Sunday, October 4, 2009


Sitting pretty.

Asian Paints (APNT) continues to be our top pick in midcap FMCG as we
see (1) good volume growth sustaining, (2) potential for positive margin surprise in FY2010E versus Street estimates and (3) likely pickup in residential sales volumes in FY2010-11E. Our EPS estimates are the highest on the Street and 10% higher than consensus. Reiterate ADD.

Sustaining good volume growth
In our view, factors aiding the good volume growth in decoratives (likely >12% in 1QFY10, similar trends seen in 2QFY10E) for APNT are (1) continuing good demand conditions in Tier II and III towns, (2) shorter repainting cycle driven by likely improvement in penetration and (3) likely return of demand in key metros. Media reports suggest APNT’s sales growth in Tier II, III towns are outperforming top metros—confirming the view highlighted earlier (report titled “Bright prospects” dated July 27, 2009). The company is likely deriving ~65% of revenues from these markets.

Mix improvement and input cost correction pose upside risks to our (relatively high) estimates
We believe that upside risk to our aggressive EBITDA margin assumption of 17.5% for FY2010E
exist as there is opportunity for APNT to retain significant portion of input cost correction in
FY2010E as the competition is rational and price differentiation is not a critical decision making
factor for the consumer (in higher end products, particularly emulsions). We highlight that our EPS estimates are highest on the Street, Rs60 and Rs69.8 (standalone) for FY2010E and FY2011E, respectively (Street estimates are Rs56.7 and Rs66.7 (consolidated)).

While APNT prefers volume growth over pricing led growth, we believe that, (1) relatively stronger position in emulsions, (2) underlying mix improvement and (3) benefits of input cost correction have helped EBITDA margins expansion of 650 bps to 21% in 1QFY10. We note that 1QFY10 margin performance is probably an outlier as (1) the company has effected a ~2.5% weighted average price correction in July 2009 and (2) 1QFY10 likely had the highest benefits of input cost correction (particularly MTO).

Favorable structural growth drivers
Growth drivers over the medium term, in our view, are, (1) growth in number of tinting machines = growth in emulsions, (2) upside in residential demand, (3) strong performance in South India and (4) improvement in mix.

  • Growth in tinting machines implies a corresponding growth in emulsions. APNT has a reach of ~26,000 distributors, we believe that further upsides from mix improvement is likely over the next 3-4 years as the company’s plans to continue adding 1,000 TMs every year. At present, APNT has about 13,000 tinting machines (TM) installed, and it was adding about 1,000 TMs annually over the last 4-5 years. We believe that the addition of TM has a direct correlation to emulsions growth which APNT had over the last few years.
  • Upswing in residential demand. APNT derives about 10 % of paints volume from new construction and the rest from repainting activity. Likely upswing in residential demand in FY2010E after the slump in FY2009 augurs well for APNT. KIE’s real estate analysts, Puneet Jain and Sandeep Reddy, expect a strong pick up in residential sales volumes in FY2010E and FY2011E.

To see full report: ASIAN PAINTS