Whistleblower Allegations, Margin Pressures And Intensifying Competition Weigh Down Asian Paints

Asian Paints is one of the best performing stocks in the Indian markets. The company’s stock has compounded at a growth rate of 25 per cent of the last 10 years. In contrast, the BSE Sensex has compounded at a modest growth rate of 10 per cent over the same period. Asian Paints has built a strong brand, translating into a market share of 42 per cent in the paint segment, according to a report by ICICI securities. The positive sentiment around the stock is evident from its relatively high valuations — the stock trades at 86 times its earnings. Despite the positives, the stock might have a bumpy ride ahead.

Whistleblower Allegations

According to a Business Line report, a whistleblower has flagged some related party transactions at Asian Paints that puts minority shareholders at a disadvantage. The two letters were written to the Securities and Exchange board of India (SEBI), between May and July of the current year. The whistleblower has alleged that funds from Asian Paints were used to acquire a stake in Paladin Paints and Chemicals (PPC).

However, the stake is now owned and controlled by Ashwin Dani and his son through their personal investment vehicles. The whistleblower has alleged that Asian Paints paid Jayram Nadkarni, a former employee, for technical know-how, design and improvement over and above his regular salary. Nadkarni founded and owned PPC entirely, before Asian Paints made the payments. According to the whistleblower, the promoters received a stake in the company after the payments were made.

Nevertheless, Asian Paints has clarified on the issue. It has said that Nadkarni had been hired solely as a technical consultant in the financial year 2006 (FY06). He was paid according to the terms of the contract for a period of 21 months. It was in FY16 that the company was informed of the promoter-director’s acquisition of PPC. According to the company, all of the transactions were undertaken with the necessary approvals of the audit committee and in accordance with the law.

Inflation Troubles

Apart from external whistleblower allegations, Asian Paints is facing another roadblock — rapidly increasing raw material prices. A key raw material in paint production, crude oil, has hit multi-year highs. As a result, Asian Paints has seen its gross margins decline from 44.4 per cent in the second quarter of FY21 to 34.7 per cent in the second quarter of FY22.

“We have restrained in the quarter from taking a price increase because we felt that the environment was not good and I think the demand sentiment would kind of get affected if we kind of take anything which is price increase in this point of time, but we have definitely taken an increase now in the month of April which is there about a 2.8 per cent increase in terms of looking at addressing the price inflation,” said the company’s management during the conference call.

Nevertheless, the company expects commodity prices to tone down and margins to recover with time. Volumes too, have risen at a healthy pace, allowing the company to exploit the operational leverage inherent in the business.

Intensifying Competition

The entry of well-funded players in the space is a threat for incumbent paint companies, including Asian Paints. JSW Paints and Grasim are among the new contenders in the space looking to eat into the margins of existing companies.

Grasim has already established a strong distribution network in place with its products in the building materials space. Its subsidiary, Ultratech, is one of the largest cement manufacturers in India, giving its access to a large distribution and retail network. JSW Paints has been focusing on growing its retail segment across India, and plans to gain a 10 per cent market share by FY26.

Overall, the paint sector is poised to do better as growth in real estate and infrastructure demand picks up at a rapid pace. The real estate sector has seen an increased demand as people look for larger and better homes in the work-from-home era. With demand picking up, paint companies might be able to make up for a part of their declining earnings. Nevertheless, the road ahead might be bumpy for Asian Paints and its shareholders.