Margin pressure and rich valuation near-term concerns for Pidilite

Pidilite Industries (Pidilite) posted good numbers in the June quarter (Q1), with comparable consolidated topline and net profit growing 23 per cent and 6.3 per cent year-on-year, to Rs 18.2 billion and Rs 2.4 billion, respectively. 

This was led mainly by a healthy 18 per cent growth in volume, amid improving demand that is likely to persist. However, rich stock valuation and expected pressure on profitability are expected to weigh on the stock, which has surged 28 per cent in the past one year to Rs 1,151.

Pidilite offers strong volume-led growth visibility, but given the near-term margin pressure and rich valuation, we see limited near-term upside,” said analysts at Emkay Global. 

Currently, Pidilite is trading at 46 times its FY20 estimated earnings, which is very close to Asian Paints — the closest comparable player in consumer space and leader in paints market. 

Prices of key inputs — vinyl acetate monomer (VAM) and other crude oil derivatives including packaging materials — are at elevated levels, which resulted in a 120 basis point y-o-y contraction in gross margin to 50.5 per cent, while operating profit margin declined 18 basis points to 20.8 per cent, partly helped by cost-cutting efforts in Q1. The situation is unlikely to change significantly anytime soon, say analysts. 

“We see gradually improving demand conditions, while input cost volatility and currency-led inflation remain areas of concern,” said P Ganesh, CFO of Pidilite, during the Q1 analysts’ call. 

But even if demand conditions improve, profit growth could be curbed by faster-than-expected cost pressures.
Analysts, however, say price hikes could help support Pidilite’s profitability. 

“Rising VAM, packaging (prices) and the depreciating rupee is a near-term concern; however, 3-5 per cent price increase in select products will prevent any meaningful margin compression in the coming quarters,” analysts at Prabhudas Lilladher said in an update this month. 

Thus, how the company manages its operating profitability in the coming quarters is a key monitorable.

Having said that, a strong balance sheet with zero debt, robust returns on equity as well as long-term growth visibility are key positives for the company. 

A significant correction could offer an entry point for long-term investors.

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