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Asian Paints' margins won't retrieve their sheen anytime soon

Asian Paints' domestic decorative business registered 8% y-o-y volume growth on a high base and value growth was at 21% y-o-y in 4QFY22.

In Q4FY22, consolidated gross margin at 38.7%, improved 195 basis points (bps) sequentially but contracted 448bps compared to the same quarter last year. One basis point is 0.01%.

In a post-earnings call, the management said, in FY22, it saw around 32-34% inflation and took price increases in the range of around 24-25% Further, the incremental inflation in Q1FY23 is 5-7% and price increases of about 2% would be effective in May and June.

In simple terms, this means, that gross margins would take time to fully recover inspite of price hikes.

"While gross margin pressure has been receding, courtesy price hikes. We suspect future price hikes are likely to lag raw material inflation, as demand elasticity from hereon may get tested," analysts at HDFC Securities Ltd said in a report on 10 May.

Further, the company's management highlighted that even after recovery, gross margin may return to 41-42% levels as compared to the 43-44% seen in a deflationary raw material cycle. Also, the management does not intend to take steep price hikes given the competition in the sector.

Analysts at ICICI Securities Ltd caution that amid elevated inflation and likely increase in competitive pressure, Asian Paints may find it difficult to achieve 22-24% Ebitda margin in the near-medium term. Ebitda is short for earnings before interest, tax, depreciation and amortization. In Q4FY22, consolidated operating margin at 18.1%, rose 19bps sequentially, but fell 154bps year-on-year (y-o-y).

Note that Aditya Birla Group company Grasim Industries Ltd announced its foray into the paints segment in early 2021 and it's entry into the market is expected in the second half of calendar 2022.

Meanwhile, Asian Paints' domestic decorative business registered 8% y-o-y volume growth on a high base and value growth was at 21% y-o-y in 4QFY22. The company saw good volume growth in February and March, however volumes fell in January impacted by the Omicron variant. In FY22, the company saw 31% volume growth and value growth of 36%, y-o-y.

So, analysts point out that some of its product categories seem to have witnessed down-trading in smaller cities and towns.

In this backdrop, Asian Paints' rich valuations are little comforting.

"Despite modest earnings growth for five years in succession and declining return on capital employed, valuations at 66x/57x FY23E/FY24E earnings per share seem high versus the five/ten/fifteen-year average of 56x/47x/39x," domestic brokerage house Motilal Oswal Financial Services Ltd said in a report on 10 May.