Muted demand and rising inflationary pressures amid the looming threat of increased competition are spoiling the picture for Asian Paints Ltd.
In the June quarter (Q1FY25), domestic decorative paints saw year-on-year volume growth of 7%, slower than the management’s double-digit target. Demand for paints was affected by the general elections and heat waves during the quarter. Lower volumes, price cuts and an inferior product mix took a toll as consolidated revenue fell 2.3% year-on-year to ₹8,943 crore in the quarter, missing consensus expectations of 1% growth.
Gross margin contracted by 40 basis points (bps) year-on-year to 42.5% in Q1, and the sequential decline was even sharper. In the past 12 months, the company trimmed prices by around 4% on a cumulative basis to pass on the benefits of easing input costs. However, management now anticipates a 1.4% to 1.5% sequential increase in input cost inflation in Q2. It has already raised prices by around 1% in July and is willing to hike them further to beat inflation.
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Adjusted for a one-time employee cost impact, the operating margin fell around 380 bps year-on-year to 18.9%, lower than a Bloomberg consensus estimate of 21.2%. Higher staff costs as the company boosted its distribution footprint, higher advertisement spends, and the addition of new capacity dented margins. Management maintained its Ebitda margin guidance at 18-20%.
A Nomura Group report cautioned that the benefits of soft material prices were now over, and said it expected a lower sales mix to put pressure on Asian Paints’s gross margin in FY25. “This, along with increased A&P (advertising and promotional) spends amid anticipation of intensifying competition and lower operating leverage should contract operating margin (by around 165 bps year-on-year) and lead to Ebitda/EPS decline of 4%/6% year-on-year in FY25F,” added the report dated 17 July. EPS is earnings per share.
Downgrades galore
According to Asian Paints’s management, the industry’s performance was weak in Q1 because of subdued demand, and it was not affected by the new competitor (Grasim Industries’s Birla Opus). Management is optimistic about demand recovering, with green shoots emerging in rural markets. It has maintained double-digit volume growth guidance for Q2 and FY25. That said, the company expects the volume-value gap to be between 500-600 bps. In simple terms, this means revenue growth will lag volume growth.
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Despite management’s confidence, the overhang of increased competition continues to haunt the Street, leading to earnings downgrades by slew of brokerage houses. For instance, analysts at Prabhudas Lilladher have cut their FY25, FY26 and FY27 EPS estimates by 10.4%, 8.4% and 6.3%, respectively.
The stock’s poor returns mirror this nervousness – it’s down 14% this year while Nifty50 is up 12%. There is still little clarity on how severely new entrants will affect the incumbents, and that’s making it tricky for investors to gauge the sector’s outlook. “Our checks suggest that Birla Opus has had a slow start and has not gained much traction among prominent paint dealers (especially the top quartile). That said, it is a bit too early to discount/dismiss Grasim in our view,” said a Kotak Institutional Equities report dated 17 July. “At this point, it is unclear to us whether acute competitive intensity will last for a few quarters or 2-3 years,” it added.
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If Grasim gets more aggressive on prices or the pace of product launches, Asian Paints may have to choose between protecting margins and gaining market share. This leaves the door ajar for further earnings downgrades. Valuations are already feeling the heat and have moderated over the past year. At FY26 price-to-earnings, Asian Paints is trading at a multiple of nearly 50 times, showed Bloomberg data. Despite the correction, the valuation looks stretched.
