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Better mix to offset material cost pressures in the near term

We spoke to a cross-section of APNT’s channel partners across Tier I/II/III cities. However, the sample size of our channel checks is limited and our findings may differ from broader demand trends. Some of the key highlights are as follows:

* Demand is better in urban cities than smaller towns and rural areas, especially after the steep price increases. Slower sales growth in Putty and the continued premiumization trend, after the lifting of COVIDrelated restrictions, augurs well for near-term margin and consequently our forecasts do not feature a material sequential decline in operating margin in 1HFY23, despite elevated titanium dioxide (TiO2) and crude oil prices.

* There has been a slowdown in the demand momentum in the last few weeks, starting from the latter part of Jun’22 – a usual phenomenon during the monsoons. In some pockets though, the slowdown is more marked than usual and needs to be monitored.

* There has been a strong demand recovery in Automotive and Industrial Paints in recent months.

Rising competition poses a risk to medium-term earnings and multiples

* In the near term, we expect APNT to deliver double-digit growth and margin expansion on account of a better mix, even though crude oil and TiO2 prices remain elevated as highlighted in our recent commodity costs note.

* We expect double-digit growth for the industry in the medium to long term, aided by

* A revival in Real Estate demand, leading to healthy growth in the Decorative Paints segment;

* Increase in Industrial demand over the medium term, with various manufacturing capacities coming up; and

* Greater demand from the Automotive sector.

* We also expect overall industry capacity to increase with the entry and sizeable capex plans of new players. With the entry of new players with deep pockets, the overall industry may see a paradigm shift in demand and margin structure due to the heightened competition. We remain cautious as the sector may not enjoy the high multiples of the past.

* APNT has delivered an earnings CAGR of 11.6% over the past five years (FY17-22), while the stock price has delivered 24.1% CAGR, implying a significant re-rating. We have assumed FY24 gross/EBITDA margin at the top end of the management’s guidance of 41-42%/18-20%. While we expect RoE to improve, it will still be lower than the 30-40% recorded in the first half of the decade gone by. At 54.1x FY24E P/E, the stock remains expensive. We maintain our Neutral rating.

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