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Muted sales with miss on margin

* Asian Paints (APNT) posted 2%/3% YoY decline in consolidated/standalone revenue in 1QFY25. Decorative volume grew 7% YoY (est. 12%). The value vs. volume gap was in the range of 5-6% vs. ~12% in 4Q. Revenue growth was affected by price cuts in the last quarter (~3.5% in 4Q), an unfavorable product mix, general elections and heat waves.

* Raw material prices rose 1.8% in 1Q and are expected to rise ~1.5% in 2Q. To offset these costs, APNT implemented a ~1% price hike in Jul’24 and may hike again in the upcoming quarter. Gross margin contracted by 40bp to 42.5% in 1Q. Monitoring gross margin in FY25/FY26 will be crucial due to the changing competitive landscape, rising raw material prices and ongoing supply chain challenges.

* Employee and other overhead costs hurt EBITDA margin, which contracted by 420bp YoY and 50bp QoQ to 18.9%. APNT added new employees to expand its distribution and retail touchpoints. EBITDA declined by 20% YoY (est. -6%). Given the changing competitive landscape, a high mix of economy/mid-segment, and the company's focus on volume traction, we estimate EBITDA margins of 20.7%/21.0% in FY25/FY26.

* Despite APNT’s various initiatives to boost volume growth, revenue growth excitement does not look like in FY25 due to price cuts, downtrading and competitive pressure. Besides, sustaining the current high-level EBITDA margin is also a challenge for APNT in the near term. We reiterate our Neutral rating with a TP of INR3,150 (based on 45x Jun’26E EPS).

Disappointing performance on all fronts

Volume growth in high-single digit:

Consol. net sales declined 2.3% YoY to INR89.7b (est. INR91.8b), impacted by weak demand, general elections, and severe heatwaves. Volumes grew by 7% (est. +12%) in the domestic decorative paints business, aided by some improvement in rural markets.

Poor margin performance:

Gross margins contracted 40bp YoY to 42.5% (est. 43.5%). Employee/other expenses grew 24%/14% YoY. EBITDA margin shrank by 420bp YoY and ~50bp QoQ to 18.9% (est. 21.7%). EBITDA was down 20% YoY at INR16.9b (est. INR19.9b). PBT fell 25% YoY to INR15.7b (est. INR18.9b). Adj. PAT declined 25% YoY to INR11.9b (est. INR14.3b).

Non-core businesses improved:

Kitchen business revenue grew 5% as sales have been growing for the past two quarters. It has maintained positive PBDIT for six quarters, with a PBT loss of INR30m, down from INR20m in 1QFY24. Bath business revenue rose 10% on a low base, with a PBT loss of INR20m. White Teak and Weather Seal delivered double-digit revenue growth. Home Décor now has over 61 stores, with several more expected to open in 2Q. Home Décor is adding about 15 to 20 stores annually.

Currency devaluation continues to affect growth:

Internationally, Ethiopia and Sri Lanka showed good growth in 1Q due to a gradual economic recovery, although macroeconomic issues in Nepal, Bangladesh and Egypt affected overall international business performance.

Key highlights from the management commentary

* Demand was affected by the heatwaves and general elections for both retail and institutional businesses. Apr-May’24 were challenging months, but Jun’24 saw signs of recovery, especially in rural demand.

* APNT delivered 7% volume growth in domestic decorative paints in 1Q on a healthy base (10% in 1QFY24). The five-year CAGR in volume is healthy at 15.3%.

* The value segment has been under pressure, down 3% vs. 7.8% growth in 1QFY24. The five-year CAGR in value is 12.7%.

* The management observed 1.8% inflation in 1Q and implemented a 1% price increase in response. In 2Q, inflation is expected to be in the range of ~1.4% to 1.5%. Consequently, there may be further price increases.

* International operations posed challenges for the overall business with a 2% decline in revenue. Adjusted for constant currency, it would have seen 1.8% growth, despite currency depreciation in Ethiopia, Egypt and Bangladesh.

* The company continued to expand its distribution footprint, reaching over 165k touchpoints in 1QFY25.

Valuation and view

* There are no material changes to our EPS estimates.

* APNT has launched “Neo Bharat Latex paint” in Jan’24 to compete with the unorganized segment with a branded solution that is affordable and accessible to consumers. It will address the market size of INR50-55b (targets to achieve 30% share in the medium term).

* With the entry of new players with deep pockets and massive commitments to investments, the overall industry may see a shift in market share and cost structures. These factors will be the key monitorables in FY25.

* We remain cautious for both value growth and margin in FY25/FY26. Despite a correction in the stock, competitive pressure still hovers around earnings. We reiterate our Neutral rating with a TP of INR3,150 (based on 45x Jun’26E EPS).

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