• MARCH 12, 2013

What we liked about this multibagger in 2002?

When Equitymaster recommended Asian Paints in 2002, the company had operations in 24 countries, with market leadership in 11 of them. With 30% share of domestic paint market, it logged turnover of around Rs 130 bn in FY02. But it was neither the size nor the market share that gave us comfort. In fact, it was the commitment of its management and ability to steer the business in the right direction that mattered.

It was not always a fairy tale ride for Mr Ashwin Dani, whose father co-founded the paints conglomerate in 1968. In October 1997, Mr Dani warded off a serious takeover threat by the Indian subsidiary of UK-based ICI Plc. That was not all. Mr Dani was also fighting to take charge of Asian Paints and to keep its three co-promoters, the Vakils, Danis and Choksis, together. This in the face of a secret deal by the then MD Atul Choksey to sell his 9.1% holding to ICI UK. Mr Dani's perseverance and ability to take competitors head on inspired confidence.

It was a different matter that in 2003, Mr Dani turned the tables on ICI Plc by acquiring the government's 9.2% holding in the company. But that the company had the making of bluechip were evident even a decade back.

The masterstroke

Differentiating itself in a largely unorganized sector and making headway amongst several competitors was not easy. However, Asian Paints' computerized dealer tinting machines changed all that way back in the year 2000. Tinting machines were appealing to not just the retail customers but to the dealers too. On one hand it increased customer involvement. On the other, it ensured that the dealer saved on inventory costs. The number of such outlets increased from 1,252 in FY00 to around 2,700 by FY02. This was therefore the masterstroke that helped the company build a wide moat of brand and dealer network. One that ensured that the gap between Asian Paints' and its closest peers' operating and net margins increases exponentially. Hardly in 3 out of last 10 years have the gap between Asian Pant's and its peers operating and net margins been less than 30%. That its peers like Kansai Nerolac and Berger clocked margins that were nearly 30% lower than that of Asian Paints.

Making competition irrelevant

Asian Paints has had to fend off not two but several competitors over the years. But early on, it displayed the ability to marry technology with marketing prowess and render competition irrelevant. Also the company did not focus too much on the industrial segment that already had too many players. Plus it offered lower pricing power. Instead it built capacities, brands and distribution network to make its decorative paint segment insuperable.

Ability to acquire fledging businesses and turn them around

Asian Paints' global presence has been strengthened by its international subsidiaries, Berger International, Apco Coatings, SCIB Paints and Taubmans. It also has a joint venture with PPG Inc, USA, one of the largest automotive coatings manufacturers in the world. This JV has helped Asian Paints service the growing demand for automotive coatings in India. The integration of these subsidiaries, some of which were fledging businesses at one point of time, has been a critical factor in Asian Paints' sustained profitability.

What could have gone wrong...but did not!

Asian Paints ventured on massive capacity expansion as the construction and housing industry began to look up. The company has increased its plant capacity by nearly 159% over the past decade as its volume sales doubled every five years. Given its concentration on the retail segment, any policy bottleneck for the housing sector could have impaired capacity utilization. Having said that, this was a calculated risk. Since most of Asian Paints' capex came through internal accruals we knew that the company could withstand volume pressure for temporary periods.

As mentioned earlier, we gave a lot of weightage to the company's Colour World initiative. Instead of being sidelined by more technology intensive applications of its peers, Colour Worlds kept adding to Asian Paints' topline and bottomline over the past decade. The total number of Colour Worlds crossed 20,500 in September 2012. Moreover, the company has added 28 Colour Ideas stores that enhance customer participation in choice of products.

The pace of turnaround of new subsidiaries is something we were skeptical about and had mentioned the same in 2002 itself. However, the company managed to allay our concerns and overtime turned the subsidiaries into its strengths.

Valuations speak for themselves

The stock price of Asian Paints went up 8.82 times (783%) between 2002 and October 2010 when we recommended Sell on it for the first time. The PE multiple awarded by the market to the stock had moved up from around 18 times in 2002 to around 25 times in 2010. Current PE valuations on trailing twelve month earnings is a notch above 40 times! That the valuations offer the stock a premium for a yawning gap in fundamentals of itself and its peers would be an understatement. Having proven itself on many counts over the past decade, we believe that Asian Paints will continue to reinvent itself. Profitability and shareholder returns are also likely to be most resilient to macroeconomic risks.

However, bought at the current valuations, we do not think the stock can prove to be a multibagger in one's portfolio over next 10 years, as was the case in the past decade. Investors will have to wait for more reasonable valuations to achieve the same.

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