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Big miss on sharp material cost inflation

* While the sales growth trend was healthy and the outlook remains positive, the lowest EBITDA margins in 50 quarters led to a ~38% miss on our forecasts at the EBITDA and PAT levels.

* The management stated that material cost inflation was the highest in four decades, and it expects this trend to persist over the near term. Further price hikes (in addition to a 4% increase in 2QFY22 and 3.5% increase in 1QFY22), cost savings, and raw material substitution could mitigate the sequential impact going forward.

* While the demand outlook remains strong, the company is also confronted with a higher base in 2HFY22, with sales growth of 25.2%/43.5% in 3QFY21/4QFY21.

* The company’s focus on topline growth and ensuing market share gains would lead to healthy earnings over the medium-to-long term. Nonetheless, earnings for the next few quarters would be affected by intense margin pressure. We maintain our Neutral rating.

Robust sales performance, sharp RM inflation lead to EBITDA decline YoY

* Consol. net sales grew 32.6% YoY to INR71b (est. INR76b). Volume growth stood at 34% (est. 45%) in the domestic Decorative Paints business.

* Gross margins were down 970bp YoY to 34.7%. Along with lower employee costs as a percentage of sales (-90bp YoY) and higher other expenses (+210bp YoY), this meant that the EBITDA margin contracted 1090bp YoY to 12.7% (est. 19.1%).

* EBITDA declined 28.5% YoY to INR9b (est. INR14.5b).

* PBT declined 28% YoY to INR8.2b (est. INR13b).

* Adj. PAT declined 29% YoY to INR6.1b (est. INR9.7b).

* 1HFY22 sales / EBITDA / adj. PAT grew 53.3%/3.9%/10.1% YoY.

* The company has announced an interim dividend of INR3.65 per share.

Highlights from management commentary

* Asian Paints (APNT) saw good demand recovery from June. The outlook is also good with the festive season going well.

* 18–20% YoY RM inflation has not been seen for the last four decades. Even when crude was at USD130 over FY12–13, other raw materials were softer. Furthermore, there is instability in terms of some raw material availability. This is increasing the lead times as well.

* APNT took a 4% price increase in 2QFY22 on a 6% sequential RM cost increase during the quarter. It has taken a 7.5% price increase YTD.

* The management expects RM inflation trends to persist. The company would take further price increases over the next three months.

Valuation and view

* The big miss on the results has led to a 22.7%/7% cut in our FY22E/FY23E EPS.

* Valuations are expensive at 69x FY23E EPS. We maintain our Neutral rating, with TP of INR2,930 on 60x Dec’23 EPS.

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