Asian Paints Oct 2014

8/17/2019 Asian Paints Oct 2014

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One-year performance (Rel to Sensex)

Source: ACE Equity

Asian Paints Ltd

PRICE: RS.625 RECOMMENDATION: BUY

TARGET PRICE: RS.700 FY16E P/E: 32.4X

Stock details

BSE code : 500820

NSE code : ASIANPAINT

Market cap (Rs bn) : 620

Free float (%) : 47.21

52 wk Hi/Lo (Rs) : 680/460

Avg daily volume : 11,25,000

Shares (o/s) (mn) : 959

Summary table

(Rs mn) FY14 FY15E FY16E

Sales 127,148 146,502 169,755

Growth (%) 16.2 15.2 15.9

EBITDA 19,979 25,091 29,231

EBITDA margin (%) 15.7 17.1 17.2

PBT 18,343 23,320 27,109

Net profit 12,188 15,824 18,476

EPS (Rs) 12.7 16.5 19.3

Growth (%) 9.4 29.8 16.8

CEPS (Rs) 15.9 20.0 23.3

BV (Rs/share) 43.5 53.7 66.7

Dividend / share (Rs) 5.3 6.0 6.0

ROE (%) 30.2 31.7 29.7

ROCE (%) 40.1 41.3 39.0

Net cash (debt) 7,750 13,417 23,318

NW Capital (Days) 12.2 13.6 15.3

EV/EBITDA (x) 27.5 22.2 19.2

P/E (x) 49.2 37.9 32.4

P/Cash Earnings 39.4 31.2 26.9

P/BV (x) 14.4 11.6 9.4

Source: Company,

Kotak Securities - Private Client Research

INITIATING COVERAGEOCTOBER 17, 2014

PRIVATE CLIENT RESEARCH

Shareholding pattern

Source: ACE Equity

Amit [email protected]+91 22 6621 6222

Asian Paints (APL) is a high-quality stock in the Indian paint industry andexpected to perform strongly in an improving macro environment withstrong pricing power. This should reflect in a healthy way on thefinancials of the company going forward. We expect earnings for APL togrow at ~20% CAGR over FY14-FY17E as against 14% over FY11 to FY14.The stock currently trades at 32.4x FY16E EPS, lower than its 3 year histori-cal average of 36x one-year forward earnings, despite improving marginsand return ratios. We initiate coverage with a BUY rating and price targetof Rs 700 for Asian Paints (APL). We value the stock at its 3 year averageone year forward PE multiple of 36x. The stock may rerate further, on ac-count of improving macros and earnings profile.

Key investment argument

APL to maintain above-industry revenue growth - APL has maintained avery healthy revenue growth of 15 to 26% between FY05-FY14. Now we esti-mate a revenue CAGR of 16% for over FY14 to FY17E to Rs 198 bn on theback of its: 1) Strong brand, 2) Pricing Power, 3) Innovation and 4) Up tradingby consumers. While as per Industry estimates, decorative paint segment isexpected to grow at 12% and Industrial Paint Segment is expected to grow at9% over FY14 to FY17E.

Market Leader the decorative paint segment - With a market share of~55% in the organised decorative paints segment, APL dominates the seg-ment. We estimate that APL would continue to be market leader for very longon the back of its wide product portfolio across all categories, wide dealernetwork, strong brand and efficient logistics and supply chain management.The company is also a price setter in the decorative paints segment followedby other paint companies.

Healthy return ratios - APL has maintained its EBIDTA margins at ~ 16% andROE at ~30% over FY10 to FY14. With improving macro environment, we ex-pect the EBIDTA margins of the company to improve 150 bps over FY14 toFY16E. With improving margins, we estimate the ROE of the company tostabilise at ~30%.

Continued focus on marketing and improved products. Despite slow-down, APL is focused on improving its brand image and improve geographicalreach through increasing its dealer base, effective regular advertisement, in-vestment in R&D and introduction of niche products which should yield results

for the company in the long run

Valuation and outlook

There has been a re-rating of the paint sector in the last 3 to 4 years with all thepaint companies trading above their historical average one year forward for thelast 5 years. The companies also trade at ~30 percent premium to global paintcompanies, which is justified by the long term prospects of Indian Paintcompanies. The stock of APL at CMP of Rs 625 is trading 32.4x FY16E P/E. Weprefer to use a P/E approach to value the stock (like any other consumercompany) and give a value of 36x one year forward FY16E P/E which is at its 3year average one year forward average historical PE multiple. We expect thestock of APL to rerate further, on account of improving macros and earnings

profile. We initiate coverage on APL with a BUY rating and at TP of Rs 700

Kotak Securities Limited has two independent equity research groups: Institutional Equities and Private Client Group. This report has been pre-pared by the Private Client Group. The views and opinions expressed in this document may or may not match or may be contrary with the views,estimates, rating, target price of the Institutional Equities Research Group of Kotak Securities Limited.


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Kotak Securities - Private Client Research Please see the disclaimer on the last page For Private Circulation 2

INITIATING COVERAGE October 17, 2014

Risk and concerns

Weak macro environment may lead to poor demand for decorative paints

Prolong slowdown in the economy leading to weak capex cycle impacting in-dustrial demand

Sharp increase in raw material prices coupled with inability to take price hikes

Increasing competition

Domestic

Decorative

81%

Domestic

Industrial (Non

Auto)

3%

Domestic

Industrial

(Auto)

4%

International12%

BACKGROUNDAPL started as a partnership with four partners in 1942. The firm was changed to aprivate limited company and was renamed Asian Paints. It went public in 1983. APLhas been the market leader in Indian paints industry since 1967 and todaycommands over 50% market share. The company operates in the decorativecoating and industrial coating segments in Indian and has extensive internationalpresence spanning 17 countries and five regions, namely South Asia, SoutheastAsia, South Pacific, the Middle East, and the Caribbean.

Revenue mix

APL has a higher focus on the decorative segment and commands a ~55% share ofthis segment in India. With product offerings spanning all price points, APL ispresent in all key sub-segments of the decorative space – emulsions, distempers,enamels and wood finishes. This segments accounts for ~80% of consolidatedrevenues, while the industrial segment contributes ~7% (automotive ~4%,nonautomotive~3%) and international operations account for the remaining ~12%.

Asian Paints Revenue Break-Up (FY14)

Source: Company


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INDIAN PAINT INDUSTRYThe Indian paint industry is pegged at about Rs 342 bn (as on FY14) and has grownat a CAGR of 13% over the past four years. Per-capita consumption of paint in Indiais fairly low, at 2.57kg/person when compared to the average of ~15kgs indeveloped markets. The Industry has shown notable resilience despite weak macros

and has been growing ahead of GDP growth with volumes growing at a multiple of1.5-2x GDP growth. The growth was a result of 1) higher disposable income inboth- urban and rural areas, 2) historically low consumption of paints which offerspotential headroom for growth, 3) rising awareness of branded paints with betterquality and longer durability, 4) Shortening of repainting cycle, 5) Increasingdemand for new homes, 6) Healthy growth in the auto segment (over FY08 toFY12) and 7) Capex by companies. As per industry estimates, per capita paintconsumption in India has risen to 2.57kg in FY12 from 2.2kgin FY08. At the sametime, organized players have expanded their distribution network, reaching out tomore cities and towns, particularly in semi-urban and rural parts; investingsignificantly behind new product offerings across price points and creating morecustomers connect via significant investments in advertising & publicity. As per AC

Nielsen, the Indian paint industry is expected to grow at a CAGR of 14% over FY14-17E.

Size of Indian Paint Industry (Rs bn)

Source: Industry

The paint industry is broadly divided into two key segments – decorative andindustrial – in the ratio ~ 70:30 in favor of decorative, which is growing at a fasterpace to industrial paints.

The Indian paint industry isexpected to grow at a CAGR of

14% over FY14-17E.

260300

342390

444

507

0

150

300

450

600

FY12 FY13 FY14 FY15E FY16E FY17E


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Indian Paint Industry

Source: Industry

Paint Industry Value Chain

Source: Industry

Raw materialsuppliersfor paintindustry

Contractmanufacturing

units

Brand ownersof

paints

Decorativepaints

Industrialpaints

Institutionalcustomers(Builders)

Individualcustomers

Dealers(Decorative

paints)

Dealers (Industrialpaints)

DirectCustomers

InstitutionalCustomers/ painting / Engg. contractors

INDIAN PAINT INDUSTRY

Decorative Segment70%

Industrial Segment30%

Automotive Sector(about 2/3rd

share)

Consumer DurablesMarine PaintsOther OEM’s

Premium Range(High end Acralic

Emulsions)

Medium Range(Enamel Paints)

Distemper Range(Low end paints)

Metros and Largecities

Small Cities Sub-urban andRural areas


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DECORATIVE PAINT INDUSTRYDecorative paints account for over 70% of the overall paint market in India andinclude wall finishes for interior and exterior use, enamels, wood finishes andancillary products such as primers, putties, etc. Over the past five years, the share ofdecorative paints has risen from 67% to over 70% now. Organized players

dominate with ~80% share of the decorative market, while 20% share isaccounted for by unorganized/local players. The lower-end distemper segment isfairly fragmented, with many unorganized players operating in this segment.

Indian Decorative paint market

The decorative segment is the faster growing paints category, having registered aCAGR of 15% over FY08-14. The growth is a result of 1) Healthy growth in Tier 2and 3 cities, 2) Healthy growth in emulsions sub-segment (+25% CAGR over thepast five years) with customers upgrading to high end products. As emulsion is ahigh end product with superior margins, this trend bodes well for paint companies.Wood coatings too have been growing high teens. The distempers and enamelssegments are growing at a relatively lower pace. Demand for decorative paints is

also influenced by seasonality factor:1) Festive season (October to December) and2) Wedding season (October to June).

Size of Indian Decorative Paint Industry (Rs bn)

Source: Industry

177225

261303

351407

0

150

300

450

600



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INDUSTRIAL PAINT INDUSTRYThe industrial paint segment accounts for ~30% of the Indian paint industry in valueterms and is primarily solvent based with few water applications. Industrial paint ismainly a B2B market with paint companies working closely with their customers todevelop formulation to match their requirements. The segment can be further sub-divided into key sub-categories of automotive paints, protective coatings, GI paints(general industrial), powder coating, coil coating and others. The sales contributionof the dealer channel is low in industrial as compared to decorative.

Size of Indian Industrial Paint Industry (Rs bn)

Source: Industry

7890

99109

120132

0

30

60

90

120

150

FY12 FY13 FY14E FY15E FY16E FY17E


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INVESTMENT ARGUMENT

Market leader in the paint Industry

As per industry sources, APL currently has a market share of ~55% in the organiseddecorative paints segment and dominates the Indian decorative paint segment.

Inspite of presence of global majors like Akzo Nobel and Kansai Paints andattempted entry by likes of British Paints, Jotun etc. the company does not face anyrisk to its leadership position.

The key strengths to its leadership position includes: 1) Proper understanding of theIndian paint industry, 2) APL’s relationship with the trade, 3) Vast dealer network 4)First mover advantage of creating brands in segments and 5) Good pricing power ina rational competitive environment.

Wide Product Range and Strong Brands

APL has the widest range of products at each price point to suit the requirement ofconsumers across income segments. With the help of a variety of products andniche product launches it has created impeccable credentials for itself.

Product Portfolio of APL

Range Products

Premium Royal Brand, Emulsion, Enamel, Apcolite, Apex

Mid range Tractor, Acrylic, Lusture, Safari, Dune

Economy Synthetic, Distemper

Exterior Ultima, ACE Supreme, Duracast

Source: Company

We expect the growth to be high (25% CAGR over FY14-17) in the premiumsegment (as consumers upgrade) which is high margin segment and should boost

the margins of the company. We expect even the mid segment to grow at ahealthy pace (16% CAGR over FY14-17).

Decorative Paint Segment for APL - Upgrading by customers helpingAPL

APL is the leader in decorative paints segment in India (which is the fastest growingpaint category) and has been consistently gaining share in this segment. It isstrongly positioned in terms of strong brand equity, wide product offering andunmatched distribution and supply chain network.

Importantly the company’s product portfolio is skewed towards mid and premiumsegment which enables it to enjoy better margins compared to its peers. Over

recent years, we have seen gradual consumer uptrading towards better quality andmore durable paints. This phenomenon is witnessed across price points. While therehas been a steady shift in rural and low-income households from lime wash todistempers, within urban and semi-urban areas consumers are now moving towardsincreased usage of emulsions and textured coatings. APL, with its comprehensiveand well diversified product portfolio, is gaining from the premiumisation trends andthis may aid long-term margin enhancement for the company


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Asian Paints Decorative Product mix

Source: Company

Strong Supply chain

Effective use of technology has played a critical role in the growth of APL. APL has

been able to stay ahead of the competition mainly because of its strong supplychain management, which helps it to service a large number of dealers almost on adaily basis and in some key market areas even twice a day. Strong brand equityand wide distribution reach have helped APL corner around 55% market share inthe domestic organised decorative paint space.

The company has also invested to modernize field operation by opening newdepots and automating operations at field locations. It has also developed a thirdgeneration cutting edge mobile application for front line sales force, which allowsterritory officers to manage dealer network efficiently. The company has 24factories located in 17 countries, which allows cost-effective and time-effectivesupply of its throughput.

Strong relationship with trade

APL has direct relationship with ~36,000 dealers. The dealers are spread pan Indiawhich enables APL wider geographical reach. As per our interaction with dealers,APL is the leader in the industry in terms of return on investments made by dealers.

The company has a network of around 36,000 dealers (27,000 dealers with tintingmachines) and the company expects to increase the number of dealers at a CAGRof 10% going ahead. We believe that growth driver for Indian paint industry will betier III and tier IV towns and rural areas and going forward APL would focus onaggressive marketing and distribution in these areas through its current network.The robust dealer network is the strongest competitive advantage APL has over itspeers.

Distribution network of APL

Particular Nos

Dealers 36000

Dealer with Tinting Machines 27000

No of Depots 120

Source: Company

Premium

25%

MID

60%

Economy

15%


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Good pricing power in a rational competitive environment

APL continues to enjoy strong competitive advantage over its peer group on most ofthe operating parameters – strong brands, well entrenched distribution network,wide product offerings, innovation, and superior supply chain network. Pricingpower is strong for APL as it derives most of its revenues (~90%) from thedecorative segment where it can pass on much of the cost inflation to consumers.This compares favorably to other firms such as Kansai Nerolac which derives ~45%of revenues from the industrial/automotive segment where pricing power is limited.

All these strengths along with ~55% share of the decorative paint industry in India(which has been on an uptrend) give it fairly high pricing power. The oligopolisticnature of the paints industry, with the top four firms accounting for 80% share, andhigh entry barriers (in terms of distribution network, technology advantage, highnumber of SKUs etc.) further enhance the pricing power of this industry. We alsonote that given that the repainting cycle is usually 4-5 years, consumers probablyare not as influenced by price increases for paints products as they are for productswhich are more frequently purchased. Given that paint product cost is only ~40% oftotal painting application cost (with labor cost accounting for the majority share,and that has been rising at a faster pace), increases in paint product prices do notimpact consumer demand in a significant manner.

Volume and Price change for APL

Source: Company

Competition remains fairly rational in the paint industry for now, though othercompanies are stepping up investments in capacity /distribution/marketing. Firmsprefer to compete on product differentiation, innovation capabilities and quality ofdistribution rather than focusing on price led competition.

Asian Paints Home Solutions to enhance brand loyalty

The company has continued to broad base its dealer network by installing morethan 3200 Asian Paints Color Worlds in FY14 (Asian Paints Color World has in-shopshade display unit with more than 1000 unique shades and interactive computersystem to show how the room will look after painting), increasing the tally of AsianPaints Color World dealers to 27,000. Count of Color Ideas stores (paint storeoffering in-store color consultancy, information about painting process and option tovisualize color choices) increased to 170 (from 100), which has made a hugeimpact, with more than 80,000 customers visiting for consultancy services. Unliketraditional dealers who sell through hardware stores, the new stores focus onhelping customer choose color of his choice. The stores are fitted with boardsdisplaying sample of interior and exterior finishes and consultants who providevisuals showing how room will look like when painted. The company also startedhassle-free painting services through Asian Paints Home solutions (APHS), whichenhances customer service experience by introducing mechanization in painting.

0

5

10

15

20

FY10 FY11 FY12 FY13 FY14

Price Chane (%) Volume Change (%)


10/19



0

200,000

400,000

600,000

800,000

1,000,000

1,200,000

FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY18E

Brief Comparison of APL and other players

Parameter APL KNPL Berger

No of Dealers 36000 15000 16000

No of Tinting Machines 27000 7500 11000

Focus Area ALL ALL Mass Products

Decorative Segment market share (%) 55 15 19

Industrial Segment market share (%) 15 45 9

FY14 Advertisement spending (Rs mn) 6,309 1,061 1,146

Overall Margins 17 11.5 11%

Source: Company, Industry

Capacity in place

In FY13, APL added additional capacity of around 300,000 KL in Khandala,Maharashtra (a Greenfield project) and 50,000 KL in Rohtak (a brownfield project).In FY14, APL shut its Bhandup facility. Going forward, management intends toincrease the manufacturing capacity from the current 2,00,000 KL per annum to

4,00,000 KL per annum at Rohtak over 4 years which a capex involving ~Rs 15 bn.Except for this, we do not expect any major capacity expansion over the next twoto three years. Current utilisation is at 72% and with the upcoming facility, thecompany is well placed in terms of capacity for medium term growth.

Year Wise Capacity for APL (Kilo Ltr)

Source: Company, Kotak Securities - Private Client Research

Expect revenue CAGR of 16% over FY14-FY17 for APL

APL’s consolidated revenue grew by ~20% CAGR over FY05-FY14 – higher than theindustry average – on the back of 14.4% volume CAGR driven by increased

distribution, continuous attention to product quality, focus on premium products,and higher ad spends. Despite a steep increase in prices in FY12, demand fordecorative paints was resilient with a lower double digit growth on a higher baseover the past two years. APL offers the broadest mix in product portfolio tocustomers and has successfully established its strength in the premium paintsegment in the past few years.


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Revenue and revenue growth for APL


Revenue break up

Rs bn FY11 FY12 FY13 FY14 FY15E FY16E FY17E

Standalone 63.3 79.6 89.1 103.0 119.8 138.7 161.9

Subsidiaries/JVs 13.9 16.7 20.3 24.1 26.7 31.0 36.8

Consolidated 77.2 96.3 109.4 127.1 146.5 169.8 198.7

% of Subsidiaries/JVs 18.0 17.4 18.5 19.0 18.2 18.3 18.5


JVs contribute additional growth

APL’s JV’s revenue contributes ~5% to the company’s consolidated revenue. Thecompany has two JVs (both with PPG USA):

PPG Asian Paints (Automotive): APL’s JV (50:50) has seen revenue growing at

21% CAGR over FY10-FY14. The company is the second largest automotive coatingsupplier in India, catering to both automotive OEM and refinish segments. SinceFY12, the company has also been offering marine coatings, consumer packagingcoatings and liquid industrial coatings. PPG manages the day-to-day operations ofthis venture. Asian Paints’ share of revenue from this JV was Rs 4 bn for FY14.

Asian Paints PPG (Non-Auto Industrial): APL’s JV (50:50) incorporated in August2011, caters to industrial liquid paints, powder coating and protective coating. APLs’share of revenue from this JV was Rs 1.5 bn for FY14.

We are building in 15% revenue CAGR over FY14-FY17E.

Even Subsidiaries contribute to growth

Through 5 direct subsidiaries and about 20+ indirect subsidiaries, APL is present in16 countries in 4 regions – Caribbean, Middle East, South Pacific and Asia. Itsconsolidated revenue from its subsidiaries has grown at about 14% CAGR overFY07-FY14, with Middle East and Asia leading the growth. APL is among top 3decorative player in each of these countries except Singapore. While SCIBChemicals (Egypt) is the largest subsidiary, fastest growing ones include that inNepal, Bangladesh and Sri Lanka.

Break-Up of Subsidiaries Revenues (Rs mn)

Geography FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14

Carribean 1,523 1,501 1,633 1,960 1,568 1,718 1,972 2,125

Middle East 2,606 3,194 4,651 6,520 5,159 5,784 7,267 8,316Rest of Asia 1,464 1,716 2,206 2,830 2,403 3,147 3,800 4,847

South Pacific 725 548 620 850 750 906 1,134 1,311

Total Revenues 6,318 6,959 9,110 12,160 9,880 11,555 14,173 16,599

Source: Company

0

7

14

21

28

0

50

100

150

200

FY09 FY10 FY11 FY12 FY13 FY14 FY15E F Y16E F Y17E

Revenue (Rs bn ‐ LHS) Growth (% ‐ RHS)


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We are building in 17% revenue CAGR over FY14 to FY17 for subsidiaries

Diversification - acquired SLEEK in FY14 which is into home improve-ment

With volume of top 5 players in the Indian paint industry expected to grow at ~9%CAGR over the coming decade, compared to 13% CAGR over FY05-FY14, APL as

a part of its strategic initiative has started diversification into home improvementsegment. The initiative has a two-pronged aim:

To garner higher share of walls / floors and ceilings in a house

To garner higher share of dealer throughput

As a first initiative, the company has acquired 51% stake in Sleek Group for aconsideration of Rs1.2 bn. Sleek is a major player in the organized modern kitchenspace and is engaged in the business of manufacturing, selling, and distribution ofmodular kitchens as well as kitchen components including wire baskets, cabinets,appliances, accessories, etc., with a pan India presence. It has a retail network ofmore than 30 showrooms including shop-in-shops and a network of 250+ dealers.While this will bring in diversification benefits to APL, one needs to be watchful ofhow aggressive APL intends to be in this new category with respect to itsinvestments and how that could affect returns over the medium term. While thestreet concerns of lower returns during the initial phase are valid, our analysissuggests that modular kitchen is the second best opportunity after paints in thehome improvement segment.

Estimated Expenditure by a family for home improvement

(Area of the house = 1000 sq. ft. /Paintable area 3000 sq. ft.)

Improvement Cycle in yrs Budgeted Annual expenditure

Paints 4 60,000 15,000

Modular Kitchen 12 120,000 10,000

Flooring 20 120,000 6,000

Bathroom fittings 10 60,000 6,000

Source: Kotak Securities - Private Client Research

The above table is based on our interactions with secondary market sources likeretailer. From the discussion, we conclude that lifetime value of a customer ishighest in decorative paints, and modular kitchen comes second.

It is also important to note that the concept of modular kitchen today is restrictedonly to big cities in the country and is in infancy stage in the country, and the sizeof overall industry today is too small compared to the decorative paints industry. Butthe above also suggest that the room for growth is significant.

Advertisment and Promotion expenditure of Paint companies - higherspending on branding and marketing by APL

Rs mn Asian Paints KNPL Berger Paints

FY09 1,971 451 475

FY10 2,443 561 588

FY11 3,426 764 810

FY12 4,101 944 1,080

FY13 5,152 1,033 1,114

FY14 6,309 1,061 1,146

Source: Company, Industry


13/19



One of the highlights of APL, is that it is one of the highest spender onAdvertisement and Promotion (A&P). The A&P expenditure of APL is almost 3 to 4times of other established players like Kansai and Berger. Heavy spend on A&Phelps APL in:

1) Effectively market its products

2) Provide every information to the customer

3) Create brand impact

It is important to note that that A&P expenditure for APL as % of sales hasremained around 4.4%-4.7% over FY08-FY14, while for other listed peers likeKNPL and Berger the share of A&P spends has increased consistently over theseyears and crossed the 5% mark (in FY12 itself) as percentage of revenues.

EBITDA margin to improve 150bps over FY14-FY16

Over FY05-FY14 the company’s EBITDA margin improved from 13% in FY05 to15.8% in FY14. APL’s key raw input costs are TiO2, solvents and pigments, whichare crude oil derivatives, and hence any sharp movement in crude oil and exchange

rate movements bring volatility to the margins.

Benign raw material environment for APL - Raw Material accountsfor more than 65% of revenues

Key raw materials for APL are titanium dioxide, pigments, resins, and solvents. Partof it is imported (around 30%) or are locally sourced, but being crude derivativeshave exposure to import pricing parity. This implies that forex exposure is fairly highfor paint companies. The input cost environment has been relatively benign forpaint companies in the last few quarters with stable to subdued prices for TiO2.Companies are able to pass any input inflation to customers in the decorativesegment but struggle to do the same in the industrial segment this works for APL.Sharp depreciation in rupee has added to the input cost of paint companies though

the trend is reversing since the last 9 months.

Pricing Power remains strong in Decorative segment

Due to high level of consolidation in organized players in the decorative paintssegment, pricing power remains fairly strong for manufacturers. Increasing price isthe biggest way to offset the impact of forex and raw material price fluctuation. Webelieve that price hikes do not have a material impact on the volume of paintcompanies due to a) lower overall cost of painting in total project cost b) weddingsand other celebrations forming a large proportion of demand for decorative paintswhich is not impacted much by price hikes and d) larger repainting cycle of 4 to 5years

Average Price hikes taken by various paints companies% APL KNPL Berger

FY09 10.1 9.1 10.2

FY10 0.0 0.0 0.0

FY11 11.1 6.3 7.8

FY12 11.0 8.0 9.0

FY13 5.0 4.6 5.0

FY14 7.0 4.5 5.0

Source: Companies


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15.9

15.8 15.7

17.1 17.2

16.9

14

15

16

17

18


EBIDTA to improve for APL by 150 bps over FY14-FY16

With improving macro environment, benign raw material cost and strong pricingpower, we expect operating margins to improve for APL as the company is derivinga significant proportion of its revenues from decorative segment (90%) wherepricing power for paint companies is quite strong. Due to brand positioning, thecompany commands strong enough pricing power to pass through cost inflation. Wehave built in 140 bps increase in operating margins in FY15E at 17.1% (Q1FY15 =16.9%) and further 10 bps improvement in FY16E at 17.2%

Titanium dioxide imported from China (Rs / kg)

Source: Bloomberg

Operating margin (%)


Even crude has corrected

Around 50% of the raw material that paint companies use are crude derivatesolvents. Prices of these crude derivate solvents are directly related to the demandsituation and indirectly to crude prices. Global crude prices dipped below $90/barrelfor the first time in two years and has corrected by 18% in this year itself. Webelieve that the margins of paint companies should improve by 25bps (than whatwe estimate) if crude prices continue to remain soft.

130135

140

145

150

155

160


15/19



Price of Brent crude in US$/barrel

Source: Bloomberg

Debt and free cash flow analysis - Cash situation to improve

Capex in the last few years have influenced FCF for the company. For FY15 to

FY17, management expects capex of Rs 15 billion. As on March 2014. APL hadcash and cash equivalents of ~ Rs 10 bn with operating cash flow generation ofaround Rs 20 bn per annum, which is self-sufficient in our view to fund anyincremental capex requirements from internal accruals. With improving profitability,we estimate cash situation of the company to improve significantly.

Debt and cash flow analysis

(Rs mn) FY13 FY14 FY15 FY16 FY17

Gross Debt 2,470 2,550 2,795 3,016 3,214

Networth 34,897 41,753 51,487 63,987 79,430

Cash 7,393 10,300 16,212 26,333 39,600

Operating cash flow 11,502 15,026 17,030 21,191 24,358Free cash flow 4,281 12,132 12,746 16,191 19,358

Capex 7,220 2,894 4,284 5,000 5,000


Return ratios would continue to be healthy

ROE for APL has moderated significantly from ~35% in FY11 to -30% in FY14which we believe should stabilise at current level over FY15E to FY17E. The fall hasbeen largely led by lower asset turnover. The asset turnover has decreased due tocontinuous capex by the company in the last 3 years. We do not estimate furtherdeterioration in ROE/ROCE.

DuPont Analysis

Parameter Ratio FY13 FY14 FY15 FY16 FY17

EBIT margin EBIT/ Revenue 0.15 0.15 0.16 0.16 0.16

Asset Turn over Revenue /Capital employed 2.81 2.72 2.56 2.41 2.29

Financial Leverage Capital Employed/ Equity 1.12 1.12 1.11 1.10 1.09

Interest Burden PBT/EBIT 0.98 0.98 0.99 0.99 0.99

Tax burden PAT/PBT 0.70 0.69 0.70 0.70 0.70

ROE (%) PAT/Equity 0.33 0.30 0.32 0.30 0.27

EBIT Margin EBIT/ Revenue 0.15 0.15 0.16 0.16 0.16

Capital Turnover Revenue/ Capital Employed 2.81 2.72 2.56 2.41 2.29

ROCE (%) EBIT/Capital Employed 0.43 0.40 0.41 0.39 0.36



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Earnings to grow ~20% over FY14-FY17E

Over FY14-FY17E, we expect consolidated sales to grow at a CAGR of 16% andEBITDA margin to improve by 120bps, leading to an EPS CAGR of ~20%.Depreciation is expected to increase over FY14-FY17 due to commissioning ofKhandala facility.

Share Price Performance

APL is a high-quality consumer name and has been favored by investors given itsdominance in the paint market, good management, and healthy sales growthtrend. The stock has seen a strong run-up, nearly doubling from the beginning ofFY12 to end September 2014. FII holdings in the company increased from 15% inFY08 to 18.2% as of June 2014 (the highest since 2007) and that also aided strongshare price performance.

Share price performance vs. Nifty for 2 years

Source: Bloomberg


17/19



VALUATIONWe believe valuation of APL would be driven by 1) sustained market share in theimproving decorative segment; 2) improvement in market share in industrialsegment. We also believe that the company is well placed to achieve healthygrowth in terms of a) capacity (9 lakh tonnes) b) ever growing dealer base

(currently at 36000) c) strong brand name; d) strong product portfolio: e)diversification (acquisition of Sleek); f)Technological Knowhow and g) strong BS.

The sector has witnessed healthy growth in the last 4 to 5 years with paintcompanies getting rerated and trading above their historical average one yearforward for the last 5 years. The companies also trade at ~30 percent premium toglobal paint companies, which is justified by the long term prospects of Indian Paintcompanies.

We expect earnings for APL to grow at a CAGR of ~20% over FY14-FY17,supported by revenue CAGR of ~16% and EBITDA margin expansion from 15.7%in FY14 to 17.2% in FY16.The stock of APL at CMP of Rs 625 is trading 32.4xFY16E P/E. We prefer to use a P/E approach to value the stock (like any other

consumer company) and give a value of 36x one year forward FY16E P/E which isat its 3 year average one year forward average historical PE multiple. We expectthe stock to rerate further, on account of better earnings growth and stable RoE.We initiate coverage on APL with a BUY rating and at TP of Rs 700.

Relative valuation - Peer analysis

Company MKt Cap PE EV/EBIDTA P/B ROE

Rs bn FY15E FY16E FY15E FY16E FY15E FY16E FY15E FY16E

Asian Paints 620 37.9 32.4 22.2 19.2 11.6 9.4 31.7 29.7

KNPL 99 39.1 32.1 13.5 11.5 5.6 4.8 21.3 24.1

Berger Paints 121 41.1 34.7 15.2 12.9 9.2 7.8 24.2 24.4

Source: Bloomberg; Industry; Kotak Securities - Private Client Research


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FINANCIALS

Profit and Loss Statement

(Rs mn) FY14 FY15E FY16E FY17E

Net sales 127,148 146,502 169,755 198,728Raw Material 73,407 84,385 97,440 114,070

Employee Cost 7,597 8,416 9,695 11,492

Other Expenses 26,165 28,610 33,390 39,554

- Operating expenses 107,169 121,411 140,524 165,116

Operating profit 19,979 25,091 29,231 33,612

+ Other income 1,243 1,250 1,250 1,250

- Depreciation 2,457 2,694 3,019 3,344

- Interest 422 327 353 376

- Tax 5,715 6,996 8,133 9,343

PAT 12,628 16,324 18,976 21,799

+ (Associates-Minorities) (440) (500) (500) (500)

Consolidated PAT 12,188 15,824 18,476 21,299


Cash Flow Statement (Rs mn)


Consolidated PAT 12,188 15,824 18,476 21,299

Non-cash items 3,029 3,394 3,832 4,278

Cash profit 15,217 19,218 22,309 25,578

Inc. in working capital 191 2,188 1,118 1,219

Operating cash flow 15,026 17,030 21,191 24,358

Capex (2,894) (4,284) (5,000) (5,000)Investments (4,254) (789) - -

Cash flow from Invest (7,148) (5,073) (5,000) (5,000)

Dividends (5,904) (6,790) (6,790) (6,790)

Equity raised - - - -

Debt raised 80 245 221 198

Inc. in minority interests 853 500 500 500

Miscellaneous items - - - -

Cash Flow from Finance (4,971) (6,045) (6,069) (6,091)

Net cash flow 2,907 5,912 10,122 13,267

+ Opening cash 7,393 10,300 16,212 26,334

Closing cash balance 10,300 16,212 26,334 39,601


Balance sheet


Equity 959 959 959 959Reserves 38,798 47,832 59,519 74,029

DTL 1,996 2,695 3,509 4,443

Networth 41,753 51,487 63,987 79,430

Debt 2,550 2,795 3,016 3,214

Minority interests 2,460 2,960 3,460 3,960

Capital employed 46,763 57,242 70,462 86,604

Fixed Assets 24,892 26,482 28,463 30,119

Investments 7,211 8,000 8,000 8,000

Working capital 4,360 6,548 7,666 8,885

Cash 10,300 16,212 26,333 39,601

Capital deployed 46,763 57,242 70,462 86,604


Ratio Analysis

FY14 FY15E FY16E FY17E

Topline growth (%) 16.2 15.2 15.9 17.1

Bottomline growth (%) 9.4 29.8 16.8 15.3

Operating margins (%) 15.7 17.1 17.2 16.9

FDEPS (Rs/share) 12.7 16.5 19.3 22.2

CEPS (Rs/share) 15.9 20.0 23.3 26.7

DPS (Rs/share) 5.3 6.0 6.0 6.0BV (Rs/share) 43.5 53.7 66.7 82.8

PER (x) 49.2 37.9 32.4 28.1

P/C (x) 39.4 31.2 26.9 23.4

Dividend yield (%) 0.8 1.0 1.0 1.0

P/B (x) 14.4 11.6 9.4 7.5

EV/Sales (x) 4.6 4.0 3.4 2.9

EV/ EBITDA (x) 27.5 22.2 19.2 16.8

Debt/Equity (x) 0.1 0.1 0.0 0.0

Working capital turn (days) 12.2 13.6 15.3 15.2

Dividend payout (%) 48.4 42.9 36.7 31.9

ROE (%) 30.2 31.7 29.7 27.4

ROCE (%) 40.1 41.3 39.0 36.4



19/19


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Documents

Asian Paints Oct 2014