The street was expecting mixed results for Asian Paints. The company declared strong volume and sales growth, lower net profit, and heavy margin contraction YoY basis: Q3FY22 results in line with street expectations. The double-digit volume and sales YoY growth was tempered by an eight percentage point contraction in operating margin YoY (due to high raw material costs)  and double-digit net profit YoY fall in Q3FY22. But investors are not too disappointed. Bowing down to high raw material inflationary pressures, the company took a 15% price hike in Q3FY22.  With Brent crude price touching $90 per barrel, will these price hikes be able to nullify raw material cost inflation in the coming months? Or will these price increases smother down demand amid Omicron uncertainty? 

Quick Takes

• Operating margins contracted by 820 bps to 18.1% in Q3FY22 mainly due to rise in raw material costs
• Asian Paints increased prices by around 7% in H1FY22, and 15% in Q3FY22, to shore up its margins
• With 22% YTD price hikes, Asian Paints’ operating margin performance is expected to improve sequentially in Q4FY22
• Paint demand in January 2022 might be impacted by the third wave, but pent up demand in February and March is expected to improve overall volumes
• Kitchen and bath business are expected to constitute 8-10% of overall business by March 2025 
• Asian Paints’ current capacity utilization is around 70–75% and fresh round of capex is expected within 2–3 years 

Margins fall despite a healthy volume and revenue growth in Q3FY22

Asian Paints’ volumes grew 18% YoY which helped revenues expand 26% YoY during Q3FY22 (to Rs 8,527 crore), despite a high base in the December 2020 quarter. The high base was due to pent-up and festive demand. .

Revenue growth in Q3FY22 was aided by strong demand in metro, tier I & II cities, and waterproofing and projects business. 

Due to a 41% YoY rise in raw material costs, 17% in employees costs, and 29% in other expenses, operating margins contracted by 820 bps to 18.1%. To counter this rise in costs, the company hiked prices by 15% in Q3FY22, which led to a 540 bps improvement in operating margins on a QoQ basis. As a result, although net profit was down 18% YoY to Rs 1,016 crore in Q3FY22, it improved by a whopping 70% sequentially.

Unprecedented raw material price inflation and price hike

The company hasn’t seen this kind of raw material price inflation over the past four decades, Amit Syngle, Managing Director and CEO at Asian Paints said. Though Syngle noted that the raw material cost is not directly correlated to crude price movement (Brent crude is up 60% YoY), the paint industry uses crude derivatives (price increases with a lag) such as polymers, solvents, monomers, and resins for manufacturing paints. 

In addition to that, another significant raw material, titanium dioxide, witnessed a strong price increase over the past year. Titanium dioxide is a naturally occurring ore with its deposits mainly in China, Canada, Australia, and South Africa. Used as an additive in paints, titanium dioxide is also used in various industries like plastics, chemicals, aerospace and the shipping industry. With the recovery in the global economy by the end of 2020, titanium dioxide demand surged leading to a rise in prices. Asian Paints’ raw material costs constituted 56.5% of total expenditure in Q3FY22. According to management, the rise in shipping costs, freight, and supply chain bottlenecks also accentuated the impact of rise in costs over the past few quarters.

Asian Paints increased prices by around 7% in H1FY22 and later by 15% in Q3FY22, to shore up its margins and maintain profitable growth. A price hike of about 22% YTD is the highest ever by a company in the Indian paints industry in a single year. It was an unprecedented decision by Asian Paints which never implemented price hikes of more than 2-5% in any given year. Close peer Berger Paints undertook a price hike of 18% YTD in FY22. 

With the price hikes in December 2021, Asian Paints’ operating margin performance is expected to improve sequentially in Q4FY22. Analysts are relieved with the price hikes, but this will dent Asian Paints’ volumes, which have grown at double digits for five consecutive quarters now.

Will volume growth be sustained?

Asian Paints’ strong focus on volume growth and market share gains meant price hikes were deferred in FY21. The company gained a 2.7% market share gain in Q2FY22 and the trend continued in the December 2021 quarter. Asian Paints garnered significant market share gains from both unorganized players and organized peers during the Covid-19 pandemic. The company has a nearly 50% market share in the Indian paint industry. Organized players own 75% of the domestic paint industry with unorganized players cornering the remaining 25%. 

In Q3FY22, volume growth was mainly led by metro and T1 and T2 cities while T3 and T4 regions registered relatively lower but healthy growth. Thus, luxury and premium products mainly demanded in metro, T1 and T2 cities witnessed strong growth compared to economy products used in rural and T3 and T4 regions. 

The company is not expecting the volume growth trajectory to be derailed by recent price hikes. According to management, even with a 10% price increase in the first fortnight of November, demand was healthy and a 5% price increase on December 5, 2021, did not impact volume growth. Syngle said that if the third wave had not hit in the second fortnight of December 2021, total volume growth in Q3FY22 would have been even better. He further added that while labour constitutes 60-70% of the cost of painting, material cost is lower at 30-40% and the overall price increase will be nullified when translated into a per square feet price. Thus, the company expects healthy volume growth especially in the premium and luxury segment while economy products might witness price increase impact. 

As crude prices inch higher, Asian Paints’ management might have to take further price hikes in Q4FY22 to mitigate the raw material price increase. According to the management, while January 2022 paint demand might be impacted by the third wave, pent-up demand in February and March will help. This may spill over into Q1FY23 as seen in the past two Covid-19 waves. The Omicron wave is peaking faster and is expected to ebb by March 2022. But with the persistent high raw material costs and festive demand out of the picture, it will be interesting to see how volumes perform in Q4FY22 and beyond.

Rural and semi-urban network expansion, home improvement segment’s strong performance

While the rural slowdown noise intensifies, Asian Paints is confident of the continued growth of rural, T3, and T4 regions. Continuous progress with upgrading at the bottom of the pyramid is aiding rural growth. Customers are also upgrading from basic painting material to purchases of emulsions and other premium products. With the increase in consumption capacity and population expansion in smaller towns and cities, rural growth is on a stronger footing not only in the near term but for the next 20 years. On an overall demand scenario, Syngle said, “I would say that if the GDP is remaining in the healthy zone of 6-8% going forward. I don't see that, growth would be a problem.” Paint industry volume growth is usually double that of the GDP growth rate.

The adjacencies are also performing well with a strong demand outlook. Waterproofing grew 50% YoY in Q3FY22. Asian Paints projects business is witnessing strong demand since last July-August 2021 which continued in Q3FY22. Kitchen and bath businesses initiated in FY14 achieved breakeven. Both businesses reported Rs 100 crore revenue individually in Q3FY22. And the company expects these business units to constitute 8-10% of the overall business by March 2025. 

Asian Paints has successfully captured customer mindshare by being not just on the walls but also being present within four walls of a home. But it needs to sharpen its skills further to combat Grasim Industries which is expected to enter the domestic paint industry in CY22.