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Margin recovery slower than expected; volume growth healthy

* Asian Paints (APNT) delivered volume growth ahead of our estimates (18% v/s expectation of 15%), while its sales growth was marginally lower. However, EBITDA, PBT, and PAT were below our estimates by 12–15%, leading to a ~10% reduction in our FY22 EPS forecasts.

* Nevertheless, there is no material change in FY23E/FY24E EPS as demand continues to be healthy and margins would rebound on account of the sharp ~15% price hikes taken in 3QFY22. 4QFY22 is seeing some demand impact due to the Omicron wave; however, this is not too concerning as there has been a strong rebound in discretionary demand, including for paints, in the aftermath of the previous COVID waves

* While the outlook is good for the next couple of quarters, no change is expected in the medium to longer term growth prospects of 12–13% sales growth in the Paints industry. Earnings growth is also likely to be broadly in the 15–16% range over the next 4–5 years. The earnings CAGR for the past 3/5 years ending FY22E is likely to be around 15%/11%. Valuations are also rich at 66x/57x FY23E/FY24E EPS.

Strong sales momentum; price hikes improve margins sequentially

* Consol. net sales grew 25.6% YoY to INR85.3b (in-line). Volume growth stood at 18% (est. 15%) in the domestic Decorative Paints business.

* Gross margins were down 830bp YoY to 36.8%. Along with lower employee costs as a percentage of sales (-40bp YoY) as well as higher other expenses (+30bp YoY), this meant that the EBITDA margin contracted 820bp YoY to 18.1% (est. 19.8%).

* EBITDA declined 13.7% YoY to INR15.4b (est. INR17.5b).

* PBT declined 17.5% YoY to INR13.8b (est. INR16b).

* Adj. PAT declined 18.5% YoY to INR10.3b (est. INR12.1b).

* 9MFY22 sales grew 40.8% YoY, whereas EBITDA / adj. PAT declined 5%/5.4% YoY.

Highlights from management commentary

* APNT gained value market share of 270bp from other organized players in 2QFY22, which persisted in 3QFY22 as well. It has also gained some share from unorganized peers.

* Urban recovery has been good and the Projects business (builders, government) has done very well, contributing to growth. APNT is strong in both these areas.

* The management expects RM inflation to be higher going forward, albeit not at the same level of increase as seen in recent quarters. APNT took a 15% price increase in 3QFY22, leading to a ~22% increase YTD. The full impact of the price increases would be realized in 4QFY22, leading to improved sequential margins.

* Currently, capacity utilization stands at 70–75%. APNT may need a fresh round of capex within 2–3 years.

Valuation and view

* The miss on earnings has led to a 9.8% cut in FY22 EPS, but there have been no material changes in our FY23 and FY24 EPS estimates.

* While sales growth was impressive in 3QFY22, even on a reasonably high base of the previous year, it remains to be seen how the company will fare on the demand front in subsequent quarters – especially as a) festive demand drivers would no longer be at play and b) the sales growth base is even more challenging going forward.

* Valuations are expensive at 66x/57x FY23E/FY24E EPS. We maintain our Neutral rating, with TP of INR3,500 on 60x Mar’24E EPS, which leaves little room for an upside.

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