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Growth momentum continues unabated, RM inflation and valuation possible headwinds

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In line with our view, the stock has seen a strong outperformance and is now trading at all‐time high valuation multiple of 68x FY23 and 59x FY24 consensus earnings. While the strong demand outlook in the near‐term and pricing actions driving margin recovery can help sustain premium valuations, there is limited room for positive surprises from here. Further rise in material inflation and margin/ROCE dilution due to diversification could be risks to an otherwise flawless execution story. Given limited absolute upside, we don’t recommend aggressive buying at current levels.

Strong double‐digit volume growth on 2/3 yr‐CAGR basis despite May weakness ‐ Continued momentum from last quarter witnessed in April, May impacted by second wave, strong uptick again in June driving strong volume growth trends; 1Q saw decorative volume growth of 106% yoy, 2‐yr CAGR of 12.7% and 3‐yr CAGR of 14%, decorative value growth of 95% yoy, 2‐yr CAGR of 4.5% and 3‐yr CAGR of 8.8%.

Results summary – Revenue/EBITDA/PAT growth of 91%/89%/161% yoy on a small base, EBITDA margins at 16.4%, down only 20bps yoy led by strong cost controls and operating leverage; Gross margins down sharply by 600bps in 1Q; after 8‐10% material inflation in 4QFY21, another 13‐15% inflation in 1Q; 3% price increase taken in 1Q, 1% in July and further increases being planned dependent upon currency and RM price movement

Segmental update – Metros and Tier 1 markets grew much faster than Tier 3,4 markets unlike last year, South markets impacted by protracted restrictions, economy and luxury range led growth, robust growth in projects and large institutional sales, waterproofing growth trajectory continued in retail, adhesive business now doing well, wood finishes category gaining strong traction.  

New launches – Aggressive innovation with launch of new fire retardant paint, teflon luxury paint, tile grout and premium wood finish.

Distribution initiatives  ‐ Enhancing rurban footprint with addition of Colour Worlds in new markets, 6 new Colour Ideas stores opened.

Home Décor business ‐ 18 Beautiful Homes stores functional now (15 in pipeline) which offer furniture, furnishing, lighting, bathroom, kitchen under one roof; partnership with Pure Brand for furnishings, wallpapers yielding good results; also entered premium designer tiles segment.

International business – 50% plus revenue growth led by Asia and Middle East, Africa impacted by local challenges, focused growth in waterproofing and increasing share of premium emulsions, gross margins impacted driving PBT loss despite 10% price hike due to material inflation.

Industrial business – Auto OE and refinishes JV faced challenges with bodyshops under timing restrictions, industrial paints did really well across segments; margins supported by cost controls despite GM pressure.

Home Improvement – Kitchen business did really well even after factoring in low base, growth supported by luxury offerings and full kitchen dealer additions, breaking even now; bath business also did reasonably well led by growth in projects, almost reached break‐even.

Outlook – Demand outlook remains positive with pent‐up demand expected in 2Q, good monsoon forecast bodes well for strong rural demand, long Diwali season should help Sep‐Oct retail sales, early signs of softening material inflation.

Commercialization prospects of strong patent repository – Most patents in industrial paints, working on unique patented products in decorative paints as well both in terms of technology and product properties to get edge over competition, also working on improving formulation efficiencies.

Consumption outlook ‐ Believe India remains a consumption‐driven market and demand will pick up sharply once markets open up further helped by pent‐up demand, most industry players across consumption categories preparing for a demand surge.

Margin outlook – Focused on maintaining EBITDA margins in the 19‐21% band, will attempt to offset gross margin pressures by controlling other cost heads.

Large vs small cities  ‐ Smaller towns recovery has been impacted due to higher COVID ingress, large cities have recovered much faster growing at 25‐30% higher growth rates than smaller markets.

Revenue mix  ‐ With coatings business expected to grow at 15% plus, new business contribution should remain in single‐digits for the next few years.

Risks and capacity utilization ‐ No demand headwinds as of now for any specific categories, risk remains of some downtrading given impact on purchasing power, capacity utilization in July at 70‐75% levels.

Organized vs unorganized players – About 100 unorganized players might be doing annual revenue of 30‐500cr, so difficult to quantify share gains, but regional players have done relatively better than pan‐India unorganized players, APNT mainly gained share from organized players which should sustain going forward.

Reducing linkage with crude prices – With business shifting towards water‐based paints, linkage of crude prices to margins coming down.

Product mix – Value growth much lower than volume growth (11% gap vs 7‐8% normal level) but not a correct benchmark currently due to COVID disturbance in demand pattern; medium term efforts underway on premiumization across markets; growth rate in economy and luxury segments higher than middle and premium segments.

COVID impact on topline – Minimal sales impact in 1Q as were able to recoup a big chunk of lost sales of May in June, operational disruptions were definitely there.

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