With soaring crude oil prices fueling inflationary worries globally amid war raging in Europe’s breadbasket, the most consistent performer on the widest gauges of the India lost about an eighth of its value over a week. For this period at least, Asian Paints looks decidedly more anemic than the Nifty, which lost 2.5%.
But should this haemorrhage discourage long-term bets on the title of India’s biggest painting group? Not really, as Asian Paints has a dominant market share and a strong track record of profitability.
Raw derivatives account for 30-40% of raw material costs for large paint companies like Asian Paints. Additionally, the stock was trading at a relatively higher valuation, and when commodity inflation rises, the erosion of pricing power impacts margins.
“The company derives higher sales from solvent-based paints. This will have a large impact of a sharp increase in crude prices on profitability in the coming quarters, especially from the June 2023 quarter,” said Kaustubh Pawaskar, analyst at Sharekhan. “The industry could opt for another round of price increases in the range of 4-5% to ease cost pressure. Price increases will impact sales volume in the short term, especially in rural markets.
For the nine months ended December 2021, Asian Paints had raised prices by 18% to 22% to ease pressure on input costs. Price increases in excess of 20% helped shore up gross margins for most paint companies.
Every 1% increase in gross derivatives costs could have a 1.3% impact on Asian Paints earnings, assuming no change in volume and product realizations.
Even after the recent drop, analysts said stock valuations still aren’t cheap. The stock is up 171% over the past five years, compared to an 83% jump for the Nifty index. As a result, the stock was trading at a price-to-earnings ratio of 84 times its trailing 12-month earnings, compared to its five-year average PE of 57. After correcting almost 24% from its peak of 52 weeks, the stock is currently trading at a one-year forward PE of 73 times from around 94 in early January.
“The costly valuation and the significant rise in oil prices have prompted investors to be cautious,” said Vinod Nair, head of research at Geojit Financial Services. “Currently, management is focused on increasing market share, which may prevent them from taking further aggressive price increases.”
However, most analysts suggest the correction be seen as an opportunity, as the long-term outlook is bright due to the shorter paint cycle, urbanization, and increased demand from Tier 1 and 2 cities. Bloomberg consensus estimates suggest a 25% rise for Asian paintings from the current level over the next year.
According to Sharekhan’s Kaustubh Pawaskar, any correction in a quality stock like Asian Paints is a great buying opportunity given its long-term growth prospects.
Foreign investors own about a fifth of the company, and the current weakness is the result of relentless global fund selling.
Latika Chopra, an analyst at JP Morgan, believes the company is a good long-term holding, with attractive growth prospects for the core decorative portfolio, good execution and medium to long-term upside potential. thanks to new growth forays into the decor space.