Asian Paints: Competition, rising ad spend a negative

Fierce competition and foreseeable increase in raw material prices are likely to impact earnings of the largest paint manufacturing company — Asian Paints — in the coming quarters. The company will continue to face cost pressures from increasing input prices and given the rising competition, it would be financially difficult for the company to pass on this increased cost to the consumers.

Major raw materials for paint manufacturing companies are crude-linked and titanium dioxide. Prices of titanium dioxide are likely to be increased from the beginning of 2012. Besides this, its major competitors have become very aggressive in terms of advertisement spends and product innovations. Its major competitors include Akzo Nobel, Kansai Nerolac, Berger and Nippon.

They have significantly increased their advertisement spends over the past few years. For instance, Akzo Nobel, known for its Dulux brand, spends roughly 9% of its sales on advertising and marketing, compared to 4% five years ago. Additionally, these companies have been launching more and more innovative products and have kept a target of increasing their market share by 1-2% year-on-year.

This will limit the company’s ability to pass on the increased cost to the customer. The impact of all this is clearly visible in the company’s operating margins over the past few quarters. In the recent September quarter, the operating margin was 15.5% down by 400 basis points YoY. Given the increased competition, growth in sales volume seems difficult. The company has gained 9% market share in the past five years. Currently, it has around 53% market share in the paints industry. Its sales volume grew 16% during the same period.

This could be mainly due to successful advertising campaigns by the company in the previous years when competition was less active. But maintaining a similar growth in the future appears unlikely. Besides, the slowdown in the overall demand for paint will make it even more difficult.

At the price of Rs 2,761, Asian Paints’ stock is trading at a price-to-earning multiple of 30. This valuation doesn’t look cheap, considering the weak business situation.