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Painting A Bright Future

Asian Paints is set to reap the benefits of an increased demand for decorative paints in the housing sector

Asian Paints Limited (APL) is India's largest paints company and ranks among the top 10 decorative paint companies in the world. Asian Paints boasts of a 32 per cent market share in India while it serves consumers in 65 countries of the world with 30 manufacturing plants in 22 of those countries. In India, APL has six manufacturing plants, namely in Sriperumbadur, Mumbai, Ankleshwar, Patancheru, Kasna and Taloja.

Investment Rationale
Booming Housing Sector

80 per cent of APL's total production capacity is used to produce decorative paints. Housing accounts for over 40 per cent of the demand for decorative paints and what paints a rosy picture for APL is the estimation that around five million new housing units are likely to be added every year in the coming times. The rising trend of nuclear families, increased incomes, government's sops for housing loans, easy financing and longer repayment tenures are other factors that will further increase the number of households and boost APL's sales.

Capacity Expansion

To cater to the ever-growing demands for decorative paints, APL is expanding its capacity by 40 per cent to achieve the target of 494,000 tonne per annum by FY10. This capacity expansion will be carried out at the cost of Rs 300 crore and would enable APL to get an edge over its competitors.

EBITDA Margins To Be Maintained

In H1FY08, the rise in raw material prices was neutralised by the appreciation of the rupee and the company was able to pass on the rise in prices to its consumers. APL also manufactures Phthalic Anhydride (PAN) and Pentaerythritol (Penta), which are key raw materials used in manufacturing paints and hence, the company's backward integration will also help it in controlling costs. The rupee appreciation has reduced the cost of imported raw materials, which account for 30 per cent of the total raw material consumed. Furthermore, the decline in prices of titanium dioxide and vegetable oil has further helped the company maintain its EBITDA margins at the 15-16 per cent levels.

Marketing Strategy To Push Sales

APL has initiated two marketing concepts to drive the volume growth: Home Solutions and Colour World Machines. Home Solutions consists of a trained team that helps customers right from selecting colours to final painting. This is a specialised value added service and is receiving a good response, despite a comparatively higher price. The other marketing strategy, Colour World Machines is a tinting machine that is installed at APL's dealer outlets and helps customers get different shades and colours. Currently, more than 8,000 such machines have been installed in India and 700 abroad. The more colour choices available to customers would certainly help increase APL's sales volumes.

Growing International Business

APL's revenue from its international operations grew by 17.6 per cent during H1FY08. The company also saw over 20 per cent increase in volumes while its EBIT margins improved to 6.8 per cent from the earlier 1.8 per cent. Sales in South Asia and the Middle East witnessed robust growth at 44 per cent and 28 per cent respectively. The company's sales from its international businesses is expected to grow from Rs 583 crore in FY07 to Rs 726.6 crore in FY10 while net profits are expected to grow from Rs 33.1 crore to Rs 41.3 crore during the same period.

Risks & Concerns
Demand For Substitutes

The demand for paints is directly related to construction and housing development. Cheaper alternatives like sand paints or wallpaper would dampen the demand for APL's products. The increasing use of wall tiles and wood could also pose a threat as APL's presence is mainly in decorative paints and such alternatives could impact its sales.

Rising Raw Material Prices

Oil-based paints are largely impacted by fluctuations in crude prices as 40 per cent of its raw materials are derived from crude. Hence a significant increase in crude prices can adversely affect APL and erode its margins. However, APL has taken effective steps like the backward integration of PAN and Penta manufacturing to mitigate the impact of rising crude prices.

Rise In Interest Rates

Any increase in interest rates could impact the demand for new houses, leading to a further slowdown in the demand for paints. APL, being the largest company in the decorative paints segment would probably suffer the most.

Valuations

At the current price of Rs 1112, the stock discounts its standalone EPS of Rs 37.5 and Rs 43.1 in FY09E and FY10E by 29.3x, and 25.5x, and consolidated EPS of Rs 41.4 and Rs 47.4 by 26.8x and 23.4x respectively. APL, the leading player in decorative paints, also has excellent return ratios. Its leadership position and earnings visibility due to increasing off-take in the domestic market, backed by strong housing demand and growing international business make the stock attractive. The stock is valued at 26x (historic range of 24x - 32x) and the consolidated EPS of Rs 47.4 to arrive at value of Rs 1,232 (a conservative valuation due to concerns for crude prices). APL also has investments in ICI India and HDFC. At a 20 per cent discount, the value of these investments comes to Rs 19 per share. A SOTP valuation gives a target price of Rs 1,251, an upside of 13.7 per cent.

Source: ICICI Direct