Impressive June show, but Asian Paints stock on wobbly ground
Premium- Asian Paints saw a solid 37% y-o-y volume growth in its decorative paints business
- But given the rich valuation, the stock may not see a big re-rating despite earnings beat
Asian Paints Ltd, the leader in the decorative paints segment, has put up an impressive show in the June quarter (Q1FY23). Consolidated operating revenue and Ebitda (earnings before interest, taxes, depreciation and amortization) stood at around ₹8,606 crore and ₹1,556 crore, respectively, beating consensus estimates by a mile. Robust volume growth, higher sales of premium products and better operational efficiencies aided the results. Decorative paints volume growth at 37% year-on-year (y-o-y) last quarter is nothing to sneeze at.
But, margin pressure remained. Gross profit margin contracted both sequentially and annually to 37.7%. But investors could get some breather soon. Raw material inflation is expected to ease gradually from the second half of FY23, the management said in the Q1 earnings call. However, near-term gross margins are seen in the 38-40% range and are unlikely to breach the upper end of this band unless the global macroeconomic situation improves significantly, the management added.
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Asian Paints has been on a price hiking spree to curb margin erosion. In FY22, it had raised prices by around 22% and by 2% in Q1FY23. Consequently, the company saw value growth of 59% y-o-y in the June quarter. The company would continue to take calibrated price hikes ahead.
The demand environment is stable, and the company saw faster growth in tier-1 and tier-2 cities compared to tier-3 and tier-4 markets. In the latter regions, the economy paints segment led the growth, while premium and luxury products did well in the former, thereby aiding the overall product mix.
The management expects a normal monsoon to boost consumer sentiment, especially in the tier-3 and tier-4 markets.
Investors’ initial reaction to robust Q1 results pushed the stock up 1.5% intraday on Tuesday on NSE. But the up move fizzled out, and the stock closed on a flat note at ₹3,108.50 apiece.
According to Varun Singh, an analyst at IDBI Capital Markets and Securities Ltd, Asian Paints’ gross margins should start improving in the next few quarters, but since paints is a discretionary play, the stock would reach or surpass its recent high, only gradually. The stock hit a 52-week high of ₹3,590 in January. So far in CY22, the stock has fallen by 8% vis-à-vis the 5% drop in the Nifty50 index.
Further, Singh pointed out that the FY24 price-to-earnings (PE) valuation multiple of Asian Paints is already expensive, so there isn’t much scope for a re-rating despite the earnings beat. Bloomberg data shows that the stock is trading at FY24 PE of 57x.
Grasim Industries Ltd’s entry into the paints sector and the resultant impact on incumbents is a potential risk and a worry for some analysts. “We expect margins to recover from 2HFY23. However, Asian Paints might settle for margins lower than historical (levels) given the expected entry of Grasim in paints," said Amnish Aggarwal, director of research at Prabhudas Lilladher, in his first cut earnings analysis note. While Aggarwal is positive on Asian Paints, he said that a re-rating looks unlikely given premium valuations and likely disruption due to the entry of a large company.
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Meanwhile, the company’s international business delivered double-digit revenue growth in Q1. The management cautioned that its units in Sri Lanka, Bangladesh, Ethiopia and Egypt are facing multiple headwinds and are expected to be under pressure for some time. In addition, investors should monitor the rupee depreciation, which could be a potential dampener for earnings outlook since paint companies import some part of their raw materials.
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