Pidilite: Margin expansion likely to continue

Volume recovery though will only be gradual

The Pidilite stock has corrected four per cent since the company announced its March quarter results late evening on Tuesday against the Sensex's 0.7 per cent gain. Weak volume growth (three per cent), due to a soft demand environment, coupled with cautious commentary by the management on the road ahead, are key reasons.

Consolidated revenue grew 5.3 per cent year-on-year (y-o-y) to Rs 1,044 crore and was about seven per cent lower than the Bloomberg consensus estimate of Rs 1,119 crore. Net profit, too, at Rs 81 crore (up 10.3 per cent) was 15 per cent lower than the Bloomberg estimate of Rs 95 crore. Not surprisingly, analysts pruned their FY16 earnings estimates by 8-13 per cent, putting further pressure on the stock.

But, even after this correction, the stock trades at 41 times the FY16 estimated earnings, much higher than its historical average one-year forward price/earnings ratio of about 22 times.

Given the backdrop, the stock valuations are rich. Another indicator is of the 13 analysts polled by Bloomberg in May so far. Six have a Buy, five have a Hold and the rest have a Sell rating on the stock. Their average target price of Rs 562 is a mere upside of two per cent from current levels.

In the March quarter, the Ebitda (earnings before interest, tax, depreciation and amortisation) margin expanded 243 basis points to 12.8 per cent, largely due to a decline in the cost of goods sold (down 384 basis points to 53.2 per cent of sales) and price hikes of two to three per cent. The margins could have been higher but for the spike in ad spends. The expenditure incurred here, as a proportion of sales, rose to 6.3 per cent versus 4.2-4.3 per cent historically, due to heightened activity during the Cricket World Cup period. Tax rate also fell to 22.8 per cent from 25.51 per cent a year ago, and aided net profit growth.

Attention needs to be given to slowing top line growth. The consumer and bazar segment, about 80 per cent of revenue, grew 7.7 per cent in the March quarter. The segment has been a key contributor to slowing top line growth, which was 21 per cent in the June 2014 quarter. Such a trend, and despite the high ad spend in the March quarter, paints a grim picture about consumer demand. The industrial chemical segment posted a subdued performance, with a 1.6 per cent decline in revenue to Rs 216 crore, reflected also demand slowdown in both domestic and international markets.

Lower crude oil prices should aid Pidilite's margins, as most raw materials are crude-based. Further, margin tailwinds are likely from a normalisation in ad spends to 4.2-4.3 per cent. The recent acquisition of Nina Waterproofing Systems will fuel growth of Pidilite's waterproofing business. But, analysts believe recovery in overall volumes will only be gradual.