Sharp dip in input cost to aid Pidilite Industries' margin recovery

While prospects remains healthy, upsides are limited post recent run up

Pidilite Industries has been a major outperformer in the consumer basket, gaining 30 per cent over the last three months, as compared to the 13 per cent gains for the BSE Fast Moving Consumer Goods, its peer index. It is the second-highest gainer in the large cap FMCG space, with only Varun Beverages ahead of it, with a gain of 46 per cent.

The gains, for the dominant market leader in the adhesive space, with brands like Fevicol, Dr Fixit, Fevikwik, M-Seal, came on the back of falling raw material costs, market share gains, growth from expansion in new categories and improved distribution reach.

Earnings upgrades by brokerages on expectation of margin expansion in the second half of the 2022-23 financial year (H2FY23) is the key trigger for the stock. The prices of key raw material for the company, vinyl acetate monomer (VAM) at $1,632 per tonne, is down 26 per cent month-on-month, according to Kotak Institutional Equities. This is the highest decline across commodities in the agriculture, oil commodities or chemical sectors.

The company’s gross margins were down 741 basis points year-on-year (YoY) and 181 basis points on a sequential basis to 41.7 per cent in the June quarter (Q1FY23). VAM prices in Q1 had risen by 39 per cent YoY to $2,230 per tonne.  Despite the pressure on the gross margin front, the impact at the operating level was contained. Operating profit margins fell by only 87 basis points YoY to 17.1 per cent due to operating leverage and the 223-431 basis points fall in employee expenses and other costs. On a sequential basis, margins improved 110 basis points due to a favourable mix.

Though raw material costs have come off, margins in the September quarter are expected to be similar to Q1 levels, given that the firm has high cost inventory. The company has guided for a March quarter (Q4FY23) exit margin of 22-24 per cent for its consumer and bazaar segment which caters to the business to consumer (B2C) requirements. This segment accounted for about 79 per cent of consolidated revenues in Q1FY23.

While margin movement will be a key trigger, the Street will also track the demand trajectory. The consumer business reported a 64 per cent increase in revenues while the industrial products segment gained 50 per cent YoY in Q1 with broad based growth across product categories. Volume growth in the consumer and industrial business were 49 per cent and 29 per cent, respectively, with demand in urban markets stronger than rural areas. While the housing demand continues to remain strong, the progress on the monsoon front would be critical for the recovery in rural market.

Long-term prospects, according to analysts led by Amnish Aggarwal of Prabhudas Lilladher Research, are intact, given aggressive innovation across categories, emerging areas like tiles/grout adhesives, market leadership in underpenetrated waterproofing segment and expansion in rural distribution.

While brokerages are positive, the recent rally in the stock has led to ‘hold’ and ‘downgrade’ ratings. At the current price, the stock is trading at 60-75 times FY24 earnings estimates. Investors could look at the stock on dips.