Asian Paints

Performance summary

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Asian Paints, the market leader in the domestic paint sector, has announced strong results for the fourth quarter and full year ended March 2006. The consolidated topline grew by 17% YoY, much of which was on account of impressive show in the domestic market (standalone topline was higher by 18% YoY). Despite raw material cost esclations and foreign exchange fluctuation, operating margins at the consolidated level were stable, which in our view is commendable. At the PBT level, profit growth was 36% YoY. However, the financial performance is not equally comparable because the company closed operations in two countries (a part of Berger International). Nevertheless, we believe that the company is well on its way to turnaround its international operations from a long-term standpoint.

Consolidated results

(Rs m)	4QFY05	4QFY06	Change	FY05	FY06	Change
Net sales	6,307	7,650	21.3%	25,739	30,210	17.4%
Expenditure	5,600	6,729	20.2%	22,387	26,293	17.4%
Operating profit (EBIDTA)	707	921	30.3%	3,351	3,917	16.9%
Operating profit margin (%)	11.2%	12.0%		13.0%	13.0%
Other income	58	117	103.5%	324	320	-1.1%
Interest	17	23	35.1%	108	114	5.7%
Depreciation & amortisation	170	203	19.9%	691	682	-1.2%
Profits from associate company	0	(4)	-	2	(9)	-
Profit before tax	579	808	39.7%	2,878	3,431	19.2%
Extraordinary items	(1)	2	-	(5)	(10)	-
Tax	182	353	93.6%	1,061	1,323	24.7%
Profit after tax	396	457	15.5%	1,813	2,098	15.8%
Minority interest	29	(9)	-	72	(23)	-
Net income	367	466	27.0%	1,741	2,121	21.9%
Net profit margin (%)	5.8%	6.1%		6.8%	7.0%
No. of shares (m)	95.9	95.9		95.9	95.9
Diluted earnings per share (Rs)					22.1
Price to earnings ratio (x)					29.0

What is the company's business?

Asian Paints is the market leader in the Indian paint industry. It has an overall market share of around 49% in the decorative paints segment. It has benefited from steady transition in the industry towards consolidation, with top four organised players eating into the market share of the unorganised segment that controls 50% of the Rs 65 bn paint industry. Asian Paints, through a 50:50 joint venture with PPG Industries, US, also has presence in the automotive paints segment. The company has significant global presence through acquisitions, which are being restructured. The management of the company is acclaimed for consistently outperforming industry and its peers in the last decade. Though conservative in nature, the company is well focused on its core business of paints and has posted a CAGR of 14% over the last six years in topline (PAT CAGR at 16% in the same period).

What has driven performance in FY06?

Volumes robust, price hike helps: Total paint volume sales in FY06, on a consolidated basis, increased by 15% YoY, which was largely driven by higher demand in India. Apart from decorative paints, for the third year in succession, industrial paint sales grew by over 20% YoY. As we have mentioned earlier in our analysis, we expect the company to gain market share in the industrial paint segment (excluding automotive paints). In automotive paints, though Asian Paints is the second largest supplier to auto manufacturers, we expect Goodlass Nerolac (the market leader) to consolidate its share in the next three years. Apart from volume growth, price increases during FY06 also helped matters (overall price increase in FY06 works out to 6% in India).

On the automotive front (a joint venture with PPG, US), sales increased by 18% YoY in FY06 on the back of higher volumes sold by the likes of Hyundai and General Motors in India. Powder coatings, which was another key focus area for the company, increased by 36% YoY (this application is in consumer durable and select auto components). As far as the international operations are concerned, investors have to remember that the turnaround involves two pronged approach. One, to consolidate the company's market share in countries like the Carribean, Middle East and Egypt by launching new products. Second, restructuring some of the South Asian operations (including closure of some facilities). While the first leg of the approach is progressing well, in our view, and like we have mentioned in the past, the second leg is likely to be time consuming. With the implementation of the ERP system, we believe that the consolidated balance sheet will strengthen (lower working capital is the first benefit).

In a nut shell…

(% sales)	Standalone		Consolidated
	FY05	FY06	FY05	FY06
Raw material	57.7%	58.3%	58.4%	59.3%
EBDITA margin	16.6%	16.7%	13.0%	13.0%
PBT margin	14.1%	14.6%	11.5%	11.6%
Net margin*	9.1%	9.5%	6.8%	7.0%

*excluding extraordinary items

Margins - Good show: Despite higher raw material costs (including higher packaging cost in light of the petrochemical cycle), the company has managed to maintain operating margins at the consolidated level. This, in our view, is commendable. We continue to repose faith in the company's ability to turnaround international operations of Berger International over the next three years. To that extent, investors have to attune their investment horizon. Of the international operations, the South Asian operations witnessed a EBDITA level loss as compared to a profit in the same period last year.

EBDITA & RoCE - International operations

('000 US$)	EBDITA		RoCE
	2004	2005	2004	2005
Carribean	2,487	2,493	13.0%	13.0%
Middle East	2,267	3,273	14.0%	21.0%
South Asia	18	(304)	-6.0%	-18.0%
South East Asia	918	(3,209)	1.0%	-33.0%
South Pacific	1,256	1,218	9.0%	9.0%

Subsidiary losses impact at the net level: Though PBT grew at a faster clip of 36% YoY on a consolidated basis, net profit growth was impacted due to losses in the South Asian operations of Berger International. As we go forward, we expect the company's net margin to improve in light of the restructuring, albeit steady over the next two to three years.

What to expect?

At Rs 642, the stock is trading at a price to earnings multiple of 29 times FY06 earnings. We expect paint demand in India to grow at 12% to 15% over the next three years, led by favorable GDP growth and housing sector. Even if the housing sector were to slow down, in our view, there is a huge market opportunity in the replacement side. But the replacement side is again a long-term story, as organised sector has to become competitive on the cost front on a relative basis to gain customer acceptance. We shall soon update the research report of the company