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Muted sales growth leads to earning miss

* Asian Paints (APNT) reported flat volume YoY (est. 5% growth) and weakerthan-expected product mix in its 3QFY23 results. Consequently, EBITDA/ PBT/PAT missed our estimates by 10-11%.

* Management indicated that after a weak Oct’22, partly caused by high base, demand recovered YoY in Nov’22 before reaching double-digit sales growth in Dec’22. Nevertheless, we expect near-term volume to be under pressure with EBITDA margin under check for the next 2-3 years because of potential competitive pressures and expanding capacity.

* APNT’s valuations are fair at 52.7xFY24E and 46.4xFY25E EPS. We retain our Neutral Rating with a TP of INR3,090 (based on 50xFY25E EPS).

Flattish sales result in miss on EBITDA/PBT/PAT estimates

* APNT reported flat consol. net sales YoY at INR86.4b (est. INR92.9b).

* Volume was also flat YoY (est. +5% YoY) in the Domestic Decorative paints business.

* Gross margin expanded 180bp YoY/280bp QoQ to 38.6%. As a percentage of sales, higher employee costs (+50bp YoY) and other expenses (+80bp YoY) implied EBITDA margin expansion of 60bp YoY/410bp QoQ to 18.7% (est. 19.5%).

* EBITDA grew 4.5% YoY to INR16.1b (est. INR18.1b).

* PBT also rose 4.6% YoY to INR14.4b (est. INR16.3b).

* Adj. PAT grew 6.4% YoY to INR11b (est. INR12.2b).

* Sales/EBITDA/Adj. PAT in 9MFY23 grew 21.2%/30.8%/32.8% to INR257.1b/ INR44.0b/INR29.4b, respectively.

Key highlights from the management commentary

* Growth: The last year price increase was heavy with a 10% rise in Nov’21 and 5% in Dec’21; hence, volumes had gone up in anticipation of the same in 3QFY22 leading to a higher base. The 3QFY23 quarter was hit by monsoon extending into Oct’22. Demand recovered in Nov’22 and reported double-digit YoY sales growth in Dec’22.

* Margin band maintained: Margins are expected to improve going forward. The product mix will also improve sequentially in 4QFY23. Management indicated that APNT may see 4-6% gap between volume and value growth going forward (flat in 3QFY23). It maintained an EBITDA margin band guidance of 17-20% and gross margin band guidance of 38-40%.

* Capacity expansion: APNT is going to invest INR87.5b in the next few years including the recently announced INR20b Greenfield capacity of 400,000 KL. The capacity will be raised to 2.6m KL per annum post-expansion. The current capacity stands at around 1.7-1.8m KL.

Valuation and view

* Changes to our model have resulted in ~3-4% reduction in our EPS forecasts for FY23/FY24/FY25.

* With the entry of new players having deep pockets and massive commitments on investments, the overall industry may see a shift in demand and margin structure due to heightened competition. We remain cautious as the paints segment may not enjoy higher multiples of the past. It needs to be noted that re-rating was a bigger driver of stock price appreciation for APNT over the past 5-6 years, as earnings CAGR has been in the 10-12% range.

* We have assumed FY24 gross/EBITDA margins at the top end of the management’s guidance. While improving margins would lead to better ROCEs, new capex plans might dilute the same. The stock remains expensive at ~52.7x FY24E EPS and 46.4xFY25 EPS. We reiterate our Neutral rating with a TP of INR3,090 (premised on 50x FY25 EPS).

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