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Grasim: Another disappointing quarter - Views on News from Equitymaster
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Grasim: Another disappointing quarter
Jan 25, 2006

Performance Summary
Grasim, the diversified major of the Aditya Birla Group, reported poor numbers for the second consecutive quarter. For 3QFY06, the company has reported a 6% YoY fall in consolidated bottomline despite a 7% YoY rise in net revenues. Pressure on margins has been the primary reason for the company faltering on its performance during the quarter. However, despite the poor performance for two consecutive quarters now, the nine-month performance reveals a bottomline growth of 10% YoY.

Consolidated financial snapshot…
(Rs m) 3QFY05 3QFY06 Change 9mFY05 9mFY06 Change
Net Sales 23,386 25,032 7.0% 68,401 72,989 6.7%
Expenditure 18,697 20,281 8.5% 53,382 58,427 9.5%
Operating Profit (EBDITA) 4,689 4,750 1.3% 15,019 14,562 -3.0%
EBITDA margin (%) 20.1% 19.0%   22.0% 20.0%  
Other income 438 296 -32.5% 1,333 1,498 12.3%
Interest 729 530 -27.3% 2,121 1,636 -22.9%
Depreciation 1,363 1,422 4.4% 4,194 4,150 -1.1%
Profit before tax 3,035 3,093 1.9% 10,036 10,274 2.4%
Tax 981 960 -2.2% 4,030 2,844 -29.4%
Profit/(Loss) before minority interest 2,054 2,134 3.9% 6,006 7,430 23.7%
Minority interest (18) 180   (305) 511  
Profit/(Loss) after tax and minority interest 2,072 1,953 -5.7% 6,312 6,918 9.6%
Net profit margin (%) 8.9% 7.8%   9.2% 9.5%  
No. of Shares (m) 91.7 91.7   91.7 91.7  
Diluted earnings per share*         99.2  
Price to earnings ratio (x)         14.3  
(* trailing 12-months earnings)            

What is the company’s business?
Grasim, an Aditya Birla Group company, has presence in various sectors. It has leadership position in four of its five businesses. The company has presence in viscose staple fiber or VSF (31% of sales in FY05), cement (44%), sponge iron (16%), chemicals (5%) and textiles (4%). While the company is a world leader in VSF with a 24% market share, it is also the seventh largest producer of cement in the world with a total capacity of 31 MT (nearly 22% of the country's capacity). It achieved the latter distinction only recently, when it acquired L&T's cement capacity for a net investment of Rs 22 bn.

What has driven performance in 3QFY06?
Cement saves the day - Again!: Grasim has reported a topline growth of 7% YoY, which could be attributed to the strong growth in the company’s cement business, which registered a 19% YoY growth for the quarter (11% growth in volumes and 7% rise in realisations). Further, unlike the previous quarter, the VSF business has contributed to the topline growth during 3QFY06. Revenues for this segment were up by 5% YoY. Despite the pressure on realisations (down 10% YoY), 18% rise in volume sales helped matters. The buoyancy in exports to South Asian countries and firm domestic demand aided improved volume sales.

However, while these two businesses contributed in a positive manner, the company’s sponge iron business tarnished the overall picture, as revenues from this business segment nearly halved as compared to 3QFY05. With the continued poor performance of this division, the share of revenues of this segment to the total revenues during 9mFY05 has come down from 11% in 3QFY05 to 7% in 3QFY06. The performance of the sponge iron business was severely hampered during the quarter due to the shortage in supply of natural gas and steep rise in input costs. This led to 50% lower production and consequently volume sales were also lower to this extent. To make matters worse, realisations were also lower by 10% YoY.

Cost break-up (% of net sales)
  3QFY05 3QFY06 9mFY05 9mFY06
Inc/Dec in stock in trade 0.4% -0.1% -1.0% -0.2%
Raw material consumed 24.0% 21.3% 23.5% 22.3%
Purchase of finished goods 0.6% 1.1% 0.6% 1.0%
Staff costs 5.2% 5.5% 5.6% 5.4%
Power & Fuel 23.0% 22.4% 22.6% 21.4%
Freight & Forwarding 11.8% 15.6% 11.6% 14.8%
Other expenditure 14.9% 15.2% 15.1% 15.4%
Total expenses 79.9% 81.0% 78.0% 80.0%

Margin pressure – don’t blame cement: Despite the growth in topline, Grasim’s operating profits grew by a meager 1% YoY, as operating margins came under pressure. These were down by 110 basis points. As can be seen in the table above, while raw materials and power and fuel costs showed an improvement as percentage of sales during the quarter, most of the other operating heads played their part in denting margins. The significant rise in freight costs could be attributed to the higher petro-product prices during the quarter.

Segmental PBIT margins…
  3QFY05 3QFY06 9mFY05 9mFY06
VSF 29.2% 20.3% 29.0% 19.6%
Cement 5.5% 13.6% 9.5% 14.1%
Sponge Iron 34.5% -3.9% 35.0% 9.0%
Chemicals 30.3% 22.2% 21.3% 28.6%
Textiles -2.7% -2.4% -0.5% 0.0%
Others 19.6% 13.1% 15.5% 15.0%
Total 14.8% 14.0% 16.8% 15.1%

Bottomline succumbs to pressure: Despite a 27% fall in interest expenses and lower tax outgo, the company reported a 6% YoY fall in profits. This could be attributed to the 33% YoY fall in other income along with Rs 180 m set aside for minority shareholders.

What to expect?
At Rs 1,416, the stock is trading at a price to earnings multiple of 14.3 times its trailing 12-month earnings and 8.4 times our consolidated FY08 estimates. However, it must be noted that the nine-month performance of the company has been below our estimates, largely owing to severe under-performance by the sponge iron division. As such, we will be revising our full year numbers downwards.

However, it must be noted that there are certain positives working in favour of the company. It has a monopoly status in VSF in the domestic market and is expanding capacity to meet the expected increase in demand post the abolition of the Multi Fibre Agreement (MFA). Also, we expect a favorable environment for the cement division on the back of better demand and pricing scenario in the medium-term. Thus, we maintain our recommendation on the stock with a medium to long-term perspective.

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