Further gains in Asian Paints may be gradual

Asian Paints' good performance in the quarter ended December saw its stock gain 2.4 per cent to close at Rs 4,400 on the BSE on Tuesday (the Sensex fell 0.6 per cent), adding to its outperformance since the beginning of 2012. While the company's prospects remain healthy, with raw material costs slipping and demand expected to rise, competition remains stiff. Stock valuations aren't cheap and analysts believe for further gains, the company would have to sustain its performance.

During the December quarter, the company saw a rise in sales, as well as margins. While the 19 per cent growth in consolidated sales was higher than 15 per cent reported in the first half of FY13, softening of titanium dioxide prices boosted the operating profit margin (16.7 per cent) by 102 basis points. A jump of 92 per cent in other income, along with lower effective tax rate, helped the company report its highest profit growth (30.4 per cent) in three quarters.

Volumes in the domestic market (decorative paints), which account for 83 per cent of the company's consolidated revenues, rose on account of the festive season. Analysts estimate it at 7-10 per cent, compared with five per cent in the quarter ended September. Overall sales growth would have been higher, had poor demand from the projects business and a slowdown in the original equipment manufacturers space not hit the industrial paints segment.

At 103, the company's raw material price index in the quarter was lower than 108 in the September quarter, as the prices of titanium dioxide (a key raw material) fell five per cent; it is 20 per cent off its peak level. Raw materials, as percentage of sales, fell 110 basis points year-on-year to 59.7 per cent. The softness in titanium dioxide prices is expected to continue in the near term, say analysts, adding the rupee has to remain stable for further gains. Given the stiff competition, overall gains would also depend on the trend in advertising costs.

BRIGHT FUTURE
In Rs crore	Q3’FY12	FY13E	FY14E
Revenue	3,053	11,348	13,375
Y-o-Y change (%)	19.0	17.8	17.9
Operating profit	511	1,856	2,252
Y-o-Y change (%)	26.7	23.1	21.4
Net profit	335	1,210	1,469
Y-o-Y change (%)	30.4	22.3	21.4
EPS (Rs)	35.0	126.0	153.0
PE (x)	-	35.0	28.8
Note: Figures are consolidated numbers Source: Company, Analysts estimates

Overall, analysts expect better times for Asian Paints. The company may opt for price cuts in the event of continued softness in raw material prices (given there were no rises in the December quarter). This, along with an expected drop in inflation (leading to higher demand for discretionary items like paints), should boost volumes further and improve sales growth. Increasing focus on high-yielding water-based emulsions (45 per cent of sales) should also support margins. Commissioning of the company's Khandala plant in the current quarter, however, would increase depreciation costs. But this would provide a leeway on the volumes front. Some analysts remain sceptical of significant gains from here.

In his post-results note, Aditya Mathur, analyst, Citi Research, said, "It is still early to call a recovery in demand in the context of a relatively slow economy. Moreover, price cuts/discounts could offset some of the potential commodity costs gains. Competition is tougher and margin gains are likely to be more modest."

Amrita Basu, analyst, Kotak Institutional Equities, said, "Operating profit margin is likely to remain well below the peak of FY10."

The market seems to have factored in near-term positives, as the stock trades above its average one-year forward price-to-earnings target multiple of 27-28 times, and higher than its five-year historical average of 23 times. Therefore, the upside in the stock may be gradual from here, provided the good show sustains.

Mathur is cautious. He feels valuation makes risk-reward unfavourable. According to Basu, justifying higher-than-sector average valuation multiples is challenging.