Asian Paints: Increasingly outsourcing

Asian Paints, the market leader in the Indian paint segment, has targeted a turnover of Rs 21 bn by FY03. However, it is operating at a capacity utilisation of 87.5%. Will the company be able to achieve this in light of current capacity constraint and subdued demand scenario? Asian Paints has a aggregate paint capacity of 162.7 THTPA (thousand tonnes per annum). Paint production in FY01 stood at 147.8 THTPA or 87.5% capacity utilisation. The other two key divisions of the company viz. Pthalic Anhydride and Pentaerythritol are also operating at 84% and 100% capacity utilisation respectively. The Pthalic plant's capacity has been increased by 2 THTPA to 24THTPA in the current year. Asian Paints utilises 69% of the production of Pthalic and 32% of production of Penta for captive consumption. However, in terms of total sales, they contributed just 6.8% in FY01. The contribution is expected to remain at the current levels, if not a decline, in coming years.

The company has been altering its production mix in recent years, where the proportion of contract manufacturing/purchases have gone up significantly. In FY01, while the in-house manufacturing increased by just 1.8%, contract manufacturing/purchases increased by a sharp 38.1%. As a result, the company has managed to increase realisation, albeit marginally, by 0.6%. Given the prevailing demand scenario and falling prices, this is a commendable performance. But this was also led by a buoyant exterior paint market, which has been growing at a CAGR of around 20%. Though margins are thin, volumes have been growing at a faster pace (exterior segment contributed to almost 10.4% of Asian Paints FY01 turnover).

Given the company's stiff target of Rs 21 bn turnover by FY03, the company will have to grow at a CAGR of almost 18% in the next two years to meet the target. However, Asian Paints has applied to the Pollution Control Board for permission to increase production within the current permissible limit of installed capacity. But permission from the board is yet to be received. If the company manages to receive a go-ahead from the board, the paint capacity will go up by 60 THTPA to 228 THTPA, a increase of 35.5% of the existing capacity. We expect the outsourcing proportion to remain at the current levels in the coming years even if the company manages to increase in-house paint manufacturing capacity.

The scrip is currently trading at Rs 258 at a P/E multiple of 19.2x annualised 1QFY02 earnings. Apart from capacity constraint, paint demand has also slowed down and is apparent from the quarterly trend in FY01. While sales grew by 19.2% in 1HFY01, turnover grew by just 6.1% in 2HFY01. The earthquake in Gujarat and a less than normal monsoon affected rural paint demand in FY01. Though monsoons are good in the current financial year, it remains to be seen whether this results in higher topline growth, which is expected only in 2HFY02. But there is one favorable factor. The festive season falls in the second half of the current year. Historically, paint demand has grown at a faster pace if the festive season falls in the second half. So, this along with a good kharif output could actually give the necessary impetus for the topline growth.