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Muted sales growth; demand improving further

* APNT reported volume growth of 6% in 2QFY24 (est. 8%). The management highlighted a top-line moderation, citing weakened consumer sentiment and emphasizing the sensitivity of demand growth to unpredictable rainfall patterns. Additionally, a decline in demand was observed in rural markets, with urban centers showing better performance than their rural counterparts.

* Gross margins currently reside at the highest levels observed in the last 10 quarters. However, looking ahead, there is an anticipation of potential upward movement in input costs. This is influenced by larger geopolitical factors and currency fluctuations, particularly expecting an upswing in material prices, especially those derived from crude.

* The management has given guidance for the EBITDA margin to be in the range of 18-20%. Management expresses optimism for an extended festival season, foreseeing a rise in rural growth in 2HFY24, buoyed by expectations of a bountiful harvest and an improving economy, supported by effective government spending. APNT’s valuations are fair at 54xFY24E and 48xFY25E EPS. We retain our Neutral rating with a TP of INR3,100 (based on 50xFY25E EPS).

Miss on sales; margin expansion led profit growth

* Asian Paints reported consol net sales of INR84.8b with flat YoY growth (est. INR90.8b).

* Volumes grew 6% YoY (est. +8%) in the domestic Decorative paints business.

* Gross margins expanded 760bp/40bp YoY/QoQ to 43.4%. (est. 42.2%)

* As a percentage of sales, higher employee costs (up 100bp YoY) and other expenses (up 90bp YoY) led EBITDA margin expanded by ~570bp YoY to 20.2% (est. 19.8%).

* EBITDA grew 39.8% YoY to INR17.2b (est. INR18.0b).

* PBT also grew 51.3% YoY to INR16.2b (est. INR16.3b).

* Adj. PAT grew 53.3% YoY to INR12.3b (est. INR12.0b).

* In 1HFY24, Net sales/EBITDA/adj. PAT growth stood at 3.5%/37.9%/50.6% YoY.

* The board has declared an Interim dividend of INR 5.15..

Key highlights from the management commentary

* APNT's top-line witnessed a moderation in growth due to unpredictable rainfall patterns, which impacted overall demand and retail sentiment. This, in turn, influenced stocking decisions and contributed to the evaluation of the affected demand for the quarter.

* The current product mix lays emphasis on a larger economy range, with notable traction in premium and luxury products, particularly in Sep’23.

* Rural and urban centers showed different behaviors, with urban centers performing better in the current quarter.

* The management is committed to maintaining EBITDA margins within the established band of 18%-20%.

* The distribution footprint expanded, reaching over ~1.6 lakh retail touchpoints, with an addition of 2,500 in 2QFY24.

Valuation and view

* Changes to our model have resulted in a 3.1%/0.6% decline in our EPS forecast for FY24/FY25. The management highlighted the adverse impact of erratic rainfall on demand. Additionally, with input costs on the rise, the margin gains in 2HFY24 are not expected to mirror those seen in 1HFY24.

* With the entry of new players with deep pockets and massive commitments to 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 five to six years, as the earnings CAGR has been in the 10-12% range.

* We have assumed FY24/FY25 EBITDA margins at the top end of the management’s guidance. While improving margins would lead to better ROCE, new capex plans might dilute it. While we have taken a higher EBITDA/PAT CAGR trajectory at 18.5%/18.7% over FY23–FY25 – higher than the preceding 10-year average in the 13–14% range – valuations are rich at ~54xFY24E EPS and 48xFY25 EPS. We reiterate our Neutral rating with a TP of INR3,100 (premised on 50xFY25E EPS).

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