Asian Paints: Decline in raw material costs to drive earnings

Street builds in 10% volume growth

Sharp corrections in large-cap stocks don't last too long. After hitting a life-time high of Rs 922 in January, Asian Paints fell till last month. The stock has recovered from those levels, more so after its June quarter numbers beat estimates.

Analysts believe given the sharp run-up, returns could be capped in the near term. However, the stock continues to be a consumer discretionary play for investors and its earnings trajectory is expected to remain strong. According to Motilal Oswal Securities, the stock might not rise much in the near term but is a compelling play on reviving urban discretionary demand.

In the June quarter, Asian Paints reported a 7.6 per cent increase in sales on robust volume growth. The company took advantage of the sharp fall in raw material prices and cut prices, which might have impacted its top line but has helped volumes.

Driven by the lower-end paints segment, volumes have grown in the low double-digits. The price cuts in March in this segment could have been to take on unorganised players. As a strategy, this seems to have paid off. Consolidated operating income rose 24 per cent and net profit grew 25 per cent over the previous year. The earnings trajectory is expected to continue over FY17.

During the June quarter, gross margins improved 370 basis points (bps) to 45.6 per cent on lower input costs. Higher expenses, however, capped expansion of operating margin, which expanded 240 bps over a year to 17.8 per cent. After adjusting for a one-time income from sale of a property, net profit grew 23 per cent, again ahead of estimates.

Though the company remains cautious on demand, the Street estimates 10 per cent volume growth over FY17 and a compound annual growth rate in earnings of 24 per cent on low raw material costs. Kotak Securities believes one major positive is the benign raw material environment.