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Don’t Buy Just Yet

Asian Paints has shown an increase in margins due to a price hike. But its stock is currently overvalued…

Price hike king: One of the very few companies that can actually undertake a price hike in these times – Asian Paints, the country’s largest paints manufacturer took a 5 per cent hike in Q1FY13. The hike along with cooling raw material (titanium dioxide) prices saw Asian Paints expand its gross margins by 3.15 per cent (y-o-y) to 56.8 per cent. The management, though, has cautioned that the gross margins may cool down going forward. It said titanium dioxide prices could remain volatile for the rest of the year on the back of global demand-supply mismatch, high crude price and rupee depreciation.

Low volumes ahead? Asian Paints’ strength lies in decorative paints – a discretionary spend in times of recession. And cracks have started showing. Even though sales were up 12.5 per cent (y-o-y), the company is estimated to have seen a 2 per cent volume decline in the first quarter of the current financial – partly attributed to destocking and remaining to a weak business environment. Consolidated sales for the company was up 12.5 per cent while subsidiaries’ (international) business grew 19 per cent.

Cracks showing? Another feature observed during the latest quarter was the deceleration of rural demand. Rural demand growth has traditionally been higher than urban growth but Q1FY13 saw demand growth for both rural and urban at near equal levels, implying a slowing down in rural demand. But that may not be the end of the story for Asian Paints if last year’s performance is anything to go by. The company reported 15 per cent volume growth in the domestic markets in FY12, in a year when it undertook a 15 per cent price hike.

Another point of note. While Asian Paints has the competitive advantage of getting away with price hikes in its decorative paints segment, it has not been a similar smooth riding for the company in the automotive and industrial paints segments which are traditionally not its core strengths and prone to more competitive intensity.

The company’s capacity expansion plans at its Khandala plant are on, capex for which is estimated around Rs 500 crore in the current financial. Phase I is expected to be completed by the last quarter of FY13. This would add 3 lakh KL to existing capacity. Total capex for the current year is estimated to be around Rs 750 crore.

Outlook and valuations: Asian Paints has managed to compound its EPS by an impressive 52 per cent annually in the last five years. The sector has positive long term prospects in a country with rising income and huge under-penetration. In such an operating environment, Asian Paints’ dominance in the domestic decorative market and high quality of earnings has meant that the company has been trading at a premium to the broadbased Sensex. At current prices, Asian Paints trades at 34 times its TTM earnings. Let pricing cool down before decorating your portfolio with Asian Paints.