Margins a sticky issue for Pidilite

Management said in a post-results call last week that VAM consumption costs increased from $2,231 per ton in the first quarter to $2,491 per ton in the second quarter. Spot VAM prices have declined to $1,200-1,400 a tonne so far this quarter.

However, this is not good enough. The management said that raw material cost, excluding VAM, is yet to return to pre-Covid levels. In addition, the Indian rupee has depreciated against the US dollar and the company still has to absorb high-cost inventory and finished goods. This could lead to more margin pressure in the third quarter, before things start improving in the fourth quarter.

For now, Pidilite’s weak operating performance has prompted several brokerage firms to downgrade the company’s earnings estimates.

Kotak Institutional Equities said in a report that Pidilite has the potential to exceed historical peak earnings before interest, tax, depreciation and amortization (EBITDA) margin of 23%.

“We improve revenue, cut our FY23E margin (2Q miss and high-cost inventory in 3Q) and trim FY24E margin. Net result: 3-11% cut in earnings per share for FY23E,” Kotak said.

Pidilite’s management has guided its EBITDA margin to cross the 20% mark by Q4FY23. Still, inflation has hurt the company’s track record of solid earnings growth. So far, Pidilite has increased prices by only 75% in raw material cost inflation to be competitive. The management is of the view that there is no need to increase the prices further. On the contrary, a cut in prices is expected in the B2B segment.

Motilal Oswal Financial Services reports, “The consistent performance across the lines is reflected in the Sales / EBITDA / Profit After Tax CAGR of ~12.1% / ~13.6% / ~14% over the last 10 years ending FY22 Is.” The growth rate however, CAGR over the last 3-5 years softened to ~8%/~7% due to the pandemic and high commodity inflation, as stated in the report.

Meanwhile, competition in the low-penetration waterproofing segment is heating up, and investors should be wary. According to a report released by Prabhudas Lilladher, Asian Paints Ltd’s aggressive foray into adhesives and potential loss of leadership in waterproofing are key risks for Asian Paints.

Pidilite has extended its coverage to 24,000 villages. The management said Pidilite’s Duniya initiative is reaching 7,000 stores. Pidilite covers almost double the number of outlets as compared to Asian Paints.

“The company is launching new products and increasing its penetration in rural markets. These are steps in the right direction, but will pay off over time,” said Kaustubh Pawaskar, Deputy Vice President, Research, Sharekhan by BNP Paribas.

If Pidilite can improve margins, volumes will catch up meaningfully, he said.

So far in FY23, Pidilite shares have gained 9.3%, outperforming the Nifty 50 index, as a fall in VAM prices improved investor sentiment. However, the high valuation of the stock is a matter of concern in the current scenario.

On FY24 price-to-earnings, Pidilite stock trades 67.56x, Bloomberg data showed. “Its premium valuations continue to grow rapidly in the near term,” Pawaskar said.