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ASIAN PAINTS 2QFY11: Below est; Volume to bounce back in 3QFY11; Recent valuation correction offers entry opportunity; Upgrade to Buy
Asian Paints (APNT IN, Mkt Cap US$5.3b, CMP Rs2503, Buy) 2QFY11 results are below estimates. Key highlights:
- Net sales grew 5% to Rs18.1b (est Rs20.5b); we estimate volume to be flat YoY.
- Lower volume growth was due to (1) Prolonged monsoon affecting paint demand, (2) Diwali being in 3Q this year (vs 2Q in FY10), and (3) dealer stocking in 1QFY11.
- Gross margins expanded 50bp YoY to 43.7%, led by lower input cost and strong pricing power; QoQ margins are up 100bp.
- EBITDA margin contracted 40bp YoY to 18.3% (est. 18%); other expenditure increased 100bp on account of lower volume growth.
- Standalone 2QFY11 sales grew 6% to Rs14.7b, EBITDA margins contracted 40bp to 19.6% while standalone Adj PAT grew 6% to Rs1.9b.
Decorative paint volumes flat in 2QFY11; likely recovery in coming quarters
- 2QFY11 standalone sales grew 6% on back of pricing led gains; we estimate volumes to be flat YoY.
- Management indicated that volume deceleration was on account of (1) Prolonged monsoon affecting paint demand, (2) Diwali impact being in 3Q this year (vs 2Q in FY10), and (3) dealer stocking in 1QFY11, presumably in anticipation of subsequent price hike.
- Demand was robust in July, though Aug-Sep sales were impacted on account of monsoons. Demand in Tier II and rural markets continued to be ahead of the market, while Emulsions and Enamels grew ahead of the Distemper range.
- We believe volume growth would recover during the course of the year on account of Diwali sales falling in 3QFY11, and post-monsoon demand catch-up.
- The company believes the 8.1% price increase (made during May-August, including by competitors, albeit with a lag) has been fairly absorbed by consumers, and the 2QFY11 deceleration in volume growth is more of a timing issue.
- We believe decorative paints remain one of the best play on the uptick in consumption sentiment; rise in new constructions, increasing aspiration for higher value-added paints (enamels), and the trend of shortening painting cycle instill confidence of a sustained mid-teen volume growth.
- Strong visibility of volumes has resulted in Asian Paints continuing its streak of capacity addition. In addition to the 150,000KL augmentation in the Rohtak plant, Asian Paints has purchased land in Maharashtra for greenfield capacity of 3,00,000KL (all emulsion range), which is likely to be operational in 4QFY13.
- Industrial and Automotive paints demand has recovered in 1HFY11 on back of strong automotive demand and onset of industrial capex cycle.
Input costs index up 12.4% from FY10 average; 8% price hike offset RM pressure; significant margin pressure unlikely
- Consolidated gross margins expanded 50bp YoY to 43.7%, as price hikes and mix improvement offset the impact of higher input cost and excise burden.
- EBITDA margins contracted 40bp to 18.3% on account of higher other expenditure (up 100bp YoY) on account of lower volume growth.
- Input cost index for Asian Paints (domestic business) increased 12.4% from the FY10 average on account of higher prices of Titanium Dioxide and other oils.
- Asian Paints have over the past 4 months have taken 3 prices increase (totaling 8.1%) which we believe offsets the current input cost pressure. We also highlight that price increases have been taken by competition as well, ruling out any price led competition in the category.
- We believe margins are unlikely to contract significantly going forward; we model 50bp margin contraction in FY11 (vs 90bp earlier) and 10bp in FY12 (flat earlier).
International business performance under pressure; Middle East profitability declines 26%
- International business reported growth of 2% during 1HFY11, while EBIT declined 16%.
- Middle East region was adversely impacted due to slowdown in Dubai and Bahrain while south Asia and Egypt maintained strong growth.
- 1H EBIT declined 40% in Caribbean and 26% in Middle East region. We note that Middle East accounts for 2/3rd of profits in this region.
- Mgt indicated that Middle East region will report pressure in sales and profits for coming few quarters due to slowdown in demand and investments behind color world and capex plans.
Volume growth to bounce back in 3Q; input prices and competitive activity unlikely to dent medium-term margins; Upgrade to Buy
- We expect decorative paint volumes to bounce back in 3QFY11 due to strong consumer sentiment in Diwali season. Industrial Paints demand is also expected to perk up with a lag as the industrial capex has started picking up. Automotive paints demand is also likely to remain robust. International sales however will remain under pressure, more so in Middle East and Caribbean region.
- Asian Paints has undertaken 8.1% price increase which more than covers the increase in input costs and excise duty burden. We are factoring in 50bp decline in EBITDA margins in the current year; margins have declined by only 20bp in 1HFY11 despite poor volume growth. We see upside risk to our estimates if the input costs don’t increase from the current levels in any significant manner.
- We note that MNCs like Sherwin Williams, Akzo, Kansai and Nippon have upped the ante in view of huge growth opportunity in the Indian market. Nippon has recently entered Mumbai and North India and Akzo is also expanding and revamping its distribution. However we believe that the impact of such aggression will be reflected in increased ad spend in the near term and material impact, if any, would take at least a couple of years due to entry barriers like distribution and brand.
- Asian Paints has corrected by 15% from its recent highs. This price correction has made valuations attractive for the sustained growth opportunity that it provides. The stock trades at 21.6x FY12 EPS of Rs116.
- We upgrade the stock to Buy with 12-month target price of Rs2,899 (25x FY12E EPS).
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