Asian Paints: Risk-reward favourable after correction

Weak demand continues to be a key risk to volume growth in FY16

The recent correction in the market could well be a boon for investors, as several expensive stocks are down from their peaks in January. Asian Paints is down 20 per cent after hitting a life-time high of Rs 922 in January. The stock lost favour after rising 100 per cent through 2014 with valuations getting stretched. Asian Paints is a market leader in the decorative paints segment and derives 85 per cent of revenues from this segment. The company has 57 per cent market-share in decorative paints. While there are no demand triggers yet to drive a re-rating, the company's earnings trajectory could see an uptick as raw material costs are down, thanks to the fall in crude oil prices, even if volume growth remains a challenge in the near-term.

After growing volumes at 11 per cent in the first quarter of FY15, Asian Paints saw volumes decelerate to 4 per cent in the fourth quarter. Over FY11-15, the company's revenues have grown at a CAGR of 11 per cent on the back of 8 per cent volume growth. The volume growth in the first two quarters of FY16 is expected to be similar to the March quarter believe analysts. However, deterioration is likely only in the event of a severe drought. Volume of paints companies tends to grow at 1.5-1.7 times real GDP growth.

Motilal Oswal Securities is factoring in mid-single digit volume growth for the next two quarters, but forecasts a double-digit growth in 2HFY16 -- aided by a pick-up in demand and benign base (volume growth in 2HFY15 was 3.5 per cent). ICICI Securities believes an economic recovery and focus on higher infra spending would lead to 11.5 per cent volume growth and moderate revenue CAGR of 14 per cent over FY15-17.

The company is taking several measures to expand distribution and reach through experience stores like Ezycolour stores.

Asian Paints has also launched new products like enamels, putty, besides other homecare products.

Most analysts are building in an improvement in earnings growth, even though demand conditions remain weak. Although demand growth has slowed, IIFL believes, a fall in input costs should aid margin expansion and offset 2 per cent price cut in February, which would drive earnings growth of 24 per cent a year over FY15-18. Asian Paints exited FY15 with an operating margin of 15.8 per cent.