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Below our estimates, but better than peer trends resume

While INDIGOPN’s 2QFY23 result was below our estimates it did not witness the huge mix deterioration reported by its peers. Consequently, the three-year sales CAGR stood at 23.6%, which is better than both APNT and KNPL, two of its Paint peers to have reported their results so far. While INDIGOPN posted much lower sales, the momentum seen in FY22 v/s its peers seems to be returning.

The management indicated a continued sales momentum and a significant pick up in margin in subsequent quarters, led by lower commodity cost pressures. We maintain our Buy rating.

Sales in line; higher than expected pressure on GM

* Net sales grew 23.7% YoY to INR2,426m (in line).

* Gross margin remained flat YoY at 41.7%, but contracted by 350bp QoQ (est. 45.5%). This, along with stable employee costs (up 20bp YoY) and lower other expenses (down 220bp), as a percentage of sales, aided the expansion of ~200bp YoY (but contracted by 180bp QoQ) in EBITDA margin to 13.9% (est. 17.5%).

* A&P spends decreased by 7% YoY to INR146.5m. However, the same rose 13.6% YoY in 1HFY23.

* EBITDA grew 45% YoY to INR338m (est. INR429m). ? PBT increased by 53% YoY to INR282m (est. INR366m).

* Adjusted PAT rose 53% YoY to INR208m (est. INR274m). ? We have adjusted INR163.3m pertaining to the excess tax provision of earlier years being reversed in 2QFY23.

* Sales/EBITDA/adjusted PAT grew 33%/59%/62% to INR4,666m/ INR690m/INR407m in 1HFY23.

Highlights from the management commentary

* Demand: The management expects the loss in demand due to an early Diwali and an extended monsoon (Oct’22 was a dull month) to get covered by Dec’22 or Jan’23.

* Kerala performed extremely well in Oct’22. It was a blended impact of the campaign launched on 15th Sep’22 and a normalized monsoon in the state.

* EBITDA margin is higher in the third quarter and the highest in the fourth quarter vis-à-vis the second quarter. The management expects a healthy improvement in gross margin and EBITDA margin.

* Price hike: The management raised prices by 20% in the past 12 months. There is no need for further price increases or decreases in the industry. As raw material prices are softening, trade discounts may be used aggressively by the industry.

Valuation and view

* As a result of the 2Q miss, the changes to our model have led to a 16% reduction in our FY23 EPS estimate. However, good sales momentum at a time when its peers are slowing down, and a sharp likely improvement in incremental margin meant that our FY24 EPS forecast has not seen any major cut.

* INDIGOPN has successfully surmounted the high entry barriers of the Indian Paints industry, through its patient and multi-pronged strategy, comprising: a) introducing of differentiated products, b) purposefully building a distribution network via rural markets, c) creating brand equity through high investments in advertising, d) rapidly driving the penetration of tinting machines, and e) engaging with influencers (painters/contractors) to build trust as indicated in our initiating coverage note in Dec’21.

* We maintain our Buy rating with TP of INR1,720 (40x Sep’24E EPS).

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