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Asian Paints: Global benefits - Views on News from Equitymaster

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Asian Paints: Global benefits
Jan 31, 2007

Performance summary
Asian Paints, the market leader in the domestic paint sector, has announced decent results for the third quarter and nine months ended December 2006. On a consolidated basis, revenues have grown by 17% YoY, led by its international operations. However, operating margins were slightly under pressure due to higher raw material costs. Despite this, net profits grew faster than operating profits owing to lower depreciation and tax expenses.

Consolidated results
(Rs m) 3QFY06 3QFY07 Change 9mFY06 9mFY07 Change
Net sales 8,023 9,356 16.6% 22,556 27,110 20.2%
Expenditure 6,930 8,122 17.2% 19,560 23,499 20.1%
Operating profit (EBIDTA) 1,094 1,234 12.9% 2,996 3,611 20.5%
Operating profit margin (%) 13.6% 13.2%   13.3% 13.3%  
Other income 80 76 -4.7% 203 236 16.5%
Interest 38 57 47.8% 92 147 60.0%
Depreciation & amortisation 159 147 -7.5% 479 438 -8.5%
Profits from associate company (0) (0) - (5) (4) -22.6%
Profit before tax 976 1,108 13.4% 2,623 3,259 24.2%
Tax 350 357 2.2% 970 1,068 10.1%
Profit after tax 627 750 19.7% 1,654 2,191 32.5%
Minority interest 4 38 - (14) 47  
Net income 623 712 14.3% 1,668 2,144 28.5%
Net profit margin (%) 7.8% 7.6%   7.4% 7.9%  
No. of shares (m)       95.9 95.9  
Diluted earnings per share (Rs)*         27.2  
Price to earnings ratio (x)*         29.2  
(*trailing 12-month earnings)            

What is the company’s business?
Asian Paints is the market leader in the Indian paint industry. It has an overall market share of around 49% in the decorative paints segment. It has benefited from steady transition in the industry towards consolidation, with top four organised players eating into the market share of the unorganised segment that controls 50% of the Rs 65 bn paint industry. Asian Paints, through a 50:50 joint venture with PPG Industries, US, also has presence in the automotive paints segment. The company has significant global presence through acquisitions, which are being restructured. The management of the company is acclaimed for consistently outperforming industry and its peers in the last decade. Though conservative in nature, the company is well focused on its core business of paints and has posted a CAGR of 14% over the last six years in topline (PAT CAGR at 16% during the same period).

What has driven performance in 3QFY07?
International business contributes: While Asian Paints’ standalone topline was higher by 13% YoY, on a consolidated basis, revenues grew at a faster clip of 17% YoY. Since the bulk of the festival sales had taken place in 2QFY07, sales growth in India was modest accounting for the slower growth on a standalone basis. As has been the case in the last two quarters, growth was not only witnessed in decoratives, but also on the industrial front. The consolidated topline grew at a faster pace largely due to the fact that the international business (including Berger International) recorded a robust 22% YoY growth during the quarter. This growth was largely attributed to the strong performance of the Middle East region. Having said that, in South East Asia, Sri Lanka and Bangladesh, while the topline growth has been good, the company still has a long way to go before it attains significant scale in these markets. We expect the topline to grow at a compounded annual rate of 14% over the next three years, while maintaining the view that the company will gain market share in the industrial segment (powder coatings especially) and also consolidate its standing on the decorative front.

Margin pressure: With petrochemical prices hardening and higher crude prices, operating margins at the consolidated level contracted marginally by 40 basis points in 3QFY07. However, for the nine-month period, the company managed to maintain its margins, which is commendable. We have actually factored in higher raw material costs in our estimates going forward, given the uncertainty on the crude price front.

Cost break-up
(% of sales) 3QFY06 3QFY07 9mFY06 9mFY07
Raw material costs 59.6% 60.8% 59.4% 59.6%
Staff costs 7.1% 7.0% 7.6% 7.2%
Other expenditure 19.6% 19.1% 19.7% 19.9%

Bottomline picture: Though net profit growth has outpaced the growth in operating profit at the consolidated level during the quarter, in our view, Asian Paints has a significant scope to unlock efficiencies in its global operations. Though some of the South East Asian operations will continue to remain a drag on the consolidated performance, we expect Berger International's operating margins to improve over the next three years.

What to expect?
At the current price of Rs 774, the stock is trading at a price to earnings multiple of 21.6 times our estimated FY09 earnings. While growth of the paint sector, on an average, is pegged at 1.5 to 2 times the GDP, with the latter expected to grow at a strong pace, the topline of Asian Paints is expected to register strong growth going forward. However, at the bottomline level, it will be some time before Berger International makes a significant contribution. Overall, the stock looks adequately valued from a medium-term standpoint.

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