Asian Paints is India’s largest and Asia’s third largest paint company. It is a vertically integrated paint company with in-house manufacturing facility. It’s product portfolio includes wall paints, metal paints, wood finishes, primers and others. The company’s market segments include decorative and industrial coating segment. The industrial coating segment consists of automotive coating, powder coating and protective coating. Besides Asian Paints, the group operates around the world through its subsidiaries Berger International, Apco Coatings, and SCIB Chemicals.

One notable aspect that I personally like about Asian Paints is that, it has been able to expand globally without taking on too much debt. It is able to support its expansion plan from its internal sources.

Trend Analysis

The whole reason for any business to exist is to generate sales revenue and make more profits. At a minimum, the parameters listed below should have continuously increasing trends. All the data below is based on last 8 years i.e. from 2000 to 2008.

• Revenue: Increasing trend with average growth of 15% (SDev. 5%).
• Earnings per share: Increasing trend with average growth of 19% (SDev. 15%). This shows very high variability over last 8 years.
• Net cash flow from operations: Overall, the net cash flow from operations has an increasing trend. For most part, the net cash flow has been higher than reported net profit. Good observation.
• Profit/Loss from operations: Looking at standalone profits only, the corporation is showing consistently increasing profits from its operations. Good observation.
• Reported net profit: Increasing trend. Good observation.
• Gross margins: Very stable gross margins. Historical average of 15.4% (narrow stdev. of 0.44%). Good observation.
• Operating margins: Very stable operating margins. Historical average of 15.1% (narrow stdev. of 0.43%). Good observation.

Quality of Dividends

In this part of my analysis, I am trying to understand dividend growth rate, consistency, and ability of the corporation to demonstrate sustainability. In is also an indirect way to gauging management’s policy vis-à-vis sharing the profits with common shareholders.

• Dividend per share: Chart 3 shows that consistently increasing dividend payments. Good observation.
• Payout factor: This is ratio of dividends per share divided by EPS. It has been maintaining consistent at around 50 to 55%. This is an indication that management believe in sharing some percentage of profits with common shareholder. Good observation.
• Dividend growth rate: In last eight years, dividends have grown at an average rate of 20%. This is very much similar to EPS growth rate of 19%. As company’s earning grew with general economy, it shared increasing dividends with shareholders. Good observation.
• Ratio of cash from operations to reported net profit: This ratio is consistently above 1.0. Good observation.
• Ratio of profits from operations to reported net profit: This ratio is consistently more than one. Good observation.
• Ratio of Cash from operations to total debt: This ratio is consistently more than one. Good observation. This indicates that company can meet its debt requirements from its operational cash flow.

Dividend Cash Flow vs. Risk Free Savings Cash Flow:

Why should I take risk if I can get a same or more cash flow by putting my capital into any risk free savings, fixed deposits, or any such risk free accounts? Therefore, I try to understand how dividends will affect my cash flow in 10 years of time period. The baseline assumptions are (1) the stock’s dividend yield is 1.5% at current price of Rs. 1099.15; and (2) savings interest rate is 7%.

• Best case scenario: considering average dividend growth rate of 20% for last eight years, the dividend cash flow will be only 0.60 times the cash flow from savings interest.
• Worst case scenario: considering low end of the dividend growth of 2% for last eight years, the dividend cash follow will be only 0.28 times the cash flow from savings interest.
• In order to have equal cash flow (i.e. dividends = savings interest) in 10 years time period, the current yield should be 2.7% with average dividend growth of 20%. At this yield the buy price is Rs. 620.10.

Projected Beta-based Expected Return: [Methodology]

I measured Beta of Asian paints stock risk (or price movement) relative to the S&P CNX NIFTY (or index movement). Here, I am trying to understand how a stock price behaves relative to the market and how to factor in the capital appreciation into my expected returns.

• The stocks eight year Beta value is 0.24. This means Asian Paints stock is relatively less volatile w.r.t. S&P CNX NIFTY index.
• The expected return is 9.1% relative to market index.
• Now factoring in 9.1% of expected return into the worst case dividend growth of 10% and current yield of 1.5%, the total cash flow is 1.82 times the savings interest rate.

Fair Value Calculation [Methodology]

I am continuing my analysis to estimate the fair value so that we can understand return characteristics for this investment.

• NPV price based on 15 year DCF: Rs. 1746.6 [Methodology]
  
• Average high yield price calculated based on past 9 years: Rs. 572.6
• Pricing relative to 9 year average PE ratio: Rs. 711.6
• Pricing based on PE ratio of 12: Rs. 348.2
• Graham number: Rs. 251.4

The range of fair value is calculated as Rs. 426.8 to Rs. 726.1

Qualitative Analysis

• Over the years, Asian Paints has been a very stable and growing corporation. It has kept growing along with the economy in both real estate and industrial paints segment. It is also increasing its reach in global markets.
• It has had a very favorable dividend strategy in which it consistently shared its profits with shareholders. The dividends have doubled in last 5 years.
• In addition, historically, it has been a very low debt company, with most of the growth coming from organic sources. I like this aspect of Asian Paints.
• Along with slowdown in our countries and global economy, I expect Asian Paints to shows reduced earnings. This is expected and extrinsic factor which company does not have any control over. The most recent analyst presentation shows that management acknowledges this challenge and presents a realistic picture. It does not hype its positioning and maintains a firm footing in realities.
• I believe company is very well position to navigate this downturn (brand value, distribution network, negligible debt, excellent management, presence in different markets).

Summary…

I like Asian Paints as a company, its brands, and management’s dividend strategy. I like its market positioning and ability to navigate the current downturn. The table below shows the return characteristics of the investment scenario for next 10 years (Note: this return characteristic is relative to savings cash flow and relative to index performance).

I love Ferrari cars; unfortunately, it is not priced for me to buy. Similarly, I love Asian Paints as a company. But it is not priced right for me to buy. I will wait until it comes within my fair value range.

Full disclosure: No position at the time of this writing.

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Disclaimer: This analysis is in the context of my long term investment philosophy. It is in line with my investment objectives and my personal risk profile. Please do your own research before making an investment decisions for Asian Paints.

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