Asian Paints' volume growth suggests demand is back

Improved demand trends, price hikes to aid profitability, which was a bit under pressure in Q4

A strong recovery in volume growth in the domestic decorative paints business from demonetisation blues was a key highlight of Asian Paints’ results for the March 2017 quarter (Q4). After growing between 11 and 15 per cent in the previous four quarters (see chart), volume growth decelerated sharply to two per cent in the December quarter due to demand softness caused by the cash crunch arising because of the note ban. For Q4 as well, analysts were expecting this metric to grow four-eight per cent. But, the metric has come at an estimated 10 per cent, reflecting the strength in consumption demand. Strong rebound in volumes, though, was accompanied by some softening of realisations as well as lower growth in international revenues, which in turn led to a year-on-year (y-o-y) growth of 7.8 per cent in consolidated revenues to Rs 3,952 crore, lower than the Bloomberg consensus estimate of Rs 4,210 crore. 

Rising input cost inflation had a bearing on the company’s Ebitda (earnings before interest, tax, depreciation and amortisation) margin, which contracted 100 basis points to 18 per cent in the quarter. Though the company took some price hikes in March, the full impact of this step will trickle in the current quarter. Higher other income, lower interest costs accompanied with significant savings in tax expenses, aided net profit, which grew 10.4 per cent y-o-y to Rs 462 crore and was in line with the Bloomberg estimate of Rs 460 crore. 

The pressure on margins, though, seems to be a passing phase. Analysts believe the company will be able to pass on higher input costs and protect its margins. Prasad Deshmukh, analyst at Bank of America Merrill Lynch, did a pan-India dealer check recently and came out positive. “Optimism at the dealer level is almost back to pre-demonetisation level. While Asian Paints has increased prices for decorative paints by about 3.5 per cent in March, we expect further price rises in the coming months to protect margins,” he said.

Adding to the domestic revenues, the company’s home improvement business, comprising the Ess and Sleek acquisitions, grew 18-19 per cent. Both these businesses, however, are in investment mode currently and their break-even will aid overall profitability as well.

While the domestic businesses are improving, there was some pressure abroad. In Q4, growth in Asian Paints’ international business lagged due to weakness in Egypt (due to currency devaluation) and Ethiopia (shortage of raw materials) markets.

Going forward, improving demand in the industrial paints segment will support the already strong momentum in the decorative paints segment. Implementation of goods and services tax (GST) will be a long-term positive for paint companies such as Asian Paints, as they can garner share from the unorganised players. The potential here is phenomenal given that the unorganised sector forms about a third of the domestic paints market. Asian Paints’ strong distribution network, leadership position, brand recall and healthy financials are other reasons why analysts remain positive on the stock.

The only possible hitch for investors is the stock’s valuations. At current levels, the Asian Paints scrip trades at 48x FY18 estimated earnings which is much higher than its historical average one-year forward price to earnings ratio of 30x. Investors can, thus, wait for a better entry point in the stock.