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Weak mix impact realization and margin

 * Results were well below estimates as realizations and gross margins were severely impacted, primarily led by product mix deterioration caused by (a) slower growth in high margin urban sales unlike the preceding couple of quarters and (b) the adverse impact of downtrading. The management guided that recovery in margins is expected to be gradual with majority of raw material (crude price) cost decline likely to come in only from 4QFY23 onwards.

* APNT also announced its capex plans for the next three to four years with a total outlay of INR67.5b. It will be expanding its existing capacity by 30% to 2.27m KL p.a. It plans to set up a new facility to manufacture VAM/VAE with a capacity of 0.1/0.15m tonnes p.a. and acquire a nanotechnology player ‘Harind’, which is into surface coating.

* The current valuations (~53.6x FY24E P/E) fully capture the upside over the next one year. We reiterate our Neutral rating on the stock.

Key highlights from the management commentary

* Tier 3/Tier 4 cities are witnessing double-digit growth and it is higher than Tier 1/Tier 2 cities.

* Product mix was dominated by economy emulsions and undercoats. Downtrading was evident in the luxury and premium category, due to steep price increases over the last six months.

* Sustainable gross margin going ahead to be in the range of 39-40%.

* Total capex outlay is expected to be ~INR67.5b over the next three to four years, including capex related to acquisitions, and brownfield and greenfield expansions.

Valuation and view

Changes to our model have resulted in an 18%/10% decline in our EPS forecast for FY23/FY24, respectively. Product mix deterioration led by downtrading and lower than expected urban salience were key factors for sales miss. As a result of which, over 20% price increase YoY and ~10% volume growth YoY has only resulted in ~19% sales growth in reported numbers. The Management also mentioned that the extended and higherintensity monsoons in September adversely impacted demand. With product mix deterioration and rupee depreciation playing spoilsport, margin gains in 2HFY23 (led by fall in crude) would not be as sharp as expected earlier.

* With the entry of new players with deep pockets and massive commitments on investments, the overall industry may see a shift in demand and margin structure due to the heightened competition. We remain cautious as the sector may not enjoy the higher multiples of the past. APNT has delivered 11.6% earnings CAGR over the past five years (FY17-22), while the stock price has delivered 24.1% CAGR, implying a significant re-rating. We have assumed a FY24 gross/EBITDA margin at the top end of the management’s guidance. While improving margins would lead to better ROCEs, the new capex plan might dilute the same. The stock remains expensive at ~53.6x FY24E P/E. We reiterate our Neutral rating with a TP of INR3,150 (50x Sep’24E EPS).

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