VAM) will be critical. From $2,491 a tonne in Q2FY23, VAM prices have halved to $1,200-1,400. The company could see some improvement in margins in the current quarter as other raw materials have yet to see as much correction as VAM.

Motilal Oswal Research, however, expects margins to recover only in Q4FY23. Says Krishnan Sambamoorthy and Aditya Kasat of the brokerage, “While the acquisition costs of VAM have nearly halved in the past few months, considerable high cost inventory, impact of rupee depreciation and no major reduction in other raw material costs mean that gross and operating profit margins now appears likely to recover from 4QFY23 onwards.”

While the analysts expect a healthy earnings growth over the next year they have assigned a neutral rating to the stock as steep valuations more than discount this growth with little upside from current levels.

Edelweiss Research has cut its FY23 and FY24 earnings estimates by 4-7 per cent. Soft demand conditions, high-cost inventory, raw material inflation and weaker rupee underlie margin and profitability deterioration, say analysts led by Abneesh Roy of the brokerage.

Given the demand worries, near term uncertainty on margins and valuations, investors should await a better entry point into the stock which is quoting at 69 times its FY24 earnings estimate.