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Commodity cost inflation has hit adhesives maker Pidilite Industries Ltd hard. High procurement costs of key input chemical vinyl acetate monomer (VAM) dragged consolidated gross margin to a multi-quarter low of 41% in the September quarter (Q2FY23). VAM’s contribution to the Fevicol maker’s total raw material basket is 20-25%.

VAM consumption cost rose to $2,491 a tonne in Q2 from $2,231 a tonne in Q1, the management said in the post-results call last week. Spot VAM prices have dropped meaningfully this quarter so far to $1,200-1,400 a tonne.

A breather
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A breather

However, this is not good enough. Raw material costs, barring VAM, are yet to return to pre-covid levels, the management said. Moreover,the Indian rupee has depreciated against the US dollar and the company is yet to absorb the high-cost inventory and finished goods. This may lead to more margin pressure in the third quarter, before things start improving in Q4.

For now, Pidilite’s weak operating performance has prompted a slew of brokerages to trim the company’s earnings estimates.

Pidilite has the potential to surpass the historical peak earnings before interest, tax, depreciation, and amortization (Ebitda) margin of 23% when the rest of the raw material basket normalizes, Kotak Institutional Equities said in a report.

“We tweak revenues, cut our FY23E margins (2Q miss and high-cost inventory in 3Q) and trim FY24E margins. Net result: 3-11% earnings per share cut for FY23E," Kotak said.

Pidilite’s management has guided its Ebitda margin to breach the 20% mark by Q4FY23. Even so, inflation has hurt the company’s track record of solid earnings growth. So far, Pidilite has increased prices by only 75% of raw material cost inflation to be competitive. The management feels there is no need to increase prices further. On the contrary, in the B2B segment, prices are expected to be cut.

“Consistently uniform performance across lines is reflected in the ~12.1%/~13.6%/ ~14% sales/Ebitda/profit after tax CAGR over the past 10 years ending FY22," said a Motilal Oswal Financial Services report. CAGR is compound annual growth rate. However, the earnings CAGR in the past 3-5 years softened to ~8%/~7% because of the pandemic and high commodity inflation, the report said.

Meanwhile, competition in the under-penetrated waterproofing segment is heating up and investors must be watchful. The aggressive entry of Asian Paints Ltd in adhesives and potential loss of leadership in waterproofing to Asian Paints are key risks, according to a report released by Prabhudas Lilladher.

Pidilite has increased coverage to 24,000 villages. The Pidilite Ki Duniya initiative is reaching 7,000 stores, the management said. Pidilite covers around twice the number of outlets than Asian Paints.

“The company is launching new products and increasing its penetration in rural markets. These are steps in the right direction, but will yield results over a period of time," said Kaustubh Pawaskar, deputy vice president, research, Sharekhan by BNP Paribas.

Volumes will catch up meaningfully only if Pidilite can improve margins, he said.

So far in FY23, shares of Pidilite have risen by 9.3%, beating the Nifty 50 index, as easing VAM prices aided investors’ sentiment. However, in the present situation, the stock’s lofty valuation is a concern.

At FY24 price-to-earnings, the Pidilite stock is 67.56x, showed Bloomberg data. “Its premium valuation limits a steep upside for the near-term," Pawaskar said.

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