Asian Paints needs fresh coat as margin pressures build up in markets

As competition intensifies, brokerages turn pale on paint maker's stock

A weaker-than-expected sales performance, concerns about higher competitive intensity in the current year, and earning cuts by some brokerages have weighed on the stock of the country’s largest paint maker, Asian Paints.
 

While the Q3 volume show was slightly below expectations, the company’s operational and bottom line beat estimates, benefiting from the falling raw material costs. The stock ended the day with a decline of over 2 per cent at Rs 3,175 apiece.  The company reported a decorative paints volume growth of 12 per cent over the year-ago quarter, which was marginally below brokerage estimates and was led by double-digit expansion in the rural and urban markets.
 

While the growth was supported by an extended festive season, the company highlighted that the benefit was offset by demand moderation in the second half of the quarter. The growth in decorative paints helped the company achieve a sales growth of 5.2 per cent year-on-year (Y-o-Y). What weighed on the sales was a price and mix decline of 650 basis points (bps). While a price cut impact was 130 bps, an adverse product mix accounted for 400-500 bps on the back of downtrading and higher sales of economy products.

 

Motilal Oswal Research points out that sales have been sluggish due to price reductions and an unfavourable mix (low premium segment sales). 
 

Lower input costs helped the company post a healthy standalone gross margin of 43.6 per cent, the best in the last 11 quarters. The 550 bps Y-o-Y improvement in the metric was driven by growth in luxury products and the softening of raw material prices as well as operational efficiencies. The operating profit margin expanded 390 basis points Y-o-Y to 22.6 per cent and was on the back of gross margin improvement.
 

The company has reiterated its medium-term target for the metric at 18-20 per cent.
 

Kotak Research says that the standalone operating profit margin was robust and was similar to the pre-pandemic peak and better adjusted for product mix deterioration. Analysts led by Jaykumar Doshi of Kotak Research, however, remain cautious on the stock given the deceleration in underlying demand and potential impact of Grasim’s launch on industry profitability. This would likely result in negligible FY2024-26 earnings per share growth, says the brokerage. 
 

Prabhudas Lilladher Research cut its FY25 earnings per share (EPS) estimates by 1.2 per cent and FY26 EPS by 1.4 per cent given little scope to improve margins which are at all-time high levels excluding the pandemic year on the expected increase in competitive activity (Grasim’s entry) despite sustained double-digit volume growth expectations.
 

Analysts led by Amnish Aggarwal of the brokerage expects stunted growth in the medium term given near peak operating profit margins, the likelihood of price cuts (1.3 per cent in Q3FY24) and the entry of Grasim in decorative paints in Q4FY24.
 

Valuations at 52.5 times FY26 EPS doesn’t factor in a slowdown in profit growth and an increase in competitive intensity fully, says the brokerage.
 

Motilal Oswal Research remains cautious as the entry of new players with deep pockets and massive commitments to investments may result in a shift in the overall industry’s market share and cost structures. These will be the key monitorables in FY25, it said, while adding the paints segment may not enjoy higher multiples of the past.