Asian Paints (APNT IN) Not a colorful performance

INSTITUTIONAL EQUITY RESEARCH Asian Paints (APNT IN) Not a colorful performance INDIA FMCG Quarterly Update Top takeaways from Q2FY19 Results were significantly below our estimates as: (1) it deferred price hikes despite RM inflation, (2) rebates were given to the trade channel to liquidate high-priced inventory in the wake of GST rate reduction to 18% from 28%, (3) festival season shifted to 3Q, (4) start-up costs relating to the Mysore plant, and (5) pressure in its international business due to macro challenges. APNT delivered a third consecutive quarter of double-digit volume growth (12-13%); however, the quality of volume growth was inferior (higher salience of distemper, putty vs. emulsions). Management attributed higher salience of low-margin distemper sales to increased price competitiveness (due to reduction in GST) vs. the unorganized sector. Market share gains is the only silver lining APNT seems to be gaining market share (Kansai Nerolac's volumes grew 9% vs. APNT's 12-13%); this was a concern a few quarters ago. We believe APNT might have gained market share since the management specifically highlighted that east India has done exceptionally well in 2Q (east is a Berger Paints stronghold). Key takeaways from concall APNT has taken price hikes of 2.35% with effect from 1st October 218 for domestic decorative paints business and intends to take further hikes in the short term to mitigate inflationary pressure, depending on the demand situation. Within the international business, Ethiopia (unavailability of forex), Egypt (reduction in fuel subsidy), Sri Lanka (rains), and Dubai (increased competitive intensity) dented performance. Plans to start Vizag plant (total capacity 5, KL) by 4QFY19. Outlook and valuation: We reiterate our positive stance towards paints despite input cost inflation (crude up 4% yoy) as decorative paints is poised to see healthy demand in the medium term and APNT has the ability to pass on RM inflation. Our optimism is based on: (1) improving consumer sentiment, (2) reducing re-painting cycle, (3) focus on distribution expansion in tier 2/3 cities, and (4) government focus on creating physical/social infrastructure in rural areas ahead of 219 general elections giving a boost to volume growth. We believe that the recent reduction in GST rates on paints to 18% from 28% shall improve the organised sector s competitiveness and accelerate the process of premiumization for the organized paint industry. We maintain BUY and our target of Rs 1,43 (45x Dec-2 EPS). 23 October 218 Buy (Maintain) CMP RS 113/ TARGET RS 143 (26%) COMPANY DATA O/S SHARES (MN) : 959 MARKET CAP (RSBN) : 1187 MARKET CAP (USDBN) : 16.2 52 - WK HI/LO (RS) : 1489 / 182 LIQUIDITY 3M (USDMN) : 23.7 PAR VALUE (RS) : 1 SHARE HOLDING PATTERN, % Sep 18 Jun 18 Mar 18 PROMOTERS : 52.8 52.8 52.8 FII / NRI : 15. 14.8 15.2 FI / MF : 11.2 11.9 11.7 NON PRO : 2.9 2.7 2.8 PUBLIC & OTHERS : 18.2 17.8 17.5 KEY FINANCIALS Rs mn FY19E FY2E FY21E Net Sales 1,94,454 2,22,789 2,55,334 EBIDTA 35,692 42,888 5,181 Net Profit 21,94 26,68 31,683 EPS, Rs 22.9 27.8 33. PER, x 49.4 4.6 34.2 EV/EBIDTA, x 3.4 25.2 21.4 ROE, % 11.6 1.4 9.1 Total debt/equity (%) 23.5 25.5 26.7 Vishal Gutka and Preeyam Tolia (Rs mn) 2QFY19 2QFY18 yoy growth % 1QFY19 qoq growth % PC yoy growth estimates % Comments Volume 12.5 9. 13. 7. Volume growth better than estimate driven by distemper and putty Net Sales 46,391 42,652 8.8 43,93 5.7 9.2 Gross Profits 18,467 17,61 4.9 18,98 (2.7) 6.9 Gross Margin (%) 39.8 41.3-148 bps 43.2-342 -144 bps Gross margins impacted on continues pressure on input cost bps Staff costs 3,73 2,822 8.9 3,64.3 15. Other operating expenses 7,553 6,777 11.4 7,171 5.3 5. EBDTDA 7,842 8,11 (2.1) 8,744 (1.3) 14. EBDTDA margin (%) 16.9 18.8-188 bps 19.9-31 bps 125 bps EBIDTA margins impacted on lower gross margins PBT 7,46 7,569 (2.1) 8,368 (11.5) 6.5 Tax rate (%) 32.8 32.5 28 bps 33.1-33 bps -34 bps PAT 4,928 5,84 (3.1) 5,58 (11.7) 6.9 Page 1 PHILLIPCAPITAL INDIA RESEARCH

Domestic volume growth led by higher salience of distempers vs emulsion 14 12 1 12 11 1 Volume gr (%) 9 1 13 13 8 6 4 4 6 2 Input cost inflation continues crude (up by ~6% yoy) while TiO2 (up by 6% yoy) for Q2FY19 3 TiO2 INR/kg 29 28 27 26 25 24 23 22 9 Brent Crude USD/bbl 85 8 75 7 65 6 55 5 45 4 Two-year forward P/E band EV/EBITDA 18 Rs 16 14 12 1 8 6 4 2 48x 36x 24x 12x 2 Rs mn 18 16 14 12 1 8 6 4 2 36x 27x 18x 9x Page 2 PHILLIPCAPITAL INDIA RESEARCH

Con-call takeaways Domestic demand for coatings continues to remain challenging because of rising crude prices, significant rupee depreciation, and tight monetary conditions; it sees no secular uptick in demand - remains stagnant. Raw-material inflation for Q2 was 5% qoq; expects this to rise further in Q3. It has taken a 2.35% price hike in October to mitigate the impact. TiO2 prices (c.2%) remains stable, but other crude derivatives (c.3%) such as monomers remain inflated. It expects operating expense to see some initial pressure in coming quarters with the starting of Mysore and Vizag plants (in Q4FY19). North, west, and east regions continue to perform well while south is seeing early signs of market-share gains. Capex for FY19 stood at Rs 1bn. Decorative paints: Higher sales of distempers and putty aided volume growth in Q2, led by higher stocking up by dealers ahead of Diwali and some shift from unorganized to organized demand. Emulsion was impacted due to higher share of emulsion in Q2FY18 as Q1FY18 was impacted due to GST implementation. Industrial paints: Industrial paints (auto and industrial) continues to perform well; it has taken price increases in both the businesses, which was not enough to fully counter the impact of input-cost pressures. International business: Forex unavailability, incessant rains, reduction in fuel subsidies in Ethiopia, Sri Lanka, and Egypt impacted the international business. Tsunami in Indonesia did not have much impact on APNT, as its presence is mostly in the Java region (most populated), which was not impacted. Its retail reach in Indonesia stands at 15 outlets and it continues to remain focused on expanding its retail network further. It has taken price hikes in all the markets except in Dubai, as it faces immense competition from the market leader. Page 3 PHILLIPCAPITAL INDIA RESEARCH

Financials Income Statement Y/E Mar, Rs mn FY18 FY19E FY2E FY21E Net sales 1,68,246 1,94,454 2,22,789 2,55,334 Growth, % 12 16 15 15 Total income 1,68,246 1,94,454 2,22,789 2,55,334 Raw material expenses -96,912-1,14,356-1,29,794-1,48,224 Employee expenses -11,155-12,27-13,865-15,945 Other Operating expenses -28,23-32,135-36,242-4,984 EBITDA (Core) 31,976 35,692 42,888 5,181 Growth, % 7.1 11.6 2.2 17. Margin, % 19. 18.4 19.3 19.7 Depreciation -3,65-4,246-4,92-5,422 EBIT 28,372 31,447 37,985 44,758 Growth, % 7. 1.8 2.8 17.8 Margin, % 16.9 16.2 17. 17.5 Interest paid -351-438 -438-438 Other Income 2,26 2,647 3,39 4,137 Non-recurring Items 7 Pre-tax profit 31,385 34,137 41,361 48,986 Tax provided -1,41-11,611-14,95-16,717 Profit after tax 2,975 22,525 27,266 32,269 Others (Minorities, Associates) -586-586 -586-586 Net Profit 2,389 21,94 26,68 31,683 Growth, % 2.9 11.4 21.6 18.8 Net Profit (adjusted) 19,689 21,94 26,68 31,683 Unadj. shares (m) 959 959 959 959 Wtd avg shares (m) 959 959 959 959 Balance Sheet Y/E Mar, Rs mn FY18 FY19E FY2E FY21E Cash & bank 4,47 2,94 8,698 17,696 Debtors 17,371 2,244 23,194 26,583 Inventory 26,583 3,899 35,42 4,574 Loans & advances 943 943 943 943 Other current assets 15,911 15,911 15,911 15,911 Total current assets 64,854 7,92 84,149 1,1,76 Investments 21,47 21,888 22,393 22,923 Gross fixed assets 47,54 58,54 64,554 71,54 Less: Depreciation -9,731-13,977-18,879-24,32 Add: Capital WIP 14,51 14,51 14,51 14,51 Net fixed assets 51,374 58,128 59,725 6,83 Total assets 1,37,635 1,5,917 1,66,267 1,85,432 Current liabilities 41,23 44,463 48,112 52,32 Total current liabilities 41,23 44,463 48,112 52,32 Non-current liabilities 9,233 9,233 9,233 9,233 Total liabilities 5,256 53,696 57,344 61,535 Paid-up capital 959 959 959 959 Reserves & surplus 83,144 92,41 1,3,515 1,17,94 Shareholders equity 87,379 97,222 1,8,923 1,23,897 Total equity & liabilities 1,37,635 1,5,917 1,66,267 1,85,432 Cash Flow Y/E Mar, Rs mn FY18 FY19E FY2E FY21E Pre-tax profit 31,385 34,137 41,361 48,986 Depreciation 3,65 4,246 4,92 5,422 Chg in working capital -1,179-3,751-3,84-4,369 Total tax paid -9,865-11,611-14,95-16,717 Cash flow from operating activities 23,946 23,2 28,364 33,322 Capital expenditure -19,365-11, -6,5-6,5 Chg in investments 5,113-481 -55-53 Cash flow from investing activities -13,795-11, -6,5-6,5 Free cash flow 1,152 12,2 21,864 26,822 Equity raised/(repaid) -527 Debt raised/(repaid) -27 Dividend (incl. tax) -11,874-12,683-15,565-17,294 Cash flow from financing activities -13,735-12,683-15,565-17,294 Net chg in cash -3,583-662 6,299 9,528 Opening cash balance 8,12 4,47 2,94 8,698 Closing cash balance 4,47 2,94 8,698 17,696 Valuation Ratios FY18 FY19E FY2E FY21E Per Share data EPS (INR) 2.5 22.9 27.8 33. Growth, % 2.9 11.4 21.6 18.8 Book NAV/share (INR) 87.7 97.3 18.9 123.9 FDEPS (INR) 2.5 22.9 27.8 33. CEPS (INR) 23.6 27.3 32.9 38.7 CFPS (INR) 22.2 2.7 25.6 29.9 DPS (INR) 1.3 11. 13.5 15. Return ratios Return on assets (%) 16.3 15.9 17.5 18.6 Return on equity (%) 23.4 23.5 25.5 26.7 Return on capital employed (%) 23. 22.6 24.7 26. Turnover ratios Asset turnover (x) 2.7 2.5 2.6 2.8 Sales/Total assets (x) 1.3 1.3 1.4 1.5 Sales/Net FA (x) 3.9 3.6 3.8 4.2 Working capital/sales (x).1.1.1.1 Receivable days 37.7 38. 38. 38. Inventory days 57.7 58. 58. 58. Payable days 14.6 97.7 93.6 89.6 Working capital days 42.9 44.2 44.8 45.3 Liquidity ratios Current ratio (x) 1.6 1.6 1.7 1.9 Quick ratio (x).9.9 1. 1.2 Interest cover (x) 8.9 71.7 86.6 12.1 Total debt/equity (%) 6.3 5.6 5. 4.4 Net debt/equity (%) 1.4 2.5 (3.3) (1.5) Valuation PER (x) 55. 49.4 4.6 34.2 PEG (x) - y-o-y growth 19. 4.3 1.9 1.8 Price/Book (x) 12.9 11.6 1.4 9.1 EV/Net sales (x) 6.4 5.6 4.8 4.2 EV/EBITDA (x) 33.9 3.4 25.2 21.4 EV/EBIT (x) 38.2 34.5 28.4 23.9 Page 4 PHILLIPCAPITAL INDIA RESEARCH

Stock Price, Price Target and Rating History 16 14 12 1 8 S (TP 72) S (TP 77) S (TP 85) N (TP 115) N (TP 1) N (TP 15) N (TP 1) B (TP 16) B (TP 14) N (TP 1215) N (TP 1125) N (TP 1215) N (TP 125) 6 4 2 S-15 N-15 D-15 F-16 M-16M-16 J-16 A-16 S-16 N (TP 1) D-16 F-17 M-17M-17 J-17 A-17 S-17 N-17 D-17 F-18 M-18M-18 J-18 A-18 Rating Methodology We rate stock on absolute return basis. Our target price for the stocks has an investment horizon of one year. Rating Criteria Definition BUY >= +15% Target price is equal to or more than 15% of current market price NEUTRAL -15% > to < +15% Target price is less than +15% but more than -15% SELL <= -15% Target price is less than or equal to -15%. Page 5 PHILLIPCAPITAL INDIA RESEARCH

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