Asian Paints - Higher depreciation slashes earnings; we reiterate a Hold - Anand Rathi

Weaker performance of subsidiaries. Asian Paints posted 11% yoy revenue growth. Standalone revenue was up 12.6% yoy. The company has indicated that volumes were up by double digits. It has hiked prices of decorative paints in its domestic business ~5%. It plans to raise prices again (by 1%) on 1 Aug'13.

Lower EBITDA margin. Lower prices of raw materials aided in expanding the gross margin 118bps. However, higher staff costs (88bps) and other expenses (186bps) brought down the EBITDA margin 157bps. Also, higher operating costs at the new plant at Khandala led to higher operating expenses. On the commencement of the Khandala plant, depreciation upped 79% yoy. The effective income-tax rate climbed 292bps yoy. The weaker operating performance pulled down the net profit 4.6% yoy.

Rupee depreciation to drive costs. We believe the company's raw material cost index has moved up considerably in the past 2-3 months. As ~85% of raw material is crude-oil linked and is imported, the steep rupee depreciation of ~15% would result in higher raw-material costs. We believe that unless the rupee appreciates, the company would be compelled to hike prices again. This could further eat into volume growth.

Our take. The paints sector is strongly correlated to GDP growth, with paint volumes scalilng up at 1.5—2x GDP growth. If GDP growth continues under stress in FY14 and FY15, we expect dull volume growth for the paints sector. Also, the slowdown in real estate has resulted in smaller paint companies marketing paint in the "re-painting" market. This has added to competitive pressures on Asian Paints. Also, we expect higher raw material costs and the rupee depreciation to cut into margins. We retain a Hold on the stock, with a price target of Rs. 4,534 at a target PE of 30x Sep'14e earnings. Risks. Lower raw-material prices.

Source : Equity Bulls

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