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Nath Balakrishnan

IT HAS been a solid performance by Asian Paints for the quarter ended December 2004; the results have been a positive surprise, indeed. With demand drivers in place, we are sanguine about Asian Paints' prospects.

As a result, we recommend investors to consider an exposure to the stock at the current level of Rs 360; our current call also represents an upgrade from our previous stance of recommending investors to buy the stock on weakness.

There was a sharp spurt in sales, which jumped 32 per cent to Rs 596 crore compared to the year-ago period.

Asian Paints effected a price increase of 4.5 per cent last December. The reasons for the steep jump in sales can be explained by two factors:

A longer painting season (with Diwali occurring in mid-November as opposed to October in 2003; this could have also muted sales in Q3 FY-04); with the hike effective December 1, 2004, members of trade could have also resorted to stocking up ahead of the price increase.

Even if one looks at sales growth over the nine months of the latest fiscal (which smoothens out phases of concentrated demand), the growth at close to 17 per cent inspires confidence.

The material cost environment in the latest quarter was particularly challenging for Asian Paints, and accounted for close to 60 per cent of sales compared to 48 per cent in the corresponding previous period.

In spite of such a precipitous increase under this cost head, the impact on operating margins was not commensurate; margins are at 15.1 per cent compared to 16.5 per cent in the year-ago period.

With other frontline paint companies also planning to increase prices, the pricing environment should, in our view, remain stable.

We also believe that once the effect of the price hike takes effect in the quarter in progress, there should be scope for margin expansion as well.

Adjusted for a one-off item of Rs 4.3 crore, earnings at Rs 54.4 crore have risen by a smart 31 per cent on a year-on-year basis.

The outlook

Much like what happened a couple of years ago, there is a possibility that with the implementation of value-added tax just around the corner, there could be some slippage in offtake. However, this would be transient and should get evened out in the subsequent quarter.

On the raw material cost front, the escalating price of crude oil (key inputs for paint companies are derivatives of crude) is, indeed, a cause for concern. But two factors should help alleviate its impact: The proposal in the Budget that has reduced peak Customs duty from 20 per cent to 15 per cent and an appreciating rupee.

On the demand side, with the Budget announcing a deduction of up to Rs 1 lakh from the taxable income, housing loans have become a compelling proposition.

The fillip this would provide to housing demand will be a substantial plus for Asian Paints, as it derives a significant portion of its revenues from the decorative paints space.

Further, the upturn in the fortunes of the chemicals business as well as the positive contribution from its subsidiaries in the latest quarter, albeit marginally, serve as a good augury.

At the current price, Asian Paints trades at about 20 times its expected standalone per share earnings for FY-05.

Though such a valuation cannot be termed as undemanding, in the case of Asian Paints, with its market leadership status and superior operational metrics, it is not entirely unwarranted.

Unlike its peers that have delivered impressive returns over the past couple of years, we believe the returns from Asian Paints would be steadier and accrue over a longer time-frame.

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