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With steep price hikes, Asian Paints Ltd is gradually winning the cost inflation battle. In a conference call with analysts post the December quarter earnings, the management said, in nine months of FY22, the company took a cumulative price hike of around 22% in response to nearly 25% raw material inflation. 

The management added that the decorative paints industry took two rounds of price increases post the festive season, with 9-10% blended price hike from 12 November, and 4-5% additional price increase from 5 December.

On a consolidated basis, gross margins improved by 200 basis points (bps) sequentially in Q3FY22 to 36.8%, although compared to the same quarter last year, margins are down by 830bps. One basis point is one hundredth of a percentage point. 

The management expects the impact of price hikes to start reflecting on earnings from the March quarter, which is expected to translate into full recovery on gross margins on a sequential basis. So, analysts feel that worries on inflation may soon be a thing of the past for the company. “Asian Paints’ performance (including the ramp-up in adjacencies) remains the most impressive among the top-three players; the recent round of price hikes means the worst of margin pressure is likely over," analysts at HDFC Securities Ltd said in a report.

Going ahead, the focus would shift back to demand growth. Asian Paints reported better-than-expected volume growth in the December quarter, in spite of the price increases. Its decorative paints business saw volumes rise 18% year-on-year (y-o-y). On a three-year and two-year CAGR basis, decorative paints volume growth was at 20% and 25%, respectively, the management said. CAGR is short for compounded annual growth rate. The company witnessed broad-based growth across markets with metros and tier-I and tier-II cities outperforming tier III and IV towns, the management said.

Further, in Q3 the company did not witness any signs of weakness in rural demand, the management said. Even so, analysts say, investors should closely watch rural demand trajectory. "Demand growth would be the key monitorable here. Given how the outlook on rural growth in consumer staples turned negative all of a sudden in recent months, we reckon the hyper-growth phase for Paints also isn’t going to last forever," analysts at JM Financial Institutional Securities Ltd said in a report.

Sharing a similar concern, analysts at Motilal Oswal Financial Services Ltd said, "While sales growth was impressive in 3QFY22, even on a reasonably high base of the previous year, it remains to be seen how the company will fare on the demand front in subsequent quarters – especially as a) festive demand drivers would no longer be at play and b) the sales growth base is even more challenging going forward."

What’s more, with the entry of Grasim Industries Ltd expected in the second half of calendar year 2022, competitive intensity in this sector is likely to increase. Investors would reckon that the Aditya Birla group company, Grasim Industries, will invest Rs5,000 crore in this venture and aspires to become the second largest decorative paint maker.

Simply put, there are some headwinds to the sector’s demand outlook and given the expensive valuations of Asian Paints, investors are better-off not ignoring these risks. Considering the earnings estimates for FY23, the Asian Paints stock is trading at a price-to-earnings multiple of around 65 times.

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