Recovery was better than expected; fears of sharp fall in earnings recede; upgraded to ‘Neutral’ with TP of Rs 1,605.
While Asian Paints (APNT) reported sharp y-o-y declines of 42.7%, 58.2%, and 67.4% in sales, Ebitda, and PAT, respectively, the numbers were still better than expected given the double-digit volume growth witnessed in Jun’20. Importantly, commentary on recovery sustaining is also reasonably strong.Despite healthy volume growth, earnings growth has been weak for several years now, which is likely to continue going ahead. Nevertheless, the likelihood of a sharp earnings decline, as feared earlier, may not materialise. Therefore, it is possible that APNT, unlike other discretionary peers, would emerge relatively unscathed from the COVID-19 crisis.
With better than expected recovery, APNT continues to remain market leader in a category with attractive long term potential. Hence, we upgrade our rating from Sell to Neutral. Rich valuations of 55x FY22 EPS for a business with uncertain earnings growth and weaker ROCE v/s peers prevent us from turning more constructive.
Sharp decline on all fronts, but momentum in June drives strong beat In Q1FY21, APNT reported consol. net sales decline of 42.7% y-o-y to Rs 29.2 bn (est.: Rs 17.9 bn). We believe volume decline to be 35% (est.: – 55%) in the domestic Decorative Paints business. Gross margins were up 110bp y-o-y to 44.7%. During the quarter, employee costs increased 6.4%y-o-y to Rs 3.6 bn, whereas other expenses declined 36.7% y-o-y to Rs 4.6 bn. As a percentage of sales, employee costs increased by 570bp y-o-y and other expenses by +150bp y-o-y.
Ebitda declined by 58.2% y-o-y to Rs 4.8 bn (est.: Rs 1.8 bn). The Ebitda margin contracted by 610bp y-o-y to 16.6% (est.: 10.2%). PBT was down 68.4% y-o-y to Rs 3.2 bn (est: Rs 319 m). Adj. PAT declined 67.4% y-o-y to Rs 2.2 bn (est.: Rs 139 m).
Highlights from commentary
Following a near-washout in April, May demand was down just 20% y-o-y, while June demand rose to double digits y-o-y in terms of volume. Demand in metros and tier 1 cities (~45% of total sales) is still weak, but has recovered in tier 2, tier 3, and tier 4 markets. Deterioration in the mix explains sequentially weaker gross margins despite lower material costs. No price increase/ decrease was posted for Q1FY21, and there are no plans going forward either.
Valuation and view
While sharp decline was reported in sales, Ebitda, and PAT, the numbers were still better than expected. Management commentary on recovery sustaining is also strong, albeit with the caveat of the negative impact of the ongoing re-imposition of lockdown in certain pockets of the country. Earnings growth has been weak for several years (PBT CAGR of 7.7% over FY16–20), and there is no evidence of a sharp reversal in this trend. Nevertheless, the likelihood of a sharp earnings decline, as feared earlier, may not materialise. We value APNT at 50x Jun’22 EPS, leading to TP of Rs 1,605, with 6% downside over CMP.