Asian Paints’ capex & backward integration plans fail to cheer analysts, investors. Here’s why

Asian Paints is committing about Rs 6,750 crore for the next three years to increase its manufacturing capacity, set up facilities for backward integration, and for acquiring a nano technology player Harind. These plans can dent free cash flow and return-on-equity (RoE) in the medium-term, believe analysts.

Here’s a look at the company’s investment plans:

Capacity expansion: Rs 3,400 crore for increasing in-house paints capacity by 30 percent to 22.7 lakh KL.

VAM and VEM plant: Rs 2,100 crore to set up a manufacturing facility for Vinyl Acetate Ethylene Emulsion (VAE) and Vinyl Acetate Monomer (VAM) in India. The facility would have capacity of 100,000 tonnes for VAM and 150,000 tonnes for VAE.

VAE is considered to be the emulsion of the future, the company said, and it is the key constituent for manufacturing environment-friendly paints. VAM is a key input for manufacturing VAE.

White cement facility: Rs 550 crore to set up white cement manufacturing and export plant in Fujairah, UAE, with capacity of 265,000 tonnes per annum. For this, Asian Paints has signed a binding term sheet with Riddhi Siddhi Crusher & Land Transport.

White cement is a key raw material in the manufacturing of powder paints and undercoats like putty.

Acquisitions: Rs 800 crore for acquisitions like White Teak, Weatherseal and Harind. While White Teak and Weatherseal acquisitions were announced earlier, Harind Chemicals and Pharmaceuticals is the newest one.

“At the moment, we are taking about a 51 percent stake in Harind, and additional stake of 39 percent could be acquired over the next five years. Harind is a specialty chemicals company and it has the NexGen nanotechnology as its core,” said MD and CEO Amit Syngle during Q2 earnings concall.

According to analysts at HDFC Securities, while this investment phase is beneficial in the long run, it will certainly be a drain on free cash flows and returns profile in the short to medium term. The brokerage firm has a Sell rating on the stock, with a target price of Rs 2,700 per share.

Meanwhile, analysts at Elara Securities believe the backward integration plans will impact the return on equity (RoE) in the medium term. It has pegged FY23 RoE at 30.7 percent, FY24 at 32 percent and FY25 at 33 percent. They have a Sell rating on the stock, with a target price of Rs 2,865.

Also Read: Asian Paints | Capex plan in the spotlight amid impressive Q2 earnings

Domestic brokerage firm Prabhudas Lilladher believes the benefits of the Rs 6,750-crore capex plan will start getting reflected from FY26 onwards. “We see little scope of further re-rating in the stock, given likely aggression from Grasim & JSW in the paints sector and impending capex plans,” said Amnish Aggarwal, head of research at the firm. They have an Accumulate rating, with a target price of Rs 3,326 on the stock.

New capex plans might dilute the return on capital employed (ROCE), Motilal Oswal Financial Services added. It has a Neutral rating on the stock, with a target price of Rs 3,150.

However, the company’s management is confident of the long-term prospects of backward integration into VAE and white cement manufacturing. “I think, gross margin improvement of about 4-5 percent will easily happen,” Syngle said.

The stock has declined 5 percent since announcement of Q2FY23 results. The company’s net profit at Rs 803 crore was sharply below analyst expectations of Rs 1,068 crore. Volume growth at 10 percent was also below estimates of 12-13 percent. This was largely on the back of downtrading from luxury range to premium and economy products. EBITDA margin came in at 14.5 percent. However, analysts had estimated EBITDA margin at 18 percent.

The stock closed at Rs 3,082.50, down 1.25 percent, on the National Stock Exchange on Tuesday, 25 October 2022.

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