Asian Paints scrip loses some lustre

However, analysts bullish on foray in other home decor segments, besides its paints business, from a longer-term perspective

Lower volume growth, higher employee expenses and input cost inflation, with a marginally higher tax rate, pulled down Asian Paints’ results for the December 2013 quarter. Consolidated net sales of Rs 3,413 crore and net profit of Rs 329 crore were lower than Bloomberg consensus estimates of Rs 3,487 crore and Rs 381 crore, respectively. The Ebitda (earnings before interest, taxes, depreciation and amortisation) margin was 14.6 per cent, down 172 basis points over the December 2012 quarter. It accounted for Rs 21 crore in income towards a value added tax refund from the Maharashtra government on its Khandala plant’s goods and expects such flows to continue.

Analysts believe the stock could fall on Tuesday in reaction to the weak numbers, declared after market hours on Monday. At the closing price of Rs 490, it traded at 31.2 times FY15 estimated earnings, near the upper band of its historical one-year forward price to earnings (PE) band of 15-35 times.

Of the 14 analysts polled by Bloomberg since December 2013, seven have a ‘Hold’, four have a ‘Sell’ and three a ‘Buy’ rating on the stock. Their average target price of Rs 479 indicates a downside of about two per cent from current levels. However, most analysts remain positive on the long-term prospects, given its strong brand and leadership position. They believe any correction would provide a good entry point in the stock.

Volumes, margins weak
The key disappointment was the lower than estimated volume growth (of seven tomeight per cent) in the decorative business, versus the expectation of 10 per cent growth, beside continuing weakness in the industrial paints segment. Notably, Asian Paints had maintained volume growth of 10-12 per cent in the first half of this financial year. The lower growth this quarter can be attributed to two factors — the high base effect of the December 2012 quarter (when volumes rose 13 per cent year-on-year) and the workers’ strike at its paint plant at Sriperumbudur, Tamil Nadu (about 15 per cent of overall capacity), from December 20. The company plans to meet the demand by utilising capacity from other plants. The management expects to maintain double-digit volume growth in the decorative segment this financial year.

In a post-results call, the management indicated it continued to witness strong momentum in rural demand, given a good monsoon. Traditionally, it benefits from higher demand in pre-election periods but early trends this time indicate only marginal pick-up. In international business, the West Asia and Asia have done well, even as Egypt and Bangladesh continue to be impacted by political uncertainty.

Surges in input costs (up 225 basis points year-on-year to 54.1 per cent of sales), employee costs (up 72 bps to 5.8 per cent) and other expenses (up 105 bps to 19.9 per cent) impacted margins in the quarter. While the company did raise prices (about four per cent in FY14 so far) to counter rising input costs, these were taken in the latter part of the quarter. Analysts believe the gains of this rise will reflect in the March 2014 quarter numbers.

“Asian Paints’ staff expenses have gone up both sequentially and over the previous year. While a year-on-year rise is driven by new plant commissioning, it is very difficult to understand the sequential rise. The contraction in consolidated margin was driven by weak performance of the domestic industrial paints segment,”says Abneesh Roy, associate director, institutional equities research, Edelweiss Securities.

Higher employee costs and other expenditure can be partly attributed to commissioning of its Khandala plant in the March 2013 quarter. This led to a 73 per cent rise in depreciation expenses to Rs 63 crore. A higher tax rate (up 167 bps to 31.2 per cent) further pulled down net profit.

Asian Paints is looking at reviving margins via pricing action. It is likely to go for another weighted average rise of 2.1 per cent from February. “The March 2014 quarter’s margins should be better as the benefits of all the price hikes kick in,” says an analyst with a domestic brokerage.

Street positive on diversification
After acquiring Sleek (a modular kitchens company) in 2013, Asian Paints is also looking to enter other home decor segments — tiles, bathroom fittings and so on. These investments could put pressure on its near-term profitability. However, from a mid-term to longer-term perspective, it will enable the company to leverage on its strong brand and drive the next leg of growth. Analysts, too, are optimistic on this front.

“Since no pan-India player is present who provides a one-stop solution for home décor, Asian Paints will be able to create a niche once it diversifies. Expansion in this space will also help leverage its current distribution, providing more solutions to the consumer at a single point of sale,” adds Abneesh Roy.

The company is scouting for acquisitions domestically and internationally, to acquire good companies in the home decor space.  “It is a good strategy to diversify into related areas. Though the diversification will impact profitability in the near term, the decision is in the right direction from a long-term perspective,” says V Srinivasan, research analyst, FMCG, Angel Broking.