Asian Paints: Painting the town red - Buy

The government’s push to housing and other growth drivers should help this company

The recent March quarter results of Asian Paints lend confidence to the company’s prospects. Making a recovery from the demonetisation blues of the December quarter, the company registered double-digit volume growth in its mainstay decorative paints business.

This, along with a good show in the industrial and international businesses, helped the company deliver consolidated revenue growth of 9 per cent y-o-y in the March quarter and profit growth of more than 10 per cent. Overall, consolidated revenue in 2016-17 grew 8 per cent to about ₹17,100 crore while profit increased 11 per cent to ₹2,016 crore.

The operating margin fell to about 16 per cent in the recent March quarter from about 17 per cent in the year-ago period, due to increase in raw material costs. For the full year 2016-17 though, operating margin improved to 17.7 per cent from 17.5 per cent in 2015-16.

The Asian Paints stock, recouped almost all lost ground after taking a sharp knock in the wake of demonetisation late last year. The buoyancy in the stock market, good economic indicators and a dip in crude oil price helped.

At ₹1,122, the stock now trades at about 55 times its trailing 12-month consolidated earnings, higher than the average of 52 times it has traded at in the past three years. While the stock is relatively expensive, investors with a long-term perspective can still buy.

The company, as the market leader in paints in the country, should benefit from strong growth drivers in the sector. These include the government’s push to the housing sector, a growing automotive industry, expected growth in industrial output, improving prospects for the farm sector which should aid rural income and benign interest rates that should aid housing demand. These factors should translate into good volume growth for Asian Paints in both the decorative and industrial segments. Also, margins should look up with the company taking price hikes in the recent past. The fall in crude oil price in recent months and the strengthening of the rupee should help to moderate raw material costs.

The company’s ongoing expansion plans should help it cater to expected growth in demand and maintain market leadership position in paints.

Market leader

Asian Paints commands more than half the market share. Its wide dealer network of over 30,000 dealers across India, product innovations and customer outreach, have helped the company retain its leadership in the decorative segment. It is the key contributor (81 per cent) to the company’s revenue.

Revenue and profit grew 6-7 per cent in 2016-17. Growth should pick up with healthy demand potential for decorative paints in both urban and rural markets.

The government’s push to the housing sector through various schemes should mean good demand for paints. Increasing income levels in the country and moderation in interest rates and expectations of a normal monsoon this year should also aid demand.

Repainting will also remain a good growth driver from across target markets such as house-owners, housing societies and educational institutions.

The impending implementation of the Goods and Services Tax (GST) could mean some supply chain disruptions in the near term, but should lead to greater consolidation in favour of organised sector paint players such as Asian Paints in the medium to long run.

The international business that accounts for about 13 per cent of the company’s revenue is also on a strong footing. Asian Paints is among the largest players in 11 of 19 countries.

In 2016-17, revenue from international business grew more than 7 per cent while operating profit grew more than 19 per cent. This was driven by contribution from Nepal, Jamaica, Fiji, Oman and Bahrain.

The company has completed the construction of a greenfield plant in Indonesia and acquired Causeway Paints, a key player in the Sri Lankan paints market. While some international markets such as Egypt and Ethiopia remain challenging, the overall outlook seems positive for the business.

The industrial segment that contributes about 4 per cent of revenue, is also doing well. Sales in the automotive and general industrial business paints category grew about 15 per cent in 2016-17. Other categories such as industrial liquid paints and powder coatings too saw double-digit revenue growth. Expansion in auto and industrial output should translate into growth opportunities for this business.

The home improvements business (home decor and bath fittings) contributes under 2 per cent of revenue and is loss-making currently. But the segment has good growth potential in the coming years with network expansion and captive customer base. That said, it is unrelated to the core paints business and progress needs to be watched.

Expanding capacity

Asian Paints is setting up two new paint plants at Visakhapatnam (5 lakh kilolitres per annum) and Mysuru (6 lakh kilolitres per annum) at an outlay of about ₹4,000 crore. The plants will come up in phases depending on the future demand conditions. Currently, the company has total capacity of approximately 1.1 million kilolitres.

Crude-oil derivatives such as titanium dioxide form a chunk of the raw material cost of paint makers. The crash of crude oil since 2014 reduced this cost significantly and aided the margins of paint companies, including Asian Paints.

Oil prices rallied in late 2016 due to output cut deals among major producers, but has dipped again in recent months (about $50 a barrel currently) with increase in supplies. Oil should be in the $45-$60 range a barrel due to global demand-supply adjustments.

This should be a comfortable range for paint makers. Besides, Asian Paints has good pricing power as indicated by the recent price hikes (about 3 per cent each in March and May 2017) to make up for cost increases and help the company improve margins. Also, with the company slowly shifting to solvent-based paints dependence on crude oil will aid cost control. The company has a strong balance sheet with low debt.

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