While benign RM costs led to 257bps y-o-y gross margin expansion, initial factory costs and ad spends jumped—staff and other expenses up 16.3% and 20.7% y-o-y, respectively – resulting in Ebitda growing mere 60bps y-o-y.
Asian Paints’ (APL’s) Q2FY20 consolidated sales and PAT growth of 9.4% and 28.6% y-o-y came in line, while 13% Ebitda growth belied estimate. Domestic volume grew ~14% y-o-y on a base of 11%, clocking seventh quarter of double-digit spurt. However, after three quarters of positive difference between value and volume growth, product mix deteriorated in Q2FY20, leading to a mere 9.4% value growth. While benign RM costs led to 257bps y-o-y gross margin expansion, initial factory costs and ad spends jumped—staff and other expenses up 16.3% and 20.7% y-o-y, respectively – resulting in Ebitda growing mere 60bps y-o-y. We continue to estimate double-digit volume growth in the decorative business as well as margin expansion led by operating leverage benefit in new plants. Maintain Buy.
Double-digit volume sustained
Standalone sales growth of 9.3% y-o-y was slower than trend (~15% average of past four quarters); volume growth, however, remained resilient at ~14% y-o-y. Slowdown in the auto sector hurt the PPG-AP JV and overall demand slowdown impacted industrial coatings JV as well. International operations performed better than in Q1FY20 with improvement in key units of Nepal and Egypt. Both segments of home improvement were impacted owing to slowdown in real estate business—revenue grew ~18.5% in both businesses. Standalone gross margin rose 257bps y-o-y, but dipped 142bps q-o-q.
Q2FY20 conference call: Key takeaways
Low-end paints emulsions and distempers have been growing at a much faster clip. Painting industry was impacted owing to prolonged monsoon. Introduced few products in distemper category – this has led to revival of distemper category. Rural and small towns continue to grow faster. Putty market size would be Rs 50-60 bn. Distempers market size would be Rs 100 bn. H1FY20 margins are fair representation of margins for the full year.
Outlook and valuation: Shining bright; maintain ‘BUY’
We expect decorative volumes to sustain riding likely demand shift from the unorganised segment (~30%). This, coupled with APL’s capability to hike prices, should help maintain margin. Rolling forward, our revised TP comes to Rs 2,050 (55x, 12-month forward PE). Maintain ‘BUY/SO’. The stock is trading at 47.8x FY21e EPS.