Asian Paints Ltd - Stock Valuation and Financial Performance

Asian Paints | Market Cap 2,60,552 Cr

CMP 2,716 | P/E 72x FY22,

Recommendation | Reduce

Results: Asian Paints reported a year on year growth of ~25% in sales to Rs. 6,788 Cr in Q3FY21. Operating profit rose by ~50% year on year to ~Rs. 1,911 Cr. The overall volume growth was 33%.

Key highlights:

• Paints segment grew 25% and Home Improvement segment grew 21% year on year.
• Strong growth in Paint market was led by continued strong growth in tier 2, 3, 4 markets. Even tier 1 markets and metros reported a strong volume growth in Q3.
• Gross margins for the quarter better than previous year supported by lower prices and sourcing/ formulation efficiency.
• Company declared an interim dividend of Rs. 3.35 per share.

Outlook: As per the management, the demand conditions continued to exhibit a strong recovery across business segments. The domestic Decorative business delivered a powerful performance and Home Décor got a big fillip from a strong performance of the Home Improvement business. The Industrial coatings business, particularly in Protective coatings and auto businesses benefited from the resurgence in the industrial activity.

MoneyWorks4me Opinion: Asian Paints has strong execution track record. It has been able to consistently compound capital thanks to strong repeat business from repainting (75%+), pricing power due to limited competition and superior distribution to take away market share from unorganised players. 

We had given buy on Asian Paints in 2013; thereafter it has always traded at steep premium to our fair value. We would recommend lower exposure to Asian Paints.

Irrespective of market sentiment we stick to our process of fundamental investing principles. We avoid a company where share price growth is higher than earnings growth. Currently Asian Paints has grown 24% CAGR versus 13% CAGR growth in earning over last 10 years. We find the risks are higher to earn returns from current prices. We have given Sell on Asian Paints in 2020 because of huge gap between business growths versus market cap growth.

Besides, there are new risks from Indigo Paints and Grasim Industries which may undercut Paints prices to grab market share from incumbents. This might be low for now, but we will monitor whether it affects Asian Paints or Berger Paints in the medium term.

Like we mentioned in our Investors’ day,“As fundamental investors, we are of opinion that capitalism is a strong force that makes sure no one company can generate superior returns (ROE) for long. Competition or substitutes drive down incumbent’s ROE. If this doesn’t happen, the government intervenes by way of price cap or breaking down a company to destroy any monopolistic power it enjoys.” So while valuing a company we have to be optimistic on a company’s strength, but we also have to be conservative enough not to ignore risks.

Asian Paints | Market Cap 2,01,000 Cr

CMP 2100 | P/E 56x FY22

Recommendation | Reduce

Results: Asian Paints reported a year on year growth of 6% in sales to ~Rs. 5,350 Cr in Q2FY21. Operating profit rose by ~31.6% year on year to ~Rs. 1,150 Cr and profit growth remaining flat.

Key highlights:

• Volume growth was 11% year on year for the domestic decorative business
• Overall, International Business revenue increased by ~ 8% on account of Africa, Middle East, Sri Lanka and Bangladesh Units.
• Operating margin expansion came from lower sales and promotional expenses. Gross margin was lower due to inferior product mix. 
• The Board of Directors approved the payment of an interim dividend of Rs.3.35 per share (335%)

Outlook: The management expects to maintain double digit growth backed by healthy demand in Tier-2 and Tier3 cities. Metros sales have recovered around 80% but still not fully. Current demand is coming from new products and also fresh demand rather than pent up demand. Usually management has maintained that their growth rate is correlated to GDP growth ~1.5-1.7x. However, it has been growing faster due to introduction and promotion of lower margin products and penetration into other markets.

MoneyWorks4me Opinion: We admire the execution of Asian Paints. It has been consistent thanks to strong repeat business from repainting, pricing power due to limited competition and superior distribution to take away market share from unorganised players. 

We had given buy on Asian Paints in 2013, thereafter it has always traded at steep premium to our fair value. We would recommend maintaining lower exposure to Asian Paints. We have stuck to our fundamental investing principles wherein we have avoided the company where share price growth has been higher than earning growth. Currently Asian Paints has grown 24% CAGR versus 13% CAGR growth in earning over last 10 years. We find the risk are higher to earn superior returns from current prices. We had given Sell on Asian Paints in 2020 because of huge gap between business growth versus market cap growth.

Asian Paints: Should Investors be invested in the stock?

Asian Paints is currently trading at a price to earnings multiple of 50. We believe that with the domestic economy turning around, the real estate and paint industries are likely to benefit from it. Taking into consideration economic reforms along with higher focus on housing development, we can expect earnings of Asian paints to grow at 20-22% CAGR for the next 3 years and then narrowing down to 15-17% levels.

However, the current market price reflects market expectations of 20-25% CAGR growth rate for next 5 years. Given that there is a limited pricing power in highly competitive market, there is a little scope for operating margin to expand beyond 15%. Therefore, we do not see any reason for earnings to grow beyond volume growth. The possible volume growth is incorporated in current price of the stock.   

What should Investors do?

We believe that at Rs. 740 level, Asian paints is on the higher side based on valuation. But we advise investors to stay invested in the company. But of course this is not a time to enter into the stock.

This is an exceptional case wherein we are suggesting our subscribers to hold the stock even when the valuation is on higher side. The company is fundamentally strong and enjoys higher profit margins than its peers. There is a strong reason to believe that the company will continue to earn high returns on equity in future due to its sustainable moat. The management has ability to deploy capital to earn higher returns than the market. Looking at its value creation history, it is fair to expect good corporate governance and shareholder friendly policies from the management in future as well.

We do not see more than 5-10% upside from these levels. However, one may expect the stock to correct in short term. We will proactively inform our subscribers of buying opportunity, if any, available in future.

We have recently revised our valuation on Asian Paints. This change was done based on our future expectations from the company and the paint industry. All major players of the industry are expanding capacities and focusing more towards the decorative segment. As a result, Asian Paints will be facing stronger competitive pressure and may not be able to maintain the high growth rate of the past. We have, thus, reduced our EPS growth estimate for Asian paints from 18% to 16%.

However, the fundamentals of the company still remain strong and investors can continue holding the stock, at present.