Is Asian Paints building a bubble on the bourses?

Our Bureau Mumbai | Updated on November 13, 2019

File photo   -  The Hindu

Asian Paints Ltd (APL), India’s largest consumer paints company, is now one of the most valued stocks among top 30 companies listed on the BSE in terms of price to earnings (PE) ratio, which is a widely used parameter. Yet, there is a scramble to buy APL.

Is there is a bubble building into it now? A recent report by Abakkus Asset Management, founded by former Reliance Mutual Fund Manager Sunil Singhania, has compared APL with global peer Sherwin Willams and concluded that the stock trades at a 300 per cent premium to the global paint major.

PE ratios

As per Abakkus, both Sherwin Willams and APL are the largest and most valued paint companies in the world. Yet, APL trades at a PE of around 78 (the PE has moved to 80 since the report was published) for financial year 2019 while Sherwin Willam’s PE of 29 is based on calendar year 2018 numbers.

“Even on the market to sales ratio the premium is startling. APL trades at a market-cap to sales of 9x while the same for Sherwin Willam’s is 3x,” said the Abakkus report titled ‘The Big Call-Bubble in Quality?’

The report further says that a quick look at other parameters of both companies shows that APL has reported a revenue growth of 13 per cent CAGR (compounded annual growth return) over the last nine years, same as the nominal GDP of India and just 2 per cent higher than that of Sherwin Willams. However, the profit growth of APL over this period is only 11 per cent compared with a healthier 16 per cent of Sherwin Willams. Even ROE (return on equity) of Sherwin Willams for the last reported annual numbers are higher than that of APL.

“Belying the perception of high growth justifying high PE, APL profit has grown much slower than Sherwin Willams since financial year 2010, but still it trades at 300 per cent premium,” the Abakkus report said.

The share price of APL has climbed 20 per cent in the last six months to hit a record high of ₹1,833 on October 31. The market cap of APL stood at over ₹1.70 lakh crore as on Monday’s closing price of ₹1,773 on the BSE.

Key positives

In a report titled ‘Why Asian Paints continues to draw investor interest,’ BusinessLine had reported on October 24 that the company’s strong pricing power, good volume growth in the economy products segment and a well-entrenched distribution network are key positives.

In the recent September quarter, APL registered revenue growth of 9.4 per cent to ₹5,051 crore with high double-digit volume growth. The company’s profit grew 67 per cent in the September quarter aided by deferred tax reversal of about ₹150 crore. Since the company has exercised the option to adopt the new corporate tax rate of 25.17 per cent (inclusive of surcharge and cess), there has been a significant jump in the net profit.

The company derives over 75 per cent of its revenue from decorative paints and the remaining from the industrial segment. The aggressive sales push efforts taken by Asian Paints at the dealer level, along with higher sales from the lower-end products such as putty, distemper and economy paints, boosted the volumes in the decorative paints segment. The stable demand in the rural and small markets is another contributing factor for revenue increase.

The benign raw material costs (as a percentage of sales) gave respite to Asian Paints, which had taken several price hikes last year. For the September quarter this year, raw material costs (as a percentage of sales) stood at 55 per cent, 100 basis points lower than in the same period last year. While crude prices had been volatile in the recent months, it is still at around $58 per barrel, lower than in the same period previous year ($79 per barrel).

Improved margins

The company was able to push stocks to dealers at better rates and improve the margins. Its operating margin improved to 19 per cent in the September quarter, up from 18 per cent in the same quarter last year.

While the industrial paints segment was adversely affected by the slowdown in the automobile industry, the volume growth from the decorative paints segment was able to offset the pain to a large extent.

Going ahead, the company’s margin outlook will depend on crude price movements. Though the company had been able to pass on the crude price hikes in the past, it needs to be seen whether it has enough leeway to hike prices in future as well, given the consumption slowdown.

Published on November 13, 2019

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