Weak crude and Indonesian foray adds colour to Asian Paints

Domestic biz sees good traction; new geographies, products to propel growth

Asian Paints scrip has significantly outperformed the S&P BSE Sensex since mid-June led by declining crude oil prices. Falling crude oil prices are just one of the positives for Asian Paints which has not just maintained its leadership position in the Indian decorative paints market (about 80 per cent of its revenues), but also managed to increase its volume market share to 54 per cent. Titanium dioxide is a key raw material for paint companies such as Asian Paints and is derived from crude oil. Thus, falling crude oil prices is a key positive. The benefit can be gauged from the fact that during FY05-08, when crude oil prices surged, Asian Paints’ raw material costs as a percentage to revenue had risen to 55-60 per cent from about 50 per cent levels.

The company's plans to set up a paint manufacturing plant at Jakarta, Indonesia is also well-received by analysts. The move will boost international business, which currently accounts for 13 per cent of the company’s consolidated revenues. Analysts believe the firm will launch its Berger brand in the Indonesian market initially and will focus on the mass market there. While competition, both in India and abroad, is rising, Asian Paints’ track-record instills confidence.

The pick-up in industrial paints (following better automobile sales) also means good news for Asian Paints, which expects growth in this segment to better in FY15 as compared to FY14. Its diversification into home improvement segment (modular kitchens, faucets, etc), however, is not well-received by some analysts, who see potential pressure on margin/ return ratios even as many others cheer this move. Other analysts are confident and point to the small capital employed worth Rs 136 crore out of its total capital employed of Rs 3,904 crore in FY14 invested in this business. They also believe the company's diversification adds another growth engine to an already strong core paints business. Company plans to leverage its existing distribution network to cross-sell home improvement products.

In the light of the expected economic recovery and recent events, analysts expect revenue and net profit growth of 17-18 per cent and 20-22 per cent in FY15 and FY16. Ebitda margins are expected to increase by 20-30 basis points in each of these years.

At the current market price, Asian Paints’ scrip trades at 33 times FY16 estimated earnings and at a slight premium to its own historical average one-year forward price/earnings ratio of 31 times. While valuations capture near-term positives, these are at a slight discount to smaller peers.

Most analysts prefer Asian Paints in this sector, given its high brand equity, strong bargaining power, good execution and healthy return ratios, and expect its valuations to catch up with peers. Intensifying competition from peers such as Berger Paints and Kansai Nerolac; a sharp rupee depreciation and rebound in raw material prices are key downside risks. Any delay in macro -economic recovery could also hit the expected gains in volumes.