Asian Paints - future perfect; visit note; Buy::Edelweiss

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Asian Paints (APNT IN, INR 2,520, Buy)

n  Demand outlook positive for decorative paints; Q2FY11 an aberration

With higher disposable income, increase in discretionary spending and paints being a leveraged play on Indian GDP (as per management, decorative volumes grew 1.5-1.7x GDP), we expect Asian Paints to benefit the most as it is the market leader (with 50% plus market share) in decorative paints. Demand for decorative paints is likely to remain lustrous, courtesy Indian media. With 26 mn DTH subscribers and incremental 10-12 mn new subscribers being added annually, brand awareness for paints is steadily rising, especially in the media dark interiors of the country. The management has an unambiguous focus on topline and increasing market share with reasonable margins. We, therefore, estimate the company to achieve 13-15% CAGR in volume over the long term.

n  Ad spends rise owing to increasing competition

Competitive intensity has amplified with the entry of foreign players like Nippon Paint, Jotun and Sherwin Williams in India and increased ads by Nerolac, Berger and ICI (Akzo Nobel). We expect A&P spends to rise, going forward, on account of higher competitive intensity and ad rate inflation. As for Asian Paints, A&P is likely to remain in the range of 3.5-4% of sales, but the management will continue evaluating the competitive landscape.

n  Margins to stabilise gradually; FY10 margins abnormally high

In FY10, due to steep raw material correction and rupee appreciation, Asian Paints generated abnormally higher margins (EBITDA margin of 18.4%). However, in the past two quarters, input prices have increased sharply. To counter this, the company is likely to increase paint prices by further by ~3% w.e.f. December 2010; it had already increased prices thrice before, by 4.15% on May 01, by 2.6% on July 01 and 1.2% on August 01. We believe the abnormally high margins of FY10 are unsustainable and are likely to stabilise gradually at their historical range of 15-17% over the longer term.

n  Outlook and valuations: Positive; ‘BUY’

Asian Paints has a dominant market share, is a leveraged play on GDP and domestic consumption which provide significant demand upsides. However, margins are likely to contract gradually over the years. With the management highly focused on increasing volumes and servicing customers, the company’s outlook is promising. We maintain ‘BUY/Sector Outperformer’ on the stock.