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Healthy demand growth leads revenue beat, valuations expensive

* The momentum witnessed in Feb-Mar’22 sustained in 1QFY23, leading to a 10-12% beat in sales/EBITDA/PAT v/s our expectations.

* EBITDA margin was in line with our forecasts and as expected (highlighted in our channel check note) was supported by ongoing mix improvements, even as commodity cost pressures sustained at higher levels in 1QFY23.

* The current valuations (~50.9x FY24E P/E) fully capture the upside over the next one-year. We maintain our Neutral rating

Sales led earnings beat

* Net sales grew 54.1% YoY to INR86.1b (est. INR78.2b). Volume growth stood at 37% (est. 26%) in the domestic Decorative Paints business.

*  Gross margin fell 70bp YoY to 37.7%. As a percentage of sales, lower employee costs/other expenses (down 200bp/40bp YoY) led to a 170bp expansion in EBITDA margin to 18.1% (est. 18%).

* EBITDA grew 70.3% YoY to INR15.6b (est. INR14.1b).

* PBT grew 81.5% YoY to INR14.2b (est. INR12.7b).

* Adjusted PAT grew 84.6% YoY to INR10.6b (est. INR9.5b).

* Three-year revenue/EBITDA/PAT CAGR stood at 19%/10.3%/16.3%.

Key highlights from the management commentary

* Demand in Tier I and II centers is growing faster as was the case in 4QFY22, leading to better mix, especially in sales of products like premium emulsions. Tier III and IV centers are seeing some downtrading due to steep price increases.

* APNT saw a further 6% sequential RM inflation in 1QFY23. It has raised prices by 2% in 1QFY23. Sequential inflation in 2QFY23 is likely to be in low single-digits (and ~25% YoY). While crude oil prices are coming down, the depreciation in the INR v/s the USD is impacting margin, as inflation in other RM.

* APNT is likely to raise prices by 0.5% in the first week of Aug’22. It is taking measured increases so as to not upset the demand environment.

* Gross margin is likely to remain in the 38-40.5% band for some time

Valuation and view

* A better-than-expected sales momentum has led to a 3%/8% increase in our FY23/FY24 EPS estimate.

* 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 we expect RoCE to improve, it will still be lower than the 30-40% recorded in the first half of the decade gone by. The stock remains expensive ~50.9x FY24E P/E. We maintain our Neutral rating with a TP of INR3,170 per share (50x Jun’24E EPS).

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