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Margins disappoint, likely to recover by Q4

* APNT reported a big earnings miss (33% below estimates) due to a sharp fall in margins. Gross and operating margins fell ~10ppts due to the steep rise in input costs and slower price increases. Growth momentum was stronger as sales rose 33% (9% beat).

* In order to improve margins, management plans to expedite price increases and focus on formulation efficiencies. APNT expects margins to return to the normal range of 18-20% by Q4. We hence trim our margin forecasts from ~22% to 18.3%/19.8% for FY23/24.

* Growth momentum remained robust as APNT significantly outpaced most consumer peers in volume/sales growth. Bullish commentary, aggressive initiatives on portfolio and distribution expansion and revival in construction/industrial demand offer a strong outlook.

* With input inflation getting back to the peak, FY21 margins appear challenging. We raise sales estimates by 6%, factoring in the strong growth momentum, but reduce margin assumptions. As a result, we cut earnings estimates by 23%/13%/7% for FY22/23/24. Retain Hold with a revised TP of Rs2,800 (Rs2,960 earlier) based on 55x Dec’23E EPS.

Strong growth momentum continues; 2-year volume CAGR of 22%:

Total revenue grew 33% (2-year CAGR of 20%), with 34% volume growth in the domestic decorative segment driven by strong momentum in Tier 1/2 markets. As consumer confidence returned, domestic sales grew 36%, witnessing a turnaround in housing construction and industrial demand. Management noted expansion in the project business and home decor, continued momentum in waterproofing and market share gains in wood finishing.

The industrial coatings business grew 30-50%, aided by demand for protective coatings and upswing in the auto sector, though profitability was impacted. Commentary on rural markets was positive with a double-digit growth outlook on the back of favorable monsoons and a strong increase in network presence with 40,000 retail outlet additions in the last one and a half years (both direct and indirect).

Margins tank as input prices surge:

While APNT took a further price increase of 4% QoQ, input inflation rose 6% QoQ, leading to a 970bps YoY contraction in gross margins (down 370bps QoQ). EBITDA margin declined 1,090bps to 13% as overhead costs jumped by 53% due to higher freight and marketing spends. Management plans to expedite price increases and formulation savings (Rs3bn savings in H1) to offset rising inflation. APNT expects EBITDA margins to return to the normal range of 18-20% by Q4FY22.

Weak margin outlook limits upsides; retain Hold:

Growth momentum remains strong, thanks to APNT’s aggressive initiatives on portfolio and distribution expansion. However, the sharp contraction in margins due to high input inflation leads us to reduce our margin assumptions. Accordingly, we cut earnings estimates by 23%/13%/7% for FY22/23/24 . Despite recent underperformance, valuations (71x FY23EPS) are unattractive. Retain Hold with a revised TP of Rs2,800 (from Rs2,960) based on 55x Dec’23E EPS.

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