Asian Paints

Asian Paints' EBITDA margin slipped 130bp in 1QFY09, but strong sales growth at 34% ensured EBITDA growth of 24%. We would be cautious on the sustainability of this high sales growth, as the high inflation in the economy could soften demand growth. We lower our target price, but reiterate Buy.

Sales growth exceeded expectations, but EBITDA margin was lower
Asian Paints reported 34% revenue growth in 1QFY09, which was driven by strong volume growth. Management indicated that growth has been strong across segments, and across the country. However, EBITDA margin fell to 14.4%, which is a decline of 130bp yoy and 180bp qoq. EBITDA growth at 24% was better than our expectation despite lower margins. PAT came in 32% higher.

Raw material cost inflation is the key worry
Management said its average materials costs so far in FY09 are 11% higher than FY08 levels. The product price hikes of 4% since February have only partly neutralised the higher-cost impact. Management said it plans to hike prices further to neutralise the cost pressure in the coming months.

Why we are cautious on revenue growth
Despite 34% revenue growth in 1QFY09, we forecast just 24% growth for FY09. Management remains optimistic on the demand trend, but we see growth slowing for the following reasons: 1) 25-30% of paint demand comes from new housing projects, which should see a lagged impact on activity levels from interest rates hikes; 2) the 5-6% price hikes for paints planned for FY09 would be the sharpest in a single year, which could have a sobering effect on demand growth;
and lastly, 3) the high level of general inflation (10-11%) could impact spending on re-painting in the coming festival season.

We maintain our Buy rating with a lower target price of Rs1,331
We have upgraded our standalone EPS estimates for FY09 and FY10 by 2%, reflecting the strong 1QFY09 vs our expectations. However, we have raised the risk-free rate to 9% (from 8.25%), and consequently our DCF-based target price falls to Rs1,331 (from Rs1,410). Asian Paints' competitive position remains very strong in India, and with an average ROE of 49.4% over the last five years, we believe the stock deserves a premium valuation.