Weak rupee set to weigh on Pidilite earnings, stock price

While margin pressure and pricey valuation are near-term headwinds, volume growth remains healthy

The operational performance of Pidilite Industries in the September 2018 quarter (Q2) was almost in line with expectations with profit margin contracting amid inflationary pressure and consolidated net profit falling 9 per cent year on year to ~2.31 billion.

Yet, the stock is up 10 per cent after the results.

So, what explains this and will the uptrend continue?

One reason is that the stock had already fallen over 20 per cent from its peak level of ~1,195 in

August on worries over rising oil prices, and consequently, due to expectations of weak Q2 results.

The profitability of Pidilite is highly dependent on how crude oil moves, even as the maker of Fevicol and Dr Fixit adhesives enjoys a dominant position in the industry with market share of over 70 per cent (for Fevicol). Vinyl acetate monomer (VAM) and other monomers, for instance, account for 50 per cent of the raw material cost, and are mainly imported or linked to crude oil.

Thanks to high oil prices, VAM prices were up 23 per cent year on year in Q2, leading to a sharp 360-386 basis points yearon-year contraction in Pidilite’s gross profit and operating margins.

The second reason for the stock’s recent gain is that oil prices have receded from the peak level of $86 to around $73 levels, or about 15 per cent.

However, these inflationary pressures are unlikely to soften significantly anytime soon, thanks to the weak rupee, and hence would weigh on Pidilite’s earnings and its stock price. Even as VAM prices receded sequentially (down 9 per cent in the December quarter so far), the rupee has fallen about 5 per cent against the dollar from Q2 levels.

Although Pidilite has hiked prices by an average 3-5 per cent and cost-savings measures should help, analysts still expect its Ebitda margin to decline 130 basis point to 20.7 per cent in FY19.

The management, too, said gross margin is high and some correction is warranted, according to an Edelweiss analysts.

Among the few positives is that volume growth at 10 per cent in Q2 remains strong. This should help top line growth and add to earnings.

In this backdrop, the stock may not move up further unless oil prices and inflationary pressures ease significantly, or price hikes take care of margin loss. The stock valuation of 44 times the FY20 estimated earnings is also rich, caution analysts.