Finvert – Page 5

February 7, 2019July 25, 2019 finvert Equity Research & Valuation

WHY ASIAN PAINTS?

A Company Analysis Report

Asian Paints Ltd., the leader of the Paint & Varnish industry trading at CMP 1400 (as on 07/02/2019) has been one of the most attractive script for the investors. Despite being trading at a Price-to-Earnings Ratio of 69.45 (whereas industry’s P/E is 44.72), the investors and broking houses are bullish about the performance of the market leader of the Paint & Varnish Industry. Having seen the performances and investors’ action against the traditional market policies over the past few years makes Asian Paints an interesting case to analyse.

ABOUT THE COMPANY

Asian Paints Ltd. is one of the most prestigious company which has been present in the market for over 75 years and having a group revenue of over USD 2.5 billion p.a. Built on the principles of providing a distinct service of paint solutions and kitchen & bath segment through constant innovation & diversification. The company works towards providing exceptional spectrum of Inspiration-Customisation-Execution service to its customer base. The company is the largest supplier in the market having nearly a significant 55% of the market cap of the country due to its conscious effort of building customer relations over the years.

PAINT INDUSTRY ANALYSIS

Asian Paints has been able to capture more than half of the market over the years. The direct competitors for Asian Paints in the market are Berger Paints India Ltd, Kansai Nerolac Paints Ltd & Akzo Nobel India Ltd. However, none of the companies has achieved the scale & diversity and the market cap as Asian Paints has over the years. The whole of Paint Industry has witnessed a steady cumulative growth of 7% Y-o-Y over the course of last 5 financial years. While Asian Paints has been able to outperform the industry and has posted a significant 10% Y-o-Y growth in the similar period surpassing the global growth trend as well as Indian growth trend of 3.7% and 6.9% respectively. With the kind of economic and infrastructure growth and development the country has been witnessing over the years which has laid the platform of the scope of development and prospect of future opportunities. This has provided a positive outlook to the industry as a whole.

STRATEGIC PLANNING- PRODUCT LINE & GEOGRAPHICAL SEGREGATION

The company’s product profile is mainly made up of paints & home improvements. It majorly consists of interior & exterior paints, wood finishes range, wall coverings, SmartCare waterproofing products, bath fittings, kitchens and wardrobes. Rainwater harvesting and water conservation schemes are also an area company is looking to expand on. The company has installed capacity of 12 lac KL p.a. in a total of 9 factories across India. Asian Paints has a very diverse consumer base ranging from housing homes to automobiles to hospitals to factories to corporates across the length and breadth of the country leading to large product portfolio. Asian Paints has separate store network in town to cater to their demands, flagship multi-category décor stores as well as dealer run painting service to provide the bouquet of products and services up on offer. The company has its presence on Global level with mergers with PPG Industry Inc, USA, Berger-Asian in the South East Asian countries, as well as newly acquired tie-ups in Sri Lanka, the Caribbean nations & Africa.

FUTURE PLANS

There are two huge factories being set-up by the company in Mysuru & Visakhapatnam with a combined installed capacity of 11 lac KL p.a. This is a clear positive indication by the company about their future plans and growth prospects. In the recent financial year out of Rs. 1350 crs of CAPEX, Rs. 1100 crs was attributed to set-up of these new plants. Being the flag bearer of the industry, the company focusses on providing premium paint solution through constant innovation via new technologies, innovation & solutions and that has been seen through growth of Research & Development. Dream home concept, Colour ideas, personalised virtual home re-imagined solution on the electronic devices with technical assistance are the ways company has imagined and planned to moving ahead in the period.

FINANCIAL ANALYSIS & PROJECTION

Asian Paints, being the market leader is setting trends and benchmarks for the other companies. The company with all its expansion and diversification plans combined with the future opportunities is expected to grow at a rate of approx. 12% p.a.
The Goodwill and reputation earned by the company in the market over the years is been reflected in its ability to maintain a highly efficient working capital cycle which indicates that it has been able to negotiate the deals and form credit policies effectively leading to quick conversion of cash back into the company. This trend is expected to be continued in the upcoming years and the net cycle is expected to be near 15 days.
Despite of the expansion and diversification in the recent years and the plans for the upcoming years which has seen a large amount of capital expenditure being incurred, the Fixed Assets turnover ratio is expected to tick on the positive side marginally at 5.5 because of the company’s ability to generate the additional sale from the increased expenditure.
Asian Paints has both secured as well as unsecured loans though of nominal amount. The interest cost hence incurred is negligible which allows the company to plough back its profits either to its shareholders or back into the business and are not flown out of the business.
The company as it seems won’t be in need of additional funds either in form of equity from the shareholders or as debt from other financial institutions. At the projected rate with the current capital, Asian Paints will be able to double its current Reserves & Surplus as well.
The Operating Expenses are assumed to be constant going ahead and no major change is expected in the current levels of expenses.
The company has a huge amount of Cash reserves and surplus which can be used going ahead in the future which can be an alternative for external debt or dilution of shares when the need arises. The cash at hand consolidates the company’s strong position in the market and industry.

COST OPTIMIZATION

Asian Paints as the flag bearer of the industry and as benchmark standards have taken many steps in order to optimize cost and use of the resources. Measures such as reduction in specific electricity consumption, use of non-product fresh water consumption, water replenishment, reduction in specific hazardous waste disposal and electricity from renewable sources have been taken up by the company.

Asian Paints Ltd. has seen its share price almost doubled over the course of five years beating the benchmark average of Nifty 50. The company has seen a hike in the share price Y-o-Y in all the previous years. This has set a positive outlook for the upcoming years as well.

The company has revenue growing at Y-o-Y at a CAGR of 11%. This trend is expected to increase in the upcoming years with new opportunities in the current segment of the company with the expected revenue to grow at a much better rate which has been seen the results of first 3 quarters of FY 2018-19.

The EBITDA margins has seen a rise over the years and are expected to maintain and further continue this trend upwards till 18% which in comparison to the industries is pretty healthy. This indicates that the company is operating in a systematic manner over the years and is been able to replicate its performance despite of some uncertain events.

The company is quite comfortably able to churn the Operating Profit (EBITDA) into Shareholder’s earnings (PAT). This in turn indicates that the funds deployed by the shareholders are effectively been converted back to profits on a consistent basis which trend looks set to continue in the near future as well.

The Earning per Share of the company has increased over the period in line with the Sales of the company indicating that the rise in revenue is been reflected in the Net Profit. The company has even paid a fair share of this earning back to the shareholders in the form of dividends constantly.

Asian Paints Ltd has had the highest P/E ratio in the industry throughout the years and still has managed to grab the investor’s interest over the years due to its fragile strength and capacity to dominate the current market with the Y-o-Y return generating capacity with the security of the investor’s funds. Hence commanding a huge premium on its price.

Asian Paints has been constantly able to generate a very high Return on the Shareholders funds deployed by them. An increasing trend in this percentages shows the efficiency of this almost debt-free company which is able to return the large chunk of profits back due to presence of negligible amount of debt on their books of accounts.

CONCLUSION

The fact that the company has been highly overvalued as on date by almost 270% as per projections and still is a hot-pick amongst investors and broking houses is well justified by its financial results and future prospects. With the real estate development, road network development, The SmartCity Project, Rural development combined with the Pradhan Mantri Awas Yojana (2024), Housing for all scheme and many more upcoming projects opportunities, Asian Paints being the market leader of the industry is expected to have a potential exponential comparative growth in the upcoming years ahead. The company also has a good dividend track report and has consistently declared significant dividends for the last 5 years providing the investors with return back year-on-year combined with the capital appreciation has led to a return greater than the market return.

Author
**Dhrumil Wani**
Team Leader – Equity Research & Valuation
(M.Sc. Finance, NMIMS – Mumbai. Batch 2018-20)

Connect with Dhrumil on LinkedIn

January 19, 2019June 7, 2019 finvert Fixed Income

Empirical Study of Credit Rating versus Credit Spread

Government bonds are subject only to interest rate risk. However, corporate bonds are subject to credit risk in addition to interest rate risk. Credit risk subsumes the risk of default as well asthe risk of an adverse rating change. In this empirical study, we analyze credit rating migration versus yield spread of the bond in US corporate bond market to bring about greater understanding of its credit risk.

DATA

The data for this study consists of ratings of the corporate bonds of US corporate bond market given by S&P Global Ratings and credit spread mentioned under description of the security on the Bloomberg Terminal.The sample consist of 15 corporate bonds issuer companies which have defaulted.

LIMITATION OF THE DATA

Small sample size (Representative Bias)- The sample size for the study is limited to 15 instances of corporate bond default and hence the conclusion cannot be generalized.

METHODOLOGY

One data set focused on the latest available spread of the defaulted US Corporate Bonds. Second data set focused on the before and after credit rating of those defaulted bonds. Both data sets were studied in comparison to figure out which set of data was more predictive of default.

RATINGS AND ITS DESCRIPTION

Following rating grades by Standard & Poor’s are used for analysis:

CREDIT RATING v/s CREDIT SPREAD FOR US DEFAULTED CORPORATE BONDS

Following table shows the changes in credit rating and latest credit spread of sampled 15 corporate bonds which defaulted for either of the reasons mentioned as under:

Missed interest or principal payments: 33% of the sample
Debt/distressed exchanges: 20% of the sample
Chapter 11 and Chapter 15 filings–along with foreign bankruptcies—together: 40% of the sample
Unknown: 7% of the sample

OBSERVATION

The sampled data set reveals that:

All defaulted corporate bonds have the credit spread of 400 bps or more
The ratings of 75% of the bonds were changed to D (Default) on the day or within few days after its default
All the Ratings lie in the ‘Speculative Grade’ defined by S&P Ratings
Following table summarises the data of credit spread (in bps) and credit ratings of the respective sampled bonds. From blue to red bands, the credit rating decreases. Therefore, red signifies that even though the bond rating was relatively better, the bond defaulted

CREDIT RATING v/s CREDIT SPREAD FOR CURRENTLY TRADED U.S. CORPORATE BONDS

From the observation of historical defaulted bonds, it can be said that bonds with wider credit spread are most likely to default. Using these findings for currently traded U.S. corporate bonds mentioned in the above table, it can be concluded that Mohegan Gaming and Acosta Inc. may default. (As on 3/29/2018)

**Author:**
Durga Jadhav
(M.Sc. Finance, NMIMS-Mumbai
Batch 2017-19)

Connect with Durga on LinkedIn

**Co-Author:**
Gauri Gotaphode
(M.Sc. Finance, NMIMS-Mumbai
Batch 2017-19)

Connect with Gauri on LinkedIn

January 19, 2019June 4, 2019 finvert Wealth Management

Should I Invest In Mutual Funds or ETF’s?

It’s an age long debate as to which is considered to be better in terms of an Investment Avenue. While both happen to be reasonably good options, due to its inherent nature, a lot of times ETF’s and Mutual Funds can be used interchangeably. In reality however, it is important that these asset classes have their own nuances that make them inherently different. In our innaugral post at Finvert, we will break down how these two securities are different and what are the things an investor should consider whilst investing in any one of the two.

What are ETF’s (Exchange Traded Funds)?

As the name suggests, an ETF tracks a particular index and allows the investor to buy the entire index as it were a stock. An ETF is therefore listed on an exchange and requires a Demat account for buying and selling of the fund. This lead to the name, ‘Exchange traded fund’. Due to this, ETF returns do not significantly vary from the overall market performance. ETF’s makes an ideal investment opportunity for Investors looking to beat inflation and expecting standard market performance based on historical data. The main attraction of an ETF is an overall lower turnover and expense ratio. These factors have contributed to high popularity enjoyed by ETF’s in the U.S. but not so much in India. The size of ETF’s in India seems poultry when compared to the AUM (Asset Under Management) of the countless mutual funds on offer in the market right now.

What are Mutual Funds?

Mutual Funds are a collection of a pool of money from different investors creating a fund which is actively/passively managed by a fund manager whose primary aim is to beat the returns offered by the stock market. Mutual funds can invest in various securities including stocks, commodities or bonds. A fund manager routinely changes the asset composition multiple times in a year so as to get the desired returns. This means higher turnover and hence, high expense ratio. Price is calculated daily at the end of the day based on fund performance. The entire money invested is then converted into units and sold for money.

Mutual funds have burgeoned in terms of popularity in India due to the fantastic returns offered by the same in the past few years. Here we have taken some of the high performing ETF’s and Mutual funds of well-known fund houses and analysed the fund on various factors which include its returns, the expense ratio, percentage of stocks that are overlapping, etc. For a more like-to-like comparison, an ETF and a large-cap mutual fund is selected from the same fund house. Likewise, five ETF’s and five mutual funds are selected for the purpose. The returns calculated are rolling returns and also states the expected amount return when 10,000 are invested in the said scheme.

Comparing a year’s return between securities is too short a term to perform a comparison. A three or a five year term is enough time to perform a comparison. Looking at the table, the most important distinction between the two is expense ratio. Where mutual funds generally charge anywhere around 1.75-2.5%, ETF’s get away with 0.05-0.15% as commission charged due to its passive nature. Add to that the turnover ratio (number of times stocks are bought and sold) of a mutual fund is high which also increases the overall expenses of the mutual fund. Things become interesting when tax comes to picture. Essentially, mutual funds are taxed yearly whereas capital gain tax on ETF’s can only be taxed when they are sold.

Overlapping of stocks in the security portfolio is another interesting thing between an ETF and a mutual fund. For eg., ICICI Prudential Nifty ETF and ICICI Bluechip fund direct growth have 74% of the stocks in their kitty that are similar. So ideally the returns for the same should match to a certain extent and that is very much the case for a 3 year period. But the mutual fund at 15.77% still manages to outperform ETF at 12.91% in the long term five year period. Another

The most important purpose of any investment is the returns generated and this is where mutual funds outperform ETF’s most of the time. The return is high but when factors such as expense ratio, stock turnover and tax come to picture, both the securities seem to offer similar returns. In some cases, ETF’s actually outperform mutual funds which question the whole idea of alpha generation in mutual funds in the first place.

While all this may look like a good picture for ETF’s, the reality is that ETF’s fail miserably in one important factor for any investor viz. which is liquidity. While mutual funds have grown to be very popular in India, ETF’s are very new and minuscule in comparison. So whilst the buying aspect may not be a problem, selling an ETF might be. So the investor needs to be cautious of this fact beforehand. But this being the stock market, no word is absolute and so both the options are to be considered by the investor while looking for an asset class to invest in.

This is not to be considered financial advice in any manner. Do your research before investing in any of the mentioned assets. Our work is limited to educating our readers regarding the same.