BackAsian Paints’ strategy to go slow on price hikes is upsetting investors
Asian Paints’ gross margins may take a few more quarters to fully recover, posing a risk to the company’s earnings outlook. The management said it expects better operating margins by 4QFY22 and aims to increase Ebitda margins to 18–20%
PremiumAsian Paints Ltd, market leader in the decorative paints segment, has been hit hard by commodity cost inflation. Very hard. In the September quarter, its gross margins slumped 970 basis points (bps) on a year-on-year basis to 34.7%. One basis point is one hundredth of a percentage point. The company’s management said raw material cost inflation was highest in four decades and it expects this trend to persist over near term.
Elevated marketing spends and increase in freight costs offset the benefit of operating leverage, pushing operating margins to a 50-quarter low of 12.7%. Ebitda margin contracted 1090 basis points y-o-y, significantly missing analysts’ estimates of 18-20%. Ebitda is short for earnings before interest, tax, depreciation and amortisation.
Clearly, this didn’t go down well with investors. The stock fell more than 5% on Thursday reacting to the company's earnings performance. On Friday as well, the stock began the day in the red, falling more than 4%.
Of course, Asian Paints is taking measures to protect margins from cost pressures by passing on the burden to consumers. The company undertook a 4% price increase in 2QFY22 on a 6% sequential raw material cost increase during the quarter, the management said. It has affected a 7.5% price increase so far this year and would raise prices over the next three months. That said, price hikes will be taken in a calibrated manner since too many of these could affect demand stability.
Analysts point out that in the wake of rising competition, demand stability is as important as shielding margins.
“We believe that Asian Paints’ delayed and inadequate price hikes thus far, notwithstanding unprecedented inflation, was a calculated move (to some extent) to capitalize on the challenging raw material inflation/sourcing environment to accelerate share gains," said analysts at Kotak Institutional Equities. Also, ahead of Grasim’s launch, the message is clear that Asian Paints is determined to defend market share even if it means sacrificing margins, added the Kotak report.
Sharing a similar view, analysts at ICICI Securities Ltd said, “Asian Paints has around 80% consumer mindshare, nearly 70% profit-pool share and around 60% value market share. The nearly 1000bps gross margin decline (though for one quarter) is unprecedented." The report added, “While management commented about “steep input cost inflation", we reckon that keeping lower profit pools and competitor signalling are important decision-drivers for Asian Paints (which we agree)."
In simple terms, this means that gross margins may take a few more quarters to fully recover, posing a risk to the company’s earnings outlook. The management said it expects better operating margins by 4QFY22 and aims to increase Ebitda margins to 18–20% levels going ahead.
Meanwhile, the company saw strong volume growth of 34% y-o-y in the decorative paints segment. On a two-year CAGR basis, volumes rose more than 22%. CAGR is short for compounded annual growth rate.
The management said tier-1 and tier-2 markets saw strong volume growth despite Covid-19 led restrictions in certain regions and a prolonged monsoon. Among categories, economy and luxury paints performed well aided by new launches. Its projects business saw good traction during the quarter, aided by an uptick in real estate construction. The management further highlighted continued market share gain from unorganised and organised players.
As for valuations, the stock continues to trade at an expensive one-year forward price-to-earnings multiple of around 70 times. Analysts say sustained periods of margin deterioration caused by reasons other than inflation, could pose a risk to future valuations of Asian Paints and the entire industry.
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