Asian Paints Shares Extend Fall On Q2 Miss, Analysts Turn Cautious

Analysts turned cautious amid lower-than-expected urban recovery and potential execution challenges in new categories.

<div class="paragraphs"><p> Asian Paints container sit outside a hardware shop in Mumbai.&nbsp; (Photo: Usha Kunji/BQ Prime) </p></div>
Asian Paints container sit outside a hardware shop in Mumbai.  (Photo: Usha Kunji/BQ Prime)

Shares of Asian Paints Ltd. extended losses on Friday after second-quarter profit missed estimates and analysts turned cautious.

India’s largest paintmaker's net profit rose 31% to Rs 782.71 crore in the July-September period, according to its exchange filing. The price hikes were not enough to offset the extended monsoon and higher input costs.

Sequentially, however, its net profit fell 23% from Rs 1,016.93 crore.

Key Highlights (YoY)

  • Revenue rose 19% to Rs 8,457.6 crore, against an estimated Rs 8,906.2 crore.

  • Operating profit rose 36% to Rs 1,227.7 crore. Analysts had pegged it at Rs 1,574.1 crore.

  • Margin expanded to 14.5% from 12.7%. On a sequential basis, it contracted due to the consumption of high-priced material inventory. Analysts had pegged the metric at 17.7%.

  • Gross margins slipped 200 basis points to 35.7% sequentially.

  • Operating margins contracted by 356 basis points over the previous quarter led by low gross margins, increase in staff costs and other expenses.

  • Domestic decorative paint volume grow 10% year-on-year despite subdued demand for exterior paints in July-August.

  • Rural outpaced urban in terms of demand. The company saw product mix deterioration as consumers downtraded from luxury range to the economy.

  • The management expects gross margins to reach 39-40% in the fourth quarter of FY23 led by a correction in input costs as well as price hikes.

Analysts, however, are betting on Asian Paints' planned investment in backward integration of white cements and vinyl acetate ethylene emulsion (VAE) and vinyl acetate monomer (VAM) production, which will reduce import dependency, enhance margins and get aggressive in adhesives.

The company expects demand in Q3 and Q4 to improve with an uptick in consumer sentiments during the festive season and upcoming wedding season. An uncertain geopolitical environment and the strengthening of the dollar, however, could play spoilsport.

Shares of Asian Paints were trading 1.01% lower as of 10.59 a.m. on Friday, while the Nifty 50 gained 0.37% on the NSE.

Of the 41 analysts tracking the company, 18 maintain a ‘buy’, 12 suggest a ‘hold’ and 11 recommend a ‘sell’, according to Bloomberg data. The average of the 12-month target price implies an upside of 6%.

Here's what analysts said about Asian Paints’ Q2 FY23 results:

ICICI Securities

  • Maintains 'hold' rating with a target price of Rs 3,200 per share, implying a potential upside of 1.8%.

  • The brokerage believes Asian Paints' investment in backward integration to be likely EVA accretive only if the savings improve overall operating margin by 200 basis points.

  • While the backward integration is considered to be a finite RoCE activity, most smaller and unorganised players will not be able to invest in backward integration. It should allow Asian Paints to offer competitive prices and better product quality to consumers and should help retain or improve market shares (DCF accretive).

  • The investments will also allow it to compete better with large entrants with deep pockets such as Grasim and JSW Paints.

  • Lower-than-expected urban recovery and potential execution challenges in new categories are key risks.

  • Input cost increases led by high crude prices and a weak INR could put pressure on the margins in the short term due to lag in price action.

Nuvama Institutional Equities

  • Maintains 'buy' with a target price of Rs 3795 apiece, implying a potential upside of 18.6%.

  • High priced inventory and product mix were instrumental in delivering disappointing margins, but H2 will likely be better.

  • Demand growth drivers remain intact, but need to factor in the early festive season, which could affect Q3 FY23 growth.

  • Cuts FY23E/FY24E earnings estimates by 6.8%/4.1% factoring in the Q2 FY23 miss and weaker rupee.

  • Business-to-business projects are also expected to do well led by revival in construction post monsoon.

  • The entry in adhesives with bigger plans for home décor is an additional growth trigger.

  • A slowdown in the economy is the biggest risk for the paints industry, as about 75% of demand for decorative paints arises from repainting, which, in turn, depends heavily on the country’s economic condition.

Motilal Oswal

  • Maintains 'neutral' with an unchanged target price of Rs 3,150 per share.

  • Cuts earnings forecast by 8%/10% for FY23/FY24.

  • Product mix deterioration led by downtrading and lower than expected urban salience were key factors for sales miss. As a result of which, over 20% price increase YoY and 10% volume growth YoY has only resulted in 19% sales growth in reported numbers. With product mix deterioration and rupee depreciation playing spoilsport, margin gains in H2 FY23 (led by fall in crude) would not be as sharp as expected earlier.

  • With the entry of new players with deep pockets and massive commitments on investments, the overall industry may see a shift in demand and margin structure due to the heightened competition. It remains cautious as the sector may not enjoy the higher multiples of the past.

  • Asian Paints has delivered 11.6% earnings CAGR over the past five years (FY17-22), while the stock price has delivered 24.1% CAGR, implying a significant re-rating. The stock remains expensive.

  • While improving margins would lead to better ROCEs, the new capex plan worth Rs 2,650 crore might dilute the same.

Nirmal Bang Institutional Equities

  • Maintains 'accumulate' rating with a target price of Rs 3,210 apiece, implying a potential upside of 2.2%.

  • While the company saw some softening in input cost inflation at the end of Q2 FY23, an uncertain geopolitical environment and strengthening of dollar could play spoilsport going forward.

  • Cuts earnings estimate by 8.6%/8%/5.5% in FY23E/FY24E/FY25 largely reflecting earnings miss and changes related to Rs 6750 crore capex over the next three years.

  • It continues to believe that valuation for Asian Paints will always be at a premium to other consumer peers, as it has consistently delivered strong volume-led growth, maintained market leadership, continuously generated robust cash flows, sustained a healthy dividend payout ratio, maintained decent ratios and is now making big investments on capacity expansion and backward integration.