For Asian Paints, the worst of inflation is over, but concerns are looming elsewhere

The management said the decorative paints industry saw two rounds of price hikes after the festive season, a 9-10% compounded price hike from November 12 and a 4-5% additional price hike from December 5.

On a consolidated basis, gross margin improved by 200 basis points (bps) sequentially to 36.8% in Q3FY22, although compared to the same quarter last year, margins have reduced by 830bps. One basis point is one hundredth of a percentile.

The management expects the impact of the price hike to start reflecting on earnings from the March quarter, which is expected to translate into a full recovery on gross margin on a sequential basis. In such a situation, analysts believe that worries about inflation may soon be a thing of the past for the company. “Asian Paints’ performance (including the impending ramp-up) continues to be the most impressive among the top three players; Analysts at HDFC Securities Ltd said in a report that the recent price hike means that the worst margin pressure is likely to end.

Going forward, the focus will be back on demand growth. Asian Paints posted better-than-expected volume growth in the December quarter despite price hike. Its Decorative Paints business saw an 18% increase in volumes on a year-on-year basis. The management said that on the basis of three-year and two-year CAGR, the volume growth of Decorative Paints stood at 20 per cent and 25 per cent, respectively. CAGR is short for Compound Annual Growth Rate. Management said the company saw broad-based growth in metros and Tier-I and Tier-II cities along with Tier III and IV cities.

Furthermore, the company saw no signs of weakness in rural demand in Q3, the management said. Still, analysts say investors should keep a close eye on rural demand. Analysts said, “Demand growth will be important to monitor here. With how the outlook on rural growth in the consumer staple has suddenly turned negative in recent months, we feel the hyper-growth phase for paints will not last forever.” JM Financial Institutional Securities Ltd said in a report.

Sharing similar concerns, analysts at Motilal Oswal Financial Services Ltd. said, “Although the sales growth in 3QFY22 was impressive, even on a fairly high basis over the previous year, it remains to be seen whether the company will later How will it perform on the demand front? The quarters – especially a) festive demand drivers will no longer be in play and b) the base of sales growth is even more challenging going forward.”

What’s more, with the entry of Grasim Industries Limited expected in the second half of the calendar year 2022, the competitive intensity in this segment is likely to increase. Investors believe that Aditya Birla Group company Grasim Industries will invest Rs 5,000 crore in this venture and aspires to become the second largest decorative paint manufacturer.

Simply put, there are some headwinds in the sector’s demand outlook and given Asian Paints’ expensive valuations, it is better for investors not to ignore these risks. Taking into account the FY23 earnings estimates, Asian Paints stock is trading at a price-to-earnings multiplier of around 65 times.