Stock Review: Asian Paints

The demand for decorative paints, which account for a bulk of Asian Paints' revenues, is robust, as paints are increasingly being looked at as a necessity and not just a discretionary spend. The industry has a strong linkage to the gross domestic product (GDP) growth. As a result, the Indian paint industry gets to cater the second-fastest growing market after China.

Though competition is increasing due to entry of global players and capacity expansions, analysts believe companies have reasonable pricing power on account of rising incomes and a shift in consumer preferences to the high-margin and fast-growing emulsions category.

With a 51 per cent market share, Asian Paints will be the biggest beneficiary of the industry growth. Moreover, competition is limited, as its distribution network of 27,000 dealers (twice its closest peer) is a good entry barrier.

Spiralling raw material prices, specifically crude-oil based goods that account for 35-40 per cent of total raw material cost, are a concern. But, the company has been able to maintain margins through price increases and an improved product mix (high-margin emulsions account for about a third of its revenues). The company had raised prices by eight per cent in the first half of 2010-11 and there would be asmall increase in the second half as well.

After a subdued September quarter, the company is expected to report a strong performance in the December quarter, as the pre-Diwali buying shifted to the third quarter of 2010-11, while it was in the September quarter last year. Though margins are expected to be stable, there could be some negative surprises on raw material and advertising cost fronts.

The stock, which hit an all-time high of `3,027 on Thursday and trades at 27 times 2011-12 average estimated earnings, is not cheap. However, there is a strong possibility that analysts will revise earnings forecast upwards, after which the price earnings multiple may not seem high.

Rising incomes and a shift in consumer preference to high-margin emulsions augur well