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Eastern Silk: All in the margins! - Views on News from Equitymaster
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Eastern Silk: All in the margins!
Jan 9, 2007

Performance summary
Eastern Silk Industries, the second largest exporter of silk garments and fabrics from the country, reported numbers for the third quarter and nine months ended December 2006. During both the periods under review, backward and forward integration, new capacities, better realisations and a change in product mix have helped the company improve its operating as well as net profit margins by nearly 400 basis points each. More importantly, lower pressure on input costs, lower tax incidence and insulation from foreign exchange risks have helped the company tide over the enhanced interest costs. A jump in other income has also aided the net profit margins for both the periods.

(Rs m) 3QFY06 3QFY07 Change 9mFY06 9mFY07 Change
Net sales 1,189 1,251 5.3% 3,075 3,547 15.3%
Expenditure 990 989 -0.1% 2,543 2,839 11.6%
Operating profit (EBIDTA) 199 263 31.8% 532 708 33.1%
EBIDTA margin (%) 16.8% 21.0%   17.3% 20.0%  
Other income 3 35 1196.3% 24 69 193.2%
Interest 44 56 25.2% 118 144 22.1%
Depreciation 25 26 5.3% 73 78 5.9%
Profit before tax 133 216 62.7% 364 555 52.4%
Tax 24 31 29.2% 38 66 76.0%
Profit after tax/(loss) 109 185 70.1% 327 489 49.7%
Net profit margin (%) 9.1% 14.8%   10.6% 13.8%  
No. of shares (m) 7.2 15.8   7.2 15.8  
Diluted earnings per share (Rs) 60.8 46.8   60.5 41.3  
Price to earnings ratio (x)         8.0  

Company background
Eastern Silk Industries, established in 1946, is one of the leading exporters of silk fabrics from India and enjoys nearly 30% share of the organised silk market. It is present across the entire value chain from yarn to basic and design fabrics to embroidered fabrics to made-ups. It caters to the specialised requirements of fashion labels (for garments and accessories) and furnishing companies. The company garners 70% of its revenues from exports, of which consumption in the US and Europe account for about two-third of its export despatches. The company has realigned its portfolio mix in favour of larger volume furnishing fabrics (80% of revenues in 9mFY07) as compared to small volume fashion apparel fabrics. It has also embarked on various initiatives such as capacity expansion, forward integration, inorganic growth and greater market reach so as to align its margins with that of the market leader (Himatsingka Seide).

What has driven performance in 9mFY07?
Margins reflect ‘value’: Strategic initiatives such as capacity expansion, forward integration and greater market reach have been filtering in to Eastern Silk’s margins over the past couple of quarters. The company has witnessed a 200 to 400 basis points margin expansion at the operating and net levels in each of the quarters of FY07. The company is expanding its fabric capacity and also setting up facility for made-ups. The sales contribution from made-ups is expected to increase from 9% in FY06 to 20% in FY08. The company has scaled up the value chain over the years and is currently operating in various segments such as handloom fabrics (realisation of US$ 5 per metre), powerloom fabrics (US$ 8 per metre), embroidered fabrics (US$ 12 per metre) and made-ups (US$ 21 per metre). The goal is to increase average realisation from the current US$ 10 per metre to US$ 18 per metre by FY08. This volume-value chain play will significantly increase the profitability of the company.

Although Eastern Silk is primarily concentrating on enhancing its realisations, being the second largest players in the Indian silk export market, the company is well poised to multiply its margins if the projected silk export targets are achieved. To put things in perspective, Indian silk exports are expected to grow from US$ 750 m in 1HFY07 to US$ 1.5 bn by FY11 (compounded annual growth of 17%). Players like Eastern Silk have the capability to deliver customised as well as variable volumes, thus leveraging on the volume growth.

Stagnant operating costs: Manufacturing capacities for silk products are being shifted from Europe to destinations such as China and India. China is the largest producer (72% of world silk production) of silk fabrics in the world, primarily focused on mass production. India is the second largest producer (17%), providing scope for an accelerated growth for the industry. India is the only country producing all varieties of silk. It stands to gain due to lower cost of production, skilled manpower, absorption of world-class technology and increasing acceptance of its value added products.

Although the fact that China remains Eastern Silk’s largest raw material source (nearly 80%), the fact that the company has entered into an associated joint venture in China wherein the latter is obligated to supply about 120 MT per annum to the company, is a comforting factor. As there is very little pressure on Eastern Silk’s input costs, the company’s operating costs in 3QFY07 have shown negligible change over that of 3QFY06.

Capex benefits yet to filter in: Eastern Silk is expanding fabric capacity and also setting up facility for made-ups (1,500 pieces a day), which will use almost the entire expanded fabric capacity. This will get commissioned in 1QFY08 and the benefits of the same will filter into margins.

Diversified customer base: The company has a wide distribution reach and longstanding relationship with over 225 international clients (over 35 clients having a business relationship across three decades). More than 75% of sales are from customers who have been with the company for over 5 years. The US and Europe contribute about 38% and 27% respectively of its target market and the balance goes to Australia, New Zealand and Middle East.

Oversupply concerns: Although, unlike cotton, apparels and home textiles, silk garments and made-ups producers in India face very little competition from the other low cost producing nations like Pakistan, Bangladesh and Turkey, the excess supply of the silk fabric from China may pressurise realisations for the value added products as well. Eastern Silk garners 70% of its revenues from exports, of which consumption in the US and Europe account for about two-thirds of its export despatches. With the signs of slowdown in the US and European economies, the risk of lower demand from these markets going forward looms large. An oversupply to these markets may also impact the company’s realisations.

What to expect?
At the current price of Rs 330, the stock is trading at an attractive valuation of 7.0 times our estimated FY08 earnings. Higher capacity in fabrics and made-ups, better realisations and enhanced product mix position Eastern Silk very favourably to compete against its peers like Himatsingka Seide that are witnessing margin suppression and lower incremental growth. It is also exploring inorganic growth opportunities including brand acquisition to enhance direct presence in US and Europe. Having said that, since some of the benefits of improved product mix and lower input costs have already filtered in, the margin expansion hereon may get moderated. Also, as mentioned earlier, an economic slowdown in the major markets and the resultant pressure on realisations cannot be ignored.

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