January 19, 2016

high gross margins not sustainable: asian paints

My analysis of Asian Paints Q3, FY16, results:

Asian Paints painted a rosy picture in its latest quarter financials by reporting the strongest yearly sales growth in the last five quarters. On Monday, the paints company, which is a constituent in the Nifty 50 index, announced its third quarter (December 2015 quarter) results for the current financial year 2015-16 (FY16).

In the third quarter, Asian Paints’ consolidated operating income shot up by 13.9 per cent to Rs 4,160 crore compared to the year-ago quarter. In the previous two quarters of FY16, the company had seen muted year-on-year growth rates of 7.8 per cent (first quarter) and 4.0 per cent (second quarter).

The last time when the operating income had seen double-digit YoY growth was in the second quarter of FY15 when it was 16.6 per cent.

The December 2015 quarter the Diwali season effect on the company’s sales was present while it was not present in the year-ago quarter. Combining the September and December quarters of FY16, the consolidated operating income growth rate, over the aggregate of the two year-ago quarters, was 9.0 per cent. This growth rate was lower than the corresponding 2-quarter aggregate growth rate in FY15 when it was 10.9 per cent, and previous years growth rates when it was 15.6 per cent (FY14) and 17.8 per cent (FY13).

The adjusted profit after tax, as per Capitaline database, of Asian Paints, shot up by 35.4 per cent to Rs 499 crore in the third quarter, on a YoY basis. This was the highest yearly growth rate seen in any quarter in the last nine quarters. It was in the second quarter of FY14, when Asian Paints had seen a yearly growth rate of 36.7 per cent.

Our analysis suggests that the company appeared to have heavily used its strong brand image to its advantage by not acceding much ground on the pricing front inspite of sharp fall in raw material costs. This meant the sales value growth kept a decent pace with the growth in its volume sales.

This was reflected in the continuing sharp growth in the company’s gross margins over the last several quarters. In the latest quarter, the consolidated gross margin (ratio of operating income minus cost of raw materials consumer to operating income) stood at 54.1 per cent, which was possibly at a record high or at least the highest in the last 19 quarters at the very minimum. In the year-ago quarter of December 2014, the gross margin stood at 49.1 per cent.

In a conference call with analysts on Monday evening, the company management was, however, categorical that the high level of gross margins was clearly not sustainable going forward. The company management claimed that there was no change in the pricing of its products. It pointed out that the newly acquired Ethiopian business had shown strong gross margins in the last one year, and domestic joint ventures had also seen strong margins expansion.

Hdg: Asian Paints Q3 results

Intro: Sales growth in double digits for first time in FY16 in Q3

Oct-Dec 2015 (Rs crore) YoY (%) Apr-Dec 2015 (Rs crore) YoY (%)

Operating income 4169 10.3 11562 8.6
EBIDTA# 728 32.4 1892 28.1
EBIDTA margin (%) 17.5 20.0 16.4 18.0
Adj. Profit after Tax 463 16.0 1318 25.0
APATM* (%) 11.1 5.2 11.4 15.2

Figures represent consolidated financials

#Profit before interest, depreciation, taxation and ammortisation
* adjusted PAT margin

Source: Company filings, Capitaline. Analysed by FC Research Bureau

Analysts, however, maintain that very high gross margins would tempt more international competition to enter the domestic paints market, and could hurt Asian Paints growth prospects in the future if that happens.

In the conference call with analysts, the company management did not disclose the exact impact of the approximately 30 per cent fall in the crude oil prices in the December 2015 quarter on its raw material costs. It only said that the company imports crude derivatives and not crude oil per se, and that the crude derivatives prices are determined by global demand-supply conditions in crude derivatives and not just by the level of crude price.

The company management disclosed that in its domestic retail segment, it was seeing considerably higher growth in smaller towns than the big cities. It said that while the southern India heavy rains in November and December affected their southern region business, it did not have a major impact on its all-India sales growth. 


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