Stock Fundamentals

Why Asian Paints is a good long-term buy

Bavadharini KS | Updated on March 21, 2020 Published on March 21, 2020

The firm’s dominant position, fall in crude prices and market share gains are positives

There was unprecedented turbulence in the market last week, with the Sensex and the Nifty in free fall. Bluechip stocks, too, took a beating, many of them recording multi-year lows. With the Covid-19 threat continuing to play havoc, volatility in equity markets across the globe is likely to continue. Hence, bottom-fishing at this juncture may not be prudent, particularly in the mid- and small-cap space.

But some of the large-cap companies with strong financials are turning attractive from a long-term perspective. While the market fall can extend in the coming days, investors who can weather near-term shocks and looking to buy for the long term (3-5 years) can start accumulating some stocks.

The stock of Asian Paints, one of the largest paint-makers in the country, that had lost about 11 per cent in the past week’s market carnage, quickly recouped most of its loss during the market rally on Friday, indicative of the stock’s resilience in volatile markets.

 

The company is also expected to gain handsomely from the sharp fall in crude prices. Raw materials of paint companies, essentially crude oil derivatives, comprise around 50 per cent of sales.

Softening of crude oil prices, a good distribution network and market share gain are key positives for Asian Paints, that is likely to cushion the blow on account of Covid-19. Also, initiatives on economy products such as putty and distemper, and an aggressive marketing campaign, have helped drive sales in the past 3-4 quarters.

The company is also slowly expanding its home improvement segment (bath and kitchen fittings business), though its contribution to the overall revenue (about 2 per cent) is not significant.

While the slowdown in demand from real-estate and industrial segments (automobile) and the ongoing economic turmoil in the country could weigh on the revenues of the company, the recent fall in crude oil prices to around $26 per barrel from $66 per barrel in December last year could benefit paint companies, lowering input costs and aiding margins.

At ₹1,745, Asian Paints trades at 47 times its likely per-share earnings of FY21. While it is not cheap, valuations are supported by the company’s dominant market position, traction in low-cost housing and a possible pick-up in residential housing demand over the medium term. The company’s negligible debt levels and the sharp fall in crude prices also lend comfort to the pricey valuation.

Raw material costs benign

A key factor that aided growth in paint companies was low crude oil prices through the past year (compared with prices in 2018).

This led to a substantial fall in the companies’ cost of raw materials, most of which are crude oil derivatives such as titanium dioxide, zinc oxide and solvents and additives.

For Asian Paints, during the nine months ended December 2019, the raw material cost (as a percentage of sales) stood at 49 per cent, about 4 percentage points lower than in the same quarter last year. The company has passed on some of this benefit to customers in the form of lower prices across products. Cumulatively, Asian Paints has reduced product prices by a little over 1 per cent during the nine months ended December 2019.

Though crude prices have been volatile in the recent months, particularly with prevailing tensions in West Asia in January, it was still at around $50-56 per barrel (lower than $66 per barrel in the beginning of FY20). This helped earnings for Asian Paints grow much faster than sales. Asian Paints’ operating margin improved to 21 per cent in the nine months ended December 2019, up 100 percentage points from the same period last year.

With crude prices crashing to a low of around $26 per barrel recently, Asian Paints is likely to gain further on the margin front.

It will help the company push stocks to dealers at better rates, aiding revenues at a time when demand could play truant.

Economy products

Asian Paints derives nearly 70 per cent of its revenue from the decorative paint segment, while about 30 per cent comes from the industrial segment (including automotive and coatings).

While the company has registered a double-digit volume growth, it is predominantly due to economy products. Its premium paint segment hasn’t seen much uptick given the slow growth in residential real estate. While the industrial paints segment was adversely affected due to the slowdown in the automobile industry, the volume growth from the decorative paints segment was able to offset the pain to a large extent.Though the revenue growth in the December quarter was subdued, the company’s strategy of gaining market share through increased market penetration could aid its sales and volume growth.

Asian Paints also has the largest distribution network of over 60,000 dealers, which is a key positive, and will help growth when the overall real-estate demand picks up.

Healthy financials

Asian Paints’ profit grew 33 per cent y-o-y to ₹2,294 crore for the nine-month ended December 2019. Since the company has exercised the option to adopt the new corporate tax rate of 25.17 per cent (inclusive of surcharges and cess), there has been a significant jump in net profit.

The company registered a revenue growth of 9 per cent y-o-y to ₹15,576 crore with a double-digit volume growth in the nine months ended December 2019.

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Published on March 21, 2020
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