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Nath Balakrishnan

SHAREHOLDERS can retain their holdings in the Pidilite stock, which trades at about Rs 390. Business Line had a `buy' recommendation outstanding on the stock when it was trading at the Rs 220 level.

Since then, the returns may not be as high as what some of the broader indices have delivered; gains have been of a more steady nature and are likely to stay that way.

Our current view is tempered by the raw material cost environment sporting an upward bias, which could keep margin expansion on a leash; the stock has appreciated by over 30 per cent over the last two months and, hence, we prefer to maintain a cautious view. The stock trades at a multiple of 14 times its expected per share earnings for FY-05.

With raw material costs accounting for 40 per cent of its costs, a rise in the prices of key inputs can have a significant impact on operating performance. The key raw material for Pidilite is vinyl acetate monomer (VAM), an organic chemical that is a derivative of crude. With prices of crude continuing to display firmness, VAM prices, too, are likely to mirror a similar trend and constrain margins.

Though raw material costs, as a percentage of sales, have remained at the same level in the first half of this fiscal compared to the corresponding previous period, an increase in staff and packing costs (both by about 20 per cent) has seen operating margins decline by about 80 basis points to 18.8 per cent.

Pidilite operates in two main segment: The consumer and bazaar products segment, which contributes 70 per cent to sales; and the industrial products segment that chips in with the rest. In the former segment, Pidilite boasts of strong brands such as Fevicol and M-Seal, to name just a couple.

Further, because of the equity these brands command, it would also confer upon Pidilite the ability to at least partially pass on any escalation in raw material costs on to customers by resorting to price hikes.

This is manifest in the PBIT margins for this segment, which was at 23.3 per cent for the first half of the current fiscal; in contrast, PBIT margins for the industrial products segment was nine per cent.

Further, the disparity in ROCE (return on capital employed) margins between the two businesses is also stark. For the year-ended March 2004, the consumer segment had ROCE margins of 61 per cent, compared to 18. 2 per cent for the industrial products segment.

Should Pidilite be successful in hiving off the industrial chemicals business, which it has been on the anvil for quite a while, it could trigger a re-rating of the stock and propel it into a different valuation trajectory, as it would then be perceived as a pure FMCG play.

However, at this juncture, a strategy of `holding' the stock appears to be appropriate.

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