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Asian Paints: Question of valuations! - Views on News from Equitymaster
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Asian Paints: Question of valuations!
Oct 26, 2005

Performance Summary
Asian Paints, the market leader in the paints sector, announced its results today. While consolidated net profit during the quarter was higher by 16%, operating margins improved significantly on the back of improved efficiency in subsidiaries' operations. This combined with the balance sheet restructuring of Berger Paints International has resulted in a healthy profit before tax growth of 18% YoY.

Consolidated results
(Rs m) 2QFY05 2QFY06 Change 1HFY05 1HFY06 Change
Net sales 6,674 7,729 15.8% 12,007 14,359 19.6%
Expenditure 5,782 6,640 14.8% 10,389 12,457 19.9%
Operating profit (EBIDTA) 892 1,089 22.0% 1,618 1,902 17.6%
Operating profit margin (%) 13.4% 14.1%   13.5% 13.2%  
Other income 131 68 -47.9% 157 123 -21.7%
Interest 33 29 -10.6% 61 53 -12.7%
Depreciation & amortisation 174 159 -8.4% 347 320 -7.7%
Profits from associate company 0 (5) - 2 (5) -
Profit before tax 817 963 17.9% 1,369 1,647 20.3%
Extraordinary items (5) (17) 282.7% (4) (16) -
Tax 312 369 18.6% 528 620 17.4%
Profit after tax 501 576 15.0% 836 1,012 20.9%
Minority interest 13 (15) - 23 (18) -
Net income 487 592 21.4% 814 1,029 26.5%
Net profit margin (%) 7.5% 7.5%   7.0% 7.0%  
No. of shares (m) 95.9 95.9   95.9 95.9  
Diluted earnings per share (Rs)* 20.3 24.7   17.0 21.5  
Price to earnings ratio (x)         23.0  
(* annualised)            

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 paint 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, USA, 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% in the same period).

What has driven performance in 2QFY06?
India paints business sets the pace: The company's domestic paints business grew at 22% YoY in the first half of the fiscal year, led by both exteriors and industrial paints. To put things in perspective, industrial paints division grew by over 30% YoY in the second quarter. We have been believers in the fact that the company would be able to replicate its exterior segment experience in industrial paints segment for long now. In the last three to four quarters, it has actually started to make a more meaningful contribution on its own. We expect this trend to continue. While we do not have much information on key subsidiaries for this quarter, the improvement in profitability of Berger International is palpable. We expect India revenues to continue to remain the key growth driver in the medium-term. Once the subsidiary restructuring is completed and depending on the exchange rate, the subsidiary contribution will increase going forward.

Operating margins improve: Despite the rising input costs, arising out of firmness in key crude related products, the consolidated margins in 2QFY06 have improved. This, we believe, is the benefit of the ongoing cost restructuring of its overseas operations as well as increased capacity utilisation in the domestic market. However, looking at the outlook for titanium dioxide (one of the key raw materials), we believe that the full year margins are likely to be lower going forward.

Decent profit growth: The company's PBT in 2QFY06 grew by 18%, despite a significant decline in other income on account of lower depreciation and interest charges. The company closed down two of its international units that were ascertained as unviable and therefore, the decline in depreciation in 2QFY06. Also the fact that Asian Paints is restructuring debts of key subsidiaries like Berger International explains the reason for the fall in interest expense. We have mentioned time and again that the consolidated margins is expected to improve much faster, despite higher raw material prices.

What to expect?
The stock currently trades at Rs 494 implying a price to earnings multiple of 23 times annualised 1HFY06 earnings. Despite promising domestic opportunities and upside from global operations, we remain cautious about the company's margins going forward. Globally, the demand-supply equation for the key raw material like titanium dioxide is not favorable and to that extent, profits will be under pressure. However, the decline in crude prices has resulted in softening of some petrochemical product prices, which will benefit the company going forward. We had recommended the stock at Rs 345 in February 2005 with a target price of Rs 450 with a two year perspective, which has been achieved. We believe that at current valuations, risk-return matrix is equally poised and therefore, we have a HOLD view on the stock.

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