With surging crude oil prices stoking inflationary concerns globally amid the raging war in Europe’s bread basket, the most consistent performer on India’s broadest gauges shed about an eighth in value over a week. Through this period at least, Asian Paints looks decidedly more anaemic than the Nifty, which shed 2.5%.
But should this haemorrhage discourage long-term bets on the stock of India’s biggest paints company? Not really, as Asian Paints has a dominant market share and strong profitability track record.
Crude derivatives form 30-40% of raw material costs for large paint companies like Asian Paints. Also, the stock was trading at a relatively higher valuation, and when raw material inflation rises, erosion of pricing power impacts margins.
“The company is deriving higher sales from solvent-based paints. This will have a large impact of a sharp increase in the crude prices on profitability in the quarters ahead, especially from June 2023 quarter,” said Kaustubh Pawaskar, analyst, Sharekhan. “The industry might opt for another round of price increase in the range of 4-5% to mitigate the cost pressure. Price hikes will impact the near-term sales volume, especially in the rural markets.”
For the nine months ended December 2021, Asian Paints had raised prices 18%-22% to mitigate the pressure on input costs. Price increases in excess of 20% helped shore up gross margins for most paints companies.
Every 1% increase in crude derivative costs could impact Asian Paints earnings by 1.3%, assuming no change in volume and product realizations.
Even after the recent decline, analysts said the stock valuations are still not cheap. The stock has rallied 171% in the past five years, compared with an 83% jump by the Nifty index. As a result, the stock was trading at a price-to-earnings ratio of 84 times its trailing 12 months earnings, compared with its five-year average PE of 57. After correcting nearly 24% from its 52-week high, the stock is currently trading at one-year forward PE of 73 times compared with around 94 in early January.
“The expensive valuation and significant rise in oil prices have led to caution among investors,” said Vinod Nair, head of research at Geojit Financial Services. “Currently, the management is focusing on increasing the market share, which may prevent them from taking further aggressive price hikes.”
However, most analysts suggest the correction be taken as an opportunity as the long-term outlook is bright due to the shorter repainting cycle, urbanization, and higher demand from Tier 1 and 2 cities. Bloomberg consensus estimates suggest a 25% upside for Asian Paints from the current level in the next one year.
According to Kaustubh Pawaskar of Sharekhan, any correction in a quality stock like Asian Paints is an excellent opportunity to buy considering its long-term growth prospects.
Overseas investors own about a fifth of the company, and the current weakness is an outcome of relentless selling by global funds.
Latika Chopra, an analyst at JP Morgan, believes the company is a good long-term holding, benefiting from an attractive growth outlook for the core decorative portfolio, good execution, and potential mid-to-long-term upside from new growth forays in the home decor space.
