We move Asian Paints to ‘buy’ from ‘hold’ as we now find valuation to be in a reasonable zone after two years of near-zero return. The stock price has swung from its 52-week high of Rs 1,467 on the day of its 1QFY19 results to near 52-week low level post a 5% fall on Wednesday, in possibly a reaction to a weak 2QFY19 earnings report, due in part to some once-off factors that impacted the quarter’s profitability.
We are quite confident, though, that margin performance going forward will be much better vs 2QFY19’s, given elements of constraint (deferral of price-hike to avoid attracting anti-profiteering provisions) and once-off rebating (on transition stocks at the time of GST rate cut) present in the latter — issues that are unlikely to repeat soon.
The industry construct remains as attractive (our proprietary framework built to analyse volume drivers backs our conviction that the organised Paints industry in India has the potential to deliver a 10%+ volume CAGR over the next decade) and target valuation no longer needs to be in the 50x zone to deliver an acceptable return vs CMP. Our 12M forward TP of Rs 1,380/share is based on 45x Sep’20 EPS — we see 22% total upside.
Consolidated revenue grew 8.5% to Rs 4,640 crore, but EBITDA and adjusted net profit declined 2.1% and 3.1% to Rs 780 crore and Rs 490 crore, respectively. Against a 3.5% hike in prices, reported financials suggest that net realisation instead declined 1.5% (volumes grew in low double-digit) – hinting at severe mix deterioration.
Of this negative swing of 5ppt, we reckon c.2ppt were once-off in nature (discontinuation of chemicals sale, higher trade rebates to dispose transition stocks prior to new GST rate coming into effect), and the balance was a function of higher distemper share (in part also because emulsions revenue was especially strong in the base). The resultant effect was a sharper than expected margin erosion of 184bps of which we estimate 90-100bps to be on account of higher rebating w.r.t. the transition stocks. The business has since hiked prices (2.35%) on Oct 1, and another hike is possibly coming soon (likely in Dec).