Falling raw material costs to aid margin expansion for Asian Paints

The country’s largest paint company, Asian Paints, is expected to be a twin beneficiary of higher sales volumes and improved profitability in the near term. Demand, which has been steady, is expected to see an increase in the festive season while margins should firm up on the back of declining raw material costs. Some of the optimism is reflecting on the stock prices of the paint maker which has registered a gain of nearly 5 per cent over the last six trading sessions, amidst a correction in both -- the benchmarks and the broader markets.  

The near term trigger for the stock is the recent fall in crude oil prices to their 9-month low. Since the start of September, oil prices have declined by 20 per cent. Titanium Dioxide (TiO2), which is a crude oil derivative, is the key raw material for paint companies.

Say Sanjay Manyal and Hitesh Taunk of ICICI Securities, Retail Equity Research, in a report earlier this month, “Asian Paints and Pidilite Industries are the key beneficiaries of the recent fall in titanium dioxide (TiO2) and vinyl acetate monomer (VAM) prices. TiO2 prices have softened by 10 per cent from their peak in March 2022 while VAM prices saw a sharp dip of about 25 per cent in August 2022 over its average prices for the first quarter of the 2022-23 financial year (Q1FY23). While Q2FY23 will see the impact of high cost inventories, the operating profit margin recovery will kick in from Q3FY23 onwards, supported by softening of raw material prices.”

Given the trajectory of crude oil prices, the gains would be even higher than the estimates mentioned here.

The brokerage has revised its operating profit margin estimates for Asian Paints and Pidilite Industries upwards by 60 basis points (bps) and 200 bps year-on-year (YoY) respectively for FY24. Gross margin in the June quarter for Asian Paints was at 37.7 per cent, down about 100 bps YoY. The management had indicated a 38-40 per cent range for the metric in the near term given macro uncertainties.

Despite the raw material pressures, the company posted a 172 bps expansion in operating profit margins as compared to the year ago period, given operating leverage benefits. The company had reported a 37 per cent YoY decorative volume growth which helped push overall sales growth by 54 per cent. Sales and decorative volume growth, even on a three-year-period have remained strong at 19-20 per cent.

Demand (and pricing power) continues to remain strong as paints was one of the few segments within the discretionary category to have reported a strong volume growth of over 30 per cent. This came despite more than 20 per cent increase in prices as both decorative and industrial paints reported strong momentum, say analysts at Prabhudas Lilladher Research.

In addition to pricing power contributing to higher sales growth, most brokerages expect the revenue trajectory to sustain going ahead given triggers such as rising demand for branded paints, dealer additions, higher traction in Tier-2 and Tier-3 cities, and shorter repainting cycles.

While there are multiple positives for the company, valuations at over 59 times its FY24 earnings estimates factor in the near term gains. Investors can consider buying the stock on dips.