Asian Paints - Seasonal impact on sales provides opportunity to ADD :: Kotak Sec

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Asian Paints (APNT)
Consumer products
Seasonal impact on sales provides opportunity to ADD. Headline sales were
disappointing as impact of seasonality was high in 2Q, (1) higher number of rainy days
this year versus drought conditions last year, (2) likely trade down-stocking and (3) late
Diwali this year (Nov 5) versus last year (Oct 17). EBITDA margins were broadly
maintained; gross margin expansion (which could have been even higher but for rains
impacting exterior paints disproportionately) helped limit the impact of higher SG&A.


Seasonality impacts sales and margins higher than expected
APNT reported lower-than-expected standalone net sales of Rs14.7 bn (+6%, KIE Rs16.1 bn),
EBITDA of Rs2.9 bn (+4%, KIE Rs3.1 bn) and PAT of Rs2 bn (+6%, KIE Rs2 bn).
In our view, the volumes have likely declined ~2% during the quarter and pricing/mix growth of
8%. While the headline sales were disappointing, impact of seasonality was high during the
quarter, (1) higher number of rainy days this year versus drought conditions last year, (2) likely
trade down stocking and (3) late Diwali this year (Nov 5) versus last year (Oct 17). Price increases
by APNT and competition in 1HFY11 indicates industry’s intention to defend the gross margins, in
our view (Akzo Nobel has followed APNT’s price increase in October 2010).
Gross margins expanded 50 bps to 44.7% as price increase of ~8% in 1HFY11 was marginally
ahead of input cost inflation of ~12%. We highlight that APNT is witnessing a secular
improvement in mix as well (uptrading to emulsions). EBITDA margin for the quarter was broadly
maintained – at 19.6%. The EBITDA margin performance of APNT is commendable considering
that Cenvat was hiked by 2% in March 2010 (APNT is a full tax paying company, do not operate
in fiscal benefit zones) and the company has faced input cost inflation in TiO2.

Two related industry trends – peak margins likely leading to higher competitive activity
􀁠 Rationale for rational competition despite industry operating at peak margins
We see rational competition in the industry as the competition has lost market share to APNT,
which has the best gross margins in the industry. However, increasing innovation and activation
spends by competition could warrant higher marketing spends for APNT (which could accelerate
market growth by encouraging a further decline in repainting cycle). We believe that competition
is still rational, however, potential pricing action by the competition in lower-end enamels cannot
be ruled out. However, we highlight that in top-end emulsions, APNT faces little risk as price
differentiation is not a critical decision making factor for the consumer.