The ‘Significant Risks’ That Turned Goldman Sachs Bearish On Asian Paints

Goldman Sachs turned bearish on India’s biggest paintmaker, citing “significant risks” to sales growth amid the new coronavirus pandemic and steep valuation.

The global research firm downgraded Asian Paints Ltd. to ‘sell’ from ‘neutral’ and cut its target price by 20 percent to Rs 1,111 apiece. That implies a nearly 28 percent downside from the current market price.

“We forecast FY22 and FY23 volume growth to be 1.5 times real GDP growth (lower than the long-term average of 1.7 times) as consumers are likely to push back repainting, given the slowdown and Covid-19 concerns,” Goldman Sachs said in a report. It expects volume growth to slow to an average of 6 percent over the next three years.

This offsets the benefits of lower raw materials prices. “While the percentage decline in input costs is now higher than in 2010, we believe gross margin expansion is unlikely to be significantly higher.” That, the research firm said, is because:

• Asian Paints is likely to pass on part of the benefits to drive volume growth
• The risk of down-trading — a practice of a consumer switching from expensive brands to cheaper alternatives — with the economy segment growing faster
• Estimated lost sales in the first quarter of FY21 due to the lockdown when the pullback in input costs is the highest

“We lower our FY21-24 estimated sales growth by 2-4 percent to reflect a weaker mix, and our EPS estimates by 18-19 percent to reflect weaker margins, as we expect gross margin benefits to be reinvested to drive volumes,” Goldman Sachs said. “Asian paints is currently trading at 47 times its FY22 price-to-earnings multiple compared to our coverage average of 39 times.” Also, the company’s sales are expected to grow at an annual rate of 3 percent through FY19-22. That’s “among the lowest in our coverage”.

Shares of Asian Paints have fallen more than 17 percent in the last three months as the world’s most expansive shutdown to tackle the pandemic hurt demand in a seasonally strong quarter for the company. On Tuesday, the stock extended its losing streak for the 10th straight session—the longest ever.

The outbreak froze all economic activities, crimping demand for both household and industrial paints. Even after the lockdown is lifted, it isn’t expected to recover quickly. Consumers are expected to cut discretionary spending because of job losses and salary cuts. The Rs 50,000-crore Indian paints industry, according to Investec, gets 75 percent of its revenue from decorative or household segment. Within that, repainting accounts for three-fourths of the sales and the rest comes from new constructions.

That’s despite a fall in raw material costs after crude tumbled more than 80 percent so far this year. BloombergQuint had reported on the issue late last month.

After Goldman Sachs’ downgrade, 24 analysts have a ‘buy’ rating on Asian Paints. While 11 recommend a ‘hold’, five suggest a ‘sell’, according to Bloomberg data. The 12-month consensus target price is Rs 1766.66 a share, an upside of 13 percent from the current market price.