Stock pick from the chemicals sector

There are very few counters that hold their ground even in difficult times, and Asian Paints (APL) is among them. Historically, APL has outperformed the Sensex many times. In 2011, it declined by 11 per cent as against a 24 per cent fall in the Sensex. Even in a difficult year like 2008, when the leading indices declined by more than 55 per cent, it was down by just around 20 per cent. While the decline was slower, its recovery was much smarter. The reason behind this outperformance was its consistent financial performance over the past several years. It has also seen higher dividend payouts, which have increased consistently since FY04.

The company enjoys a leadership position in the decorative paints market. It has registered double digit volume growth even in trying times, indicating the long-term sustainability of its growth and a strong management bandwidth. Further, new capacity addition is expected to be another driving factor for the company. On the valuations front, the CMP discounts its trailing four-quarter earnings by 31x. The valuations may seem to be on the higher side, but APL has always commanded a premium on account of being a market leader.

The consolidated business of the company can be bifurcated into three major segments, viz. decorative paints (81 per cent of revenues), international business (13 per cent) and industrial paints (six per cent). Its total manufacturing capacity stands at nearly six lakh kilolitre per annum (klpa). The company will be adding another 1.50 lakh klpa at Rohtak, which will take the capacity of the plant to three lakh klpa by Q4 FY13. The plant at Khandala (near Pune, Maharashtra) with a capacity of three lakh klpa will be commissioned around the last quarter of FY13. The total capex amounting to around Rs 1000 crore will be funded through debt and internal accruals.

As regards APL’s growth prospects, the decorative segment is expected to be a growth driver going forward, with even the management hinting at the sustenance of double digit growth in this segment. In fact, the segment has driven double digit volume growth on a consolidated front for three consecutive quarters. The best part is that the volume growth has come about despite two price hikes taken by the company. In the international business too, the demand has witnessed some improvement. Sales growth was around 20 per cent owing to better volume growth. The demand was better from South Asia. Further, with the global macro-economic factors improving, the demand from the Middle East (contributing 51 per cent of revenues and 81 per cent of EBITDA to its international business) may also witness some traction. However, not much is expected from the industrial segment.

On the margins front, the EBITDA margins for the December 2011 quarter stood at 15.50 per cent. Though margin pressures continue, the improving performance in international business, the continued price hikes, stabilising input costs and the appreciation in the rupee will aid the margins in the coming quarters.

On the financial front, for 9M FY12, it has posted a topline of Rs 7071 crore and a bottomline of Rs 757 crore as against Rs 5741 crore and Rs 690 crore respectively in 9M FY11. With the better volume growth and price realisation, the coming quarters are expected to be good. We recommend that investors should buy the scrip with a target price of Rs 3350.